Durocher v. R. - TCC: Option not a nullity - corporation not a CCPC - no capital gains exemption

Durocher v. R. - TCC:  Option not a nullity - corporation not a CCPC - no capital gains exemption

http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/127320/index.do

Durocher v. The Queen  (December 9, 2015 – 2015 TCC 297, Rip J.).

Précis:  The appellants disposed of the shares of Gestion RJCG Inc. ("RJCG") in 2006 and claimed a capital gains exemption in respect of the disposition.  CRA denied the exemption on the basis that RJCG was not a "qualified small business corporation shares" as defined by subsection 110.6(1) of the Income Tax Act (the “Act”).  CRA concluded that RJCG was controlled by Aviva Canada Inc. ("Aviva"), a public corporation, by virtue of an option agreement throughout the 24 month period preceding the disposition.  Thus it was not a Canadian-controlled private corporation (“CCPC) and, as a result, not a qualified small business corporation.

The appellants had two arguments.  In the first place they argued that under Quebec law the option was a nullity.  In the alternative they argued that the option only applied to the shares of another corporation in the chain of RJCG ownership of an underlying operating company, Dale Parizeau, and therefore did not disqualify the RJCG shares themselves.  The Tax Court rejected both arguments and dismissed the appeals with costs.

Decision:   This decision has a highly intricate factual background:

[1]             The principal issue in all appeals is whether the appellants may claim a capital gains deduction in 2006 in accordance with subsection 110.6(2) of the Income Tax Act ("Act"). To decide the issue I must determine whether at all relevant times the shares of Gestion RJCG Inc. ("RJCG") were "qualified small business corporation shares" as defined by subsection 110.6(1).

[2]             A question to be answered is whether throughout the 24 months immediately preceding the disposition of the shares of RJCG by its shareholders, another person had a right under a contract, either immediately or in the future, absolutely or contingently, to acquire the shares of RJCG and therefore "be deemed to have the same position in relation to control of the corporation as if the person owned the shares at that time": subsection 125(7) and paragraph 251(5)(b) of the Act.

[3]             In assessing the appellants, the Minister of National Revenue ("Minister") assumed, among other things, that Aviva Canada Inc. ("Aviva") held an option to acquire the shares of RJCG notwithstanding a unanimous shareholders agreement (“Shareholders Agreement”), signed in 2002, provides for an option to Aviva to acquire shares of Gestion Lagarde Massicotte Inc. (“Gestion Lagarde”). The Crown argued that as of December 20, 2005, Aviva had the right to acquire the shares of RJCG and at that date, RJCG ceased to be a Canadian controlled private corporation: subsection 125(7).

[4]             The appellants are Claudine Lagarde, Vincent Lagarde, Geneviève Lagarde, Élise Lagarde, Line Durocher, Francis S. Labonté, Nathalie Monette, Marisol Ringuet, Olivier Ringuet, Catherine Sansoucy, Xavier Vallerand, Loik Vallerand, Aïsha Blondeau, Marie‑Pier Blondeau, G. Marius Bérubé and Francine Bussières (“nine individuals”).

[5]             All the appellants realized a taxable capital gain following the 2006 disposition. They then claimed a capital gain deduction.

[6]             The appellants Nathalie Monette, Francine Bussières, Élise Lagarde, Claudine Lagarde, G. Marius Bérubé, Marie‑Pier Blondeau, Vincent Lagarde and Aïsha Blondeau also claimed minimum tax carry-over deductions for the 2007 and 2008 taxation years. As for the appellants Line Durocher, Genviève Lagarde and Francis Labonté, they also claimed this deduction for the 2008 taxation year.

[7]             Three corporations, other than RJCG, have been identified in the pleadings and are relevant to the disposition of the appeals. They are:

(a)     Dale Parizeau L.M. Inc. (“Dale Parizeau” or “DPLM”), an insurance brokerage company in Quebec;

(b)     Gestion Lagarde, a company that holds all the common and preferred shares in Dale Parizeau; and

(c)    Aviva Canada Inc. (“Aviva”), formerly CGU Group Canada Ltd. ("CGU"), incorporated under the laws of Ontario, was a wholly owned subsidiary of Aviva International Holdings Limited ("Aviva International"), a non‑resident corporation. Aviva carried on a general insurance business.

[8]             RJCG held all the common shares in Gestion Lagarde, while Aviva held all the preferred shares in Gestion Lagarde.

