Sweeney v. The Queen, 90 DTC 6507, [1990] 2 CTC 342 (FCTD)

Denault, J.:—This is an appeal by the plaintiff, Walter G. Sweeney, from a reassessment by the Minister of National Revenue with respect to the plaintiff's 1983 tax return by which a taxable capital gain of $312,500 was added to the plaintiff's income. The sole issue for determination in this dispute is the proper calculation of the adjusted cost base of the plaintiff's right to purchase his father's shares in Lawrence Sweeney Fisheries Ltd., pursuant to an agreement of December 18, 1950.

Pursuant to subsection 26(3) of the Income Tax Application Rules, 1971, the adjusted cost base would be the middle figure of cost, fair market value as at December 31,1971, and proceeds of disposition. If two of these figures are the same, the adjusted cost base will be that figure. Both parties are in substantial agreement as to the cost and the proceeds of disposition, they disagree however as to the fair market value of the plaintiff's right as of December 31, 1971 (valuation day). The plaintiff submits that the fair market value at valuation day is in excess of the amount obtained from the proceeds of disposition, and that as a result no capital gain resulted and no tax is owing. The Minister submits that the fair market value of the plaintiff's right at valuation day was nil, and that consequently half of the entire proceeds of disposition is a taxable capital gain.

The Facts

The plaintiff returned from his studies in 1948 to enter his father's business. On December 18, 1950 Walter Lawrence Sweeney submitted to his son Gordon an agreement whereby the son could purchase the father's shares in his company, for a stipulated sum upon the father's death. The price agreed upon was $1,327.13 per share. The agreement provided that the son would contribute towards a life insurance policy for the father, the proceeds of which would be used to purchase the shares; it also provided that the price per share would be reviewable, that the father would not dispose of the shares other than pursuant to the agreement and that if a bona fide offer by a third party was considered then the son would have a right of first refusal. The agreement provided furthermore that it could be revoked by either party upon 60 days' notice.

On December 31, 1971, the father was 67 years old, in good health and active in the business. At that time he owned 79 of the 100 shares issued by the company. Twenty shares had been given over the past eight years to his three other children without the plaintiff's knowledge, and contrary to the agreement. Moreover the father's will, which was drawn up in 1965, provided that his trustees should continue his interests in Lawrence Sweeney Fisheries Ltd., and then wind up the company. The plaintiff had no knowledge of the existence of this will. The fair market value of the father’s remaining shares on valuation day was $1,200,000.

When the father died on January 20, 1983, he had been ill for merely a week prior to his death. Shortly before his death he had assured his son of the continued validity of their agreement. After his father's death the son obtained the proceeds of the life insurance policy, and tendered to purchase the father's 79 shares in the company for $104,843 ($1,327.13 x 79). The tenders were returned by his brother and sisters, and he launched an action before the Supreme Court of Nova Scotia for specific performance of his right of purchase. After three days of hearing the case was settled out of court and the plaintiff was paid $625,000 in “lieu of damages". It is agreed by the parties that this amount represents the proceeds of disposition of the plaintiff's right. No portion of that capital receipt was included in the plaintiff's 1983 tax return.

Plaintiffs Argument

The plaintiff has put forward four distinct arguments in support of his position. The principal argument advanced by the plaintiff is that in determining the fair market value of the plaintiff's right at valuation day the agreement setting forth his rights should be evaluated as though it contained no revocation clause. It is on this basis that the plaintiff's expert estimated the valuation day fair market value of the plaintiff's right to be between $821,000 to $876,000.

The plaintiff sought to establish that from the mid-1960s up until and including valuation day, the father no longer considered the 1950 agreement to be valid. In support of this contention it was pointed out that from 1957 until 1978, the plaintiff was not involved in the functioning of the company and that when he left in 1957 he stopped paying the yearly premiums on the life insurance policy as stipulated in the contract. Except for a few occasions his father took over that responsibility. Moreover in making gifts of his shares to his other son and to his daughters in the mid-1960s the father breached clause 5 of the agreement, and his will of 1965 also seems to indicate his belief that the agreement was no longer of value. Finally two memos written by the father, one in April 1967, and one in January 1970, indicate that he was then of the opinion that the agreement was no longer valid.

The Crown objected to the filing of both these memos and of two other letters, as they were unsigned. However the plaintiff established that the memos had been drafted in reply to letters from Walter P. Wakefield, the father’s solicitor. It appears from handwritten comments on the memos, from the father's peculiar drafting style, and from the uncontradicted evidence that he constantly wrote memos to himself, that Walter Lawrence Sweeney was the author of these documents and that they should be accepted and filed in Court as such. They therefore also contribute to the submission that the father considered the agreement to be void at the time of valuation day.

However in spite of his belief that the agreement was null and void, it was never revoked or even altered in any way by the parties. In fact the father never even indicated to his son that he privately believed the agreement to be invalid. The father and son worked very closely and enjoyed good relations, even during the time the son moved away to Yarmouth to look after another family business. In 1978 the son returned to help his father in the running of Lawrence Sweeney Fisheries Ltd. In late 1982 the plaintiff was told by an intimate friend of his brother's that he was in for a big surprise when his father died. This prompted the plaintiff to ask his father whether the 1950 agreement was still valid and his father replied: “Certainly!” A few days before Christmas, and just four weeks before his death the father handed the original agreement over to his son and told him: "Keep this in a safe place.”

In essence the plaintiff is submitting that, while the father may have later confirmed the validity of the 1950 agreement, at the material time, December 31, 1971, it is submitted that the father considered the agreement to be void. As the father thought the agreement was void, there was virtually no likelihood that the revocation clause would have been invoked at that time. The plaintiff submits that given that fact, it is appropriate to read the agreement as if the revocation clause did not exist. The plaintiff relied on the case of Goodwin Johnson (1960) Ltd. v. The Queen, [1983] C.T.C. 389; 83 D.T.C. 5417 (F.C.T.D.) for the proposition that the Court should look beyond the specific words of a contract to its surrounding circumstances, to determine the contract's effect, and that it was indeed permissible to find that no termination clause did exist even in a case where it was expressly stipulated in the contract.

Three alternative arguments were also presented by the plaintiff. The first alternative argument starts from the assumption that the termination clause ceased to have effect at least 59 days prior to the father's death, since by its own terms it required a 60-day notice period. Thus from 59 days before his death onward any revocation by the father would have been invalid. On that basis it is submitted that from the beginning of that 59-day period the value of the plaintiff's rights increased considerably by virtue of the fact that the agreement could no longer be revoked. The plaintiff's expert presented uncontested evidence that the value of the 1950 agreement, 59 days prior to the father's death, was close to the value of the shares themselves, that is it was worth between $8,200,000 and $8,700,000.

The plaintiff submitted that the agreement allowed the father to pass on one of the family businesses to his eldest son. It remained in effect, unaltered, for 33 years. The plaintiff had suggested to his father over the years that the agreement be reviewed but the father declined. The father confirmed the validity of the agreement just months prior to his death. The plaintiff submits that all these events, perfected by the father's forbearance from terminating the agreement when he was legally able to do so, constitute a "transaction" within the meaning of subsection 245(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), in which case the fair market value of the right, according to paragraph 69(1)(c) of the Act, is to be determined not at valuation day but at the time the transaction was completed, namely 59 days prior to death.

Counsel for the plaintiff stressed that the words "other transactions of any kind whatever" have been given a very broad interpretation by the Court, and one that should include the circumstances of this case (M.N.R. v. Granite Bay Timber Co., [1958] Ex. C.R. 179; Dufresne v. M.N.R., [1967] 2 Ex. C.R. 128; [1967] C.T.C. 153; and Boardman et al. v. The Queen, [1986] 1 C.T.C. 103; 85 D.T.C. 5628.) If the offer of the right to buy the shares can be viewed as a transaction perfected at the time the agreement became irrevocable, then the fair market value, assessed as of that time would be over $8,000,000, a figure well in excess of the proceeds of disposition and the plaintiff would have no capital gain to declare.

The second alternative argument is that at the time the plaintiff's father delivered to him the agreement with instructions to keep it in a safe place, he was in effect making a gift to the plaintiff of the sizeable increase in value of the agreement due to the fact that the agreement had been handed over to the son for his safe-keeping with the intimation that no changes or revocation would follow. It was submitted that this benefit constituted either a "transaction" within the meaning of subsection 245(2) or a "gift" which again, according to paragraph 69(1)(c) of the Act, would cause the fair market value to be calculated at the time of death when the right to purchase was at its most valuable which would again result in no capital gain for the plaintiff.

The final alternative argument is that a “gift” or “inheritance” occurred within the meaning of paragraph 69(1)(c), at the time of the father's death due to the certainty that no revocation or changes would be made, and that the agreement remained in force. The plaintiff cited the American case Armstrong's Estate v. C.I.R., 146 Fed. R. 2nd 457, for the proposition that such words ought to be interpreted in a broad manner, so that substance may rule over form. In that case it was held that benefits which were derived from a contract entered into during the taxpayer's lifetime, were in substance benefits in the nature of legacies, and should be recognized as such.