[9]             Until April 2002, a group of nine persons living in Canada, namely Carmen Bérubé, Maurice Bussières, Sonia Blondeau, Christian Dumais, Robert Lagarde, Luc Labonté, Jean‑Pierre Ringuet, François Vallerand and Jean‑Charles Massicotte ( the “nine shareholders”), held the capital stock shares in RJCG. Each individual held 6,400 common shares in RJCG, except for Robert Lagarde and Jean‑Charles Massicotte who each held 47,603. They were also all managers at Dale Parizeau.

[10]        On April 1, 2002, each of the nine individuals sold their shares in RJCG for fair market value to a family trust residing in Canada. The appellants are the beneficiaries of these family trusts.

[11]        On April 12, 2002, Gestion Lagarde, the shareholders in Gestion Lagarde, namely RJCG and CGU (Aviva) and Gestion Lagarde as sole shareholder of Dale Parizeau and Dale Parizeau entered into a unanimous shareholders agreement ("Shareholders Agreement"). Gestion Lagarde identified itself as a "Corporation" in the agreement. The "Shares" are identified as those of Gestion Lagarde. The Shareholders Agreement defined and regulated the respective rights and obligations of the parties as shareholders of Gestion Lagarde. Gestion Lagarde, as sole shareholder of Dale Parizeau, acknowledged that the Shareholders Agreement also constituted a unanimous shareholders agreement of Dale Parizeau. The Shareholders Agreement was subject to the laws of Québec.

[12]        The parties to the Shareholders Agreement recognized that Aviva had been granted an option, with various rights ("put/call") ("option"), to subscribe to and purchase a number of Class "A" shares in the capital stock of Gestion Lagarde, which, when issued and added to the number of Class "A" shares already issued would result in the shares subject to the option representing 66.305 per cent of all issued Class "A" shares. (The Class "A" shares and Class "F" shares of the capital stock of Gestion Lagarde are referred to as "Shares".) The appellants state that this is not a matter affecting the appeals.

[13]        The April 12, 2002 Shareholders Agreement set out the following provisions:

6.         CGU OPTION

The parties recognize that CGU has been granted the option to subscribe to and purchase that number of Class "A" Shares (the "Optioned Shares") which, when issued and added to the issued and outstanding Class "A" Shares, would result in the Optioned Shares representing 66.305% of the resulting issued and outstanding Class "A" Shares (which include the Optioned Shares), for a price of one dollar ($1.00) per Share, pursuant to a restated and amended option agreement entered into between CGU and the Corporation as of April 12, 2002 (the "CGU Option"). The Shareholders shall, and shall cause their respective nominees to the board of directors of the Corporation to, give effect to the CGU Option and cause the Corporation to issue the appropriate number of Shares to CGU upon the exercise of the CGU Option.

7.         DISPOSITION OF SHARES

7.1       Put by RJCG

At any time after May 1, 2005, RJCG will be entitled to put all but not less than all its Shares to CGU (which notice may be given six months prior to May 1, 2005), and CGU will, in such event, purchase such Shares at Fair Value or cause such Shares along with all Shares held by CGU together with the CGU Option to be purchased by a third party at fair market value.

7.3       Call on RJCG Shares by CGU

CGU will be entitled to require RJCG to sell on May 1, 2005, and any May 1 thereafter, all but not less than all of its Shares to CGU upon giving six (6) months’ prior notice to RJCG, (which notice may be given six months prior to May 1, 2005), and CGU will, in such event, purchase such Shares at their Fair Value increased by an amount equal to the following:

and RJCG shall be obliged to sell such Shares at such purchase price.

7.4       Closing of Call on RJCG Shares by CGU

The sale of Shares pursuant to the call in Section 7.3 will take place at the principal office of the Corporation on the date indicated in CGU's notice, which date shall be within thirty (30) days following expiry of the six (6) months' notice period set forth in Section 7.3.

[14]        Article 18.1 of the Shareholders Agreement permitted a modification of the Agreement with the consent of all the parties but any change would not take effect until a document setting out such change or modifications is signed by all the parties. Article 18.6 provided that:

The Agreement shall be governed and construed in accordance with the laws of the Province of Quebec and the federal laws of Canada applicable therein.

[15]        In 2005 and 2006, the Shareholders Agreement was subject to several amendments and attempts to amend.

[16]        By letter dated September 16, 2005, from Aviva to RJCG, Gestion Lagarde and Dale Parizeau, the parties agreed to free Aviva of its obligation in the Shareholders Agreement to give six months' notice to exercise the option on May 1, 2006 (Article 7.3) and agreed that from thereon Aviva could give notice until February 1, 2006. In consideration of the change, Aviva agreed to pay Gestion Lagarde $400,000.

[17]        Soon after the corporations agreed to the terms of the letter of September 16, 2005, the nine individual shareholders of RJCG added their signatures to the letter agreeing to its terms. I note that earlier in the year by agreement dated April 1, 2005, the nine shareholders had transferred their shares in RJCG to family trusts. A directors' resolution of RJCG approving the transfers and the actual share transfer is dated April 1. Aviva executed its acceptance of the terms of the letter on October 13, 2005.

[18]        Both the Shareholders Agreement and letter of September 16, 2005, were signed on behalf of Aviva by Ross Betteridge who, at the time, was Chief Financial Officer of Aviva, and another officer of Aviva. At trial, Mr. Betteridge stated that Aviva wanted to purchase the shares of Gestion Lagarde so as to prevent any competitor acquiring Dale Parizeau. In his letter of September 16, Mr. Betteridge advised that Aviva would be in a position to give formal notice whether it would acquire RJCG no later than February 1, 2006.

[19]        Another letter, dated October , 2005 (sic) was addressed to Aviva but apparently drafted by Aviva and sent by email to Ms. Sonia Blondeau, Vice President – Finance and Chief Information Officer of Dale Parizeau. This letter clarified that Aviva would pay RJCG $400,000 in consideration for amending the Shareholders Agreement on September 16. The nine individuals and the corporations all signed the letter agreeing to its contents. Aviva accepted the terms of the letter on October 27, 2005.

[20]        The next amendments are in a letter dated December 20, 2005, again originating with Aviva; one in the form of a letter, the other in the form of amendments to the Shareholders Agreement and attached as a Schedule to the letter entitled "Amendments to the Unanimous Shareholders Agreement made on September 20th, 2005". Section 7.3 of the Shareholders Agreement was further amended, among other things, so that Aviva was not required to give six months prior notice to purchase the Shares of Gestion Lagarde but instead may give prior notice to RJCG at any time from the date of the letter until and including March 3, 2006.

[21]        In the letter of December 20, Aviva also agreed, at page 2:

a)         that in the event it provides notice to RJCG requiring it to sell to Aviva its shares, as outlined above, Aviva agrees to purchase the shares held directly by the individual shareholders of RJCG;

[22]        A recital to the Schedule to the letter of December 20 stated that "for fiscal purposes the individual shareholders of RJCG wish to transfer their shares of the capital stock of RJCG to family trusts" and the parties have agreed to such transfers. I note that the RJCG shares had already been transferred to the trusts. The Schedule also provided that all provisions of the Shareholders Agreement that apply to individual shareholders of RJCG also apply to the family trusts of each individual.

[23]        The letter of December 20 was signed by each of the corporations, RJCG, Gestion Lagarde and Dale Parizeau and the nine individuals. Whether the individuals signed as shareholders, trustees or otherwise is not apparent from the letter. The Schedule itself was signed only by the four corporations.

[24]        It is this letter of December 20, 2005, and the Schedule that the respondent argues granted Aviva the option to acquire the shares of RJCG.

[25]        By letter dated March 29, 2006, the parties agreed to again amend the notice provision in Section 7.3 of the Shareholders Agreement, among other provisions. The contents of the letter were agreed to by three corporations and nine individuals. Again, from the face of their signatures, the capacity of the nine individuals was not identified. Ms. Blondeau stated the nine shareholders signed as officers and executives of the corporations.

[26]        Aviva prepared a letter, dated April 17, 2006, addressed to itself for signature by RJCG, Gestion Lagarde, Dale Parizeau and the nine individuals.

[27]        The letter referred to the December 20, 2005, letter purporting to amend section 7.3 of the Shareholders Agreement "such that the exercise by Aviva of its call right thereunder would result in the acquisition of the shares held by each of the individual shareholders of RJCG in RJCG instead of the acquisition of the [shares] of Gestion Lagarde". Ms. Blondeau did not agree that the Shareholders Agreement was so amended. She was also unaware at the time that Aviva planned to assign its option to 1695711 Ontario Inc. ("Newco"). She did say three corporations and nine individuals refused to agree to the execution and delivery of any share purchase agreement by Aviva or Newco and each of the shareholders of RJCG. The letter was not signed by any of the corporations or individuals.

[28]        In any event on the next day, April 18, 2006, Aviva gave written notice to RJCG that it was exercising its call right under Section 7.3 of the Shareholders Agreement, as amended, to acquire the shares of RJCG. It also agreed to subscribe to 572,449 Class "A" shares of Gestion Lagarde. RJCG owned 550,000 Class "A" shares. Aviva would therefore own 51 per cent of the Class "A" of Gestion Lagarde shares and all of the shares of RJCG. Aviva would not be acquiring all of the shares of Gestion Lagarde from RJCG as originally contemplated in the Shareholders Agreement.

[29]        By agreement dated as of April 28, 2006 ("Rollover Agreement") Aviva transferred its rights under the Shareholders Agreement, as amended, to Newco in consideration of 1,000 Class "F" shares in the capital of Newco.

[30]        In another agreement, the "Holdback Agreement", also dated as of April 28, 2006, the sale of the shares of RJCG to Newco was acknowledged and agreed. According to one of the recitals to the Holdback Agreement:

WHEREAS a call notice was delivered on April 18, 2006 whereby Aviva exercised its call right under Section 7.3 of the Unanimous Shareholders Agreement (the "Call Notice") and in accordance therewith required the sale to Aviva of the shares held by each of the individual shareholders of RJCG in RJCG (the "RJCG Shares"), such sale to occur on April 28, 2006 (the "Acquisition Date"):

[31]        Each of the Vendors of the shares of RJCG consented in the Holdback Agreement to the assignment by Aviva to its "right to acquire the RJCG shares pursuant to the call notice."

[32]        Article 3.1 of the Shareholders Agreement states that:

DPLM shall be managed by a board of directors of four (4) directors, of whom two shall be nominated by CGU (the "CGU Directors of DPLM") and two shall be nominated by RJCG (the "RJCG Directors of DPLM").

Resolutions, decisions or approvals of the board of directors of DPLM shall not be effective unless consented to in writing by all of the directors of DPLM or, if considered at a meeting, where a quorum of the directors is present at the time such resolution, decision or approval is considered and such resolution, decision or approval is passed by a majority of the directors present, provided that such majority shall include the affirmative vote of the CGU Directors of DPLM and that the chairman of the board of directors of DPLM shall not have a second or casting vote.

[33]        The trustees of each family trust as well as Newco, RJCG and Dale Parizeau executed the Holdback Agreement. The obligations of each trust were guaranteed by one of the nine erstwhile shareholders who transferred his or her shares in RJCG to their respective trusts.

The appellants argued that the Aviva option was a nullity under Quebec law.  The Tax Court did not agree.  The Court rejected the argument that the option was a nullity because it violated the prohibition contained in the Act respecting financial services against acquiring more than 20 per cent of a corporation:

[50]        Whether, on the facts of the appeal, the right of Aviva to acquire more than 20 per cent of the shares of Gestion Lagarde violated the spirit and object of section 148 of the Act respecting financial services may be rather moot. Until such time as the contemplated transaction closed, it is arguable that Aviva could have carved up its rights to acquire the shares among other persons so that, at closing, it would acquire not more than 20 per cent of the target company. And, in fact, Aviva did so.

[51]        The interpretation of the words "shares [that] may be held directly or indirectly …" in section 148 of the Act respecting financial services cannot be said to be influenced by the deeming provision of subparagraph 251(5)(b)(i) of the Act. The words of section 148 speak of actual ownership, "shares … held", not influence of control of the corporation due to a right to acquire shares.

[52]        As far as section 148 of the Act respecting financial services is concerned, neither Aviva nor an assignee "held" or owned shares of Gestion Lagarde or RJCG before April 28, 2006. However, prior to April 28, 2006, Aviva, on the particular facts before me, may have been deemed by a different statute of a different jurisdiction, the Act, to be in the same position in relation to the control of Gestion Lagarde or RJCG as the shareholders of those corporations. One ought not confuse a provision in one statute with a provision in another statute of a different authority.

Similarly the Court held that the Shareholders Agreement was not a nullity under the provisions of the Civil Code:

[64]        This is the situation in the present case. Under section 184 of the Act respecting financial services, the AMF is the body responsible for the compliance with this act; it ensures the protection of the public with regard to the activities governed by the Act respecting financial services.

[65]        Additionally, I have trouble applying the sanction of absolute nullity of the contract when the legislator provided the appropriate sanction at section 485 of the Act respecting financial services:

485. Unless otherwise specifically provided, every person that contravenes a provision of this Act or the regulations is guilty of an offence and is liable to a minimum fine of $2,000 in the case of a natural person and $3,000 in other cases, double the profit realized or one fifth of the sums entrusted to or collected by the person, whichever is the greatest amount. The maximum fine is $150,000 in the case of a natural person and $200,000 in other cases, four times the profit realized or half the sums entrusted to or collected by the person, whichever is the greatest amount.

[66]        The Quebec Court of Appeal, in Elge financialease Inc. v. Dépanneur Kildare Enr. noted the importance of applying the absolute nullity sanction with restraint and diligence.

[67]        In that case, Dépanneur Kildare had signed a leasing contract with Elge for financing to use a rotisserie provided by N.A. Credit Services Inc. A few months later, Dépanneur Kildare realized that the rotisserie did not conform to the standards required under the Electrical Installations Act. It complained to the supplier, but to no avail. It therefore decided to stop making rental payments to Elge, and offered to return the rotisserie. Elge refused this offer and took action for the amount of rent owing. The Court of Quebec maintained Elge's action and ordered Dépanneur Kildare to pay the rent in arrears. On appeal from this decision, Dépanneur Kildare alleged that the lease was an absolute nullity, considering the rotisserie was non-compliant.

[68]        The Quebec Court of Appeal dismissed the appeal. Per Justice Rothman, the Court noted that the object of the contract was merely to obtain financing, which was received. Justice Rothman stated the following about the concept of absolute nullity:

In principle, of course, the object of an obligation or contract must not be something forbidden by law…and prohibitive laws import nullity…. But application of these principles has evolved over the years to meet changing needs and realities…

Not all contracts which violate a law or regulation, however indirectly or theoretically, must be considered absolutely null. The theory of public order and nullity must be applied with due regard to the nature of the law and the violation as well as the nature of the contract.

[69]        It is on this basis that I find that the Shareholders Agreement, and in particular Section 7.3 of the Agreement, is not absolutely null and is a "bona fide" agreement.

[Footnotes omitted]

Finally the Court rejected the argument that the interposition of Gestion Lagarde between RJCG and the operating company, Dale Parizeau, meant that there was no option to acquire the shares of RJCG:

[81]        The definition of "qualified small business corporation share", therefore, appears to disqualify the shares of RJCG as qualified small business corporation shares. At least throughout the 24 months immediately preceding the disposition of the shares on April 28, 2006 not more than 50 percent of the fair market value of RJCG's assets were attributable to assets used principally in an active business carried on primarily in Canada by RJCG or a corporation related to it.

[82]        Also, throughout the same 24 months period the shares of Gestion Lagarde owned by RJCG were not shares of a Canadian-controlled private corporation more than 50 percent of the fair market value of the assets of which was attributable to assets used principally in an active business carried out primarily in Canada by Gestion Lagarde or a corporation related or connected to it. In my view it does not matter whether or not Aviva obtained an option to purchase the shares of RJCG in December 2005, as alleged by the respondent. During the period of 24 months preceding April 28, 2006, RJCG's shares were not qualified small business corporation shares.

[83]        The appellants complain that the sales of the RJCG shares took place in April 2006, nine years ago, and it is therefore impossible to prove or contradict the value of RJCG's assets at the time. Not so. Surely financial statements are available. But nevertheless Ms. Blondeau has testified that the sole assets of RJCG were shares of Gestion Lagarde; RJCG was a holding company not carrying on a business. There was no evidence that any corporation that owned RJCG or any holding company met the threshold requirements in paragraphs 110.6(1)(c) and 110.6(1)(d). Paragraph 110.6(14)(e) does not affect the “interposition of a holding company between themselves and the small business corporation.”  There are no financial statements in evidence to verify whether the threshold requirements were met at each subsidiary level. However, the threshold requirement is a moot point since the option on Gestion Lagarde’s shares, even if never exercised, tainted the definition of “qualifying small business corporation” in section 110.6(1) since the operating company was no longer under Canadian control as required by paragraph 251(5)(b).

[84]        Therefore, the appeals will be dismissed. The appellants did not dispose of any qualified small business corporation shares in 2006 and are not eligible to claim a capital gain deduction. It would also follow that appellants Nathalie Monette, Francine Bussières, Élise Lagarde, Claudine Lagarde, G. Marius Bérubé, Marie‑Pier Blondeau, Vincent Lagarde and Aïsha Blondeau are not eligible to claim a minimum tax carry-over for the 2007 and 2008 taxation years, and for Line Durocher, Geneviève Lagarde and Francis Labonté, for the 2008 taxation year also.

Thus the appeals were dismissed with costs.