Defendant's Argument

The defence consisted entirely of a rebuttal of the plaintiff's arguments. As for the first argument the defendant's expert maintained that a mathematical approach, estimating the impact of each individual limitation on the plaintiff's right at valuation day, was inappropriate. He claimed that the fair market value of the plaintiff's right to purchase the shares upon his father's death had to be determined, as any other property, from the perspective of a third party in a bona fide offer. In light of the numerous limitations on the plaintiff's right of purchase the Crown's expert claimed that the fair market value of the right was nil. Among the limits mentioned by the expert in his opinion were; (1) the fact that the father could raise the purchase price at any time and if it were not accepted by the plaintiff or a third party purchaser, the father could terminate the agreement; (2) the fact that should a bona fide offer from a third party be made the plaintiff, or any other notional purchaser, would only have 30 days under the agreement to exercise his right of first refusal —not by paying the stated price in the agreement, but by matching the bona fide offer; (3) the father could revoke the agreement for any reason with 60 days' notice; and (4) there was nothing to prevent the father from decreasing the value of the company, either through mismanagement or otherwise. The expert insisted first on the termination clause on a 60-day notice being the most negative one, and second on the possibility by the father to change the purchase price.

The Crown also submitted that the fact that the father thought the agreement to be invalid actually strengthened its submission that the right to purchase had no value at valuation day since the informed, prudent party making a bona fide offer would have sought to have the father confirm the agreement's continued existence. All these factors, along with the likelihood of litigation concerning the legal validity of the right, would have, in the Crown expert's opinion, rendered the right without value.

As for the plaintiff's alternative arguments the Crown responded that no “transaction” within the meaning of subsection 245(2) can be deemed to occur if no benefit accrues to the taxpayer. In this case the Crown submitted that no benefit occurred; the plaintiff merely offered to purchase shares for less than their market value, but his offer was refused. The Crown submitted that the plaintiff's father had not directly or indirectly disposed of any shares or even of a right to purchase shares, and that as no property was transferred there can be no deemed disposition, by way of gift or otherwise.

Finally the Crown submitted that the father's will belies any intention to impart any benefit on the plaintiff by way of gift or inheritance, and that the agreement itself demonstrates that there was a contract, based on mutual consideration, which also belies the suggestion of a gift having been made.

For these reasons the Crown concluded that the cost of the agreement was nil, that the fair market value at valuation day was nil, and that the adjusted cost base pursuant to subsection 26(3) of the Income Tax Application Rules, 1971 was therefore also nil.

Decision

I cannot accept the plaintiff's main submission that the 1950 agreement should be appraised at valuation day, as though it did not contain a termination clause. In Goodwin Johnson (1960) Ltd., supra, the case relied on by the plaintiff for this submission, the defendant therein had submitted that the timber sales contract between the parties could not be transferred or assigned from the plaintiff to anyone else. Those submissions however were not based on the terms of the contract itself, but merely on statements in correspondence from the provincial Forestry Service. However, the Court found, as a matter of fact, that the contract could have been assigned by way of a power of attorney, to any other reputable operator. There is also some indication in the decision that this matter was not strenuously contested. I see therefore little relevance between that case and the present one. Here the termination clause is part and parcel of the agreement itself. Even if the Court were to accept the plaintiff's allegation of an erroneous belief by the father that the agreement was invalid, that is certainly no grounds for reading the agreement as if it contained no termination clause. The clause merely remains there unused, if only for the very good reason that the father may have preferred to construe the agreement to be valid at a later date, as the mood suited him, and as he later asserted.

I rather agree with the Crown's expert that in view of the numerous limitations in the agreement, the fair market value of the plaintiff's right had to be determined from the perspective of a third party in a bona fide offer and that these limitations rendered the right without value.

I now turn to the plaintiff's first alternative argument that since the termination clause had ceased to have effect at least 59 days prior to the father's death, at that point in time the father, even though he was not aware of his upcoming death, conferred a benefit on the plaintiff. It was further argued that numerous events including the father's confirmation of the validity of the agreement a few months prior to his death, perfected by his forbearance from terminating it when he was legally able to do so, constitute a transaction within the meaning of subsection 245(2) of the Act.

I do not share that view. First it is a requisite for the application of subsection 245(2) that there be in fact a benefit to the taxpayer (Boardman et al. v. The Queen, supra). In this case, the Court cannot accept that on November 23, 1982, 59 days prior to the father's death and without the benefit of hindsight, the failure by the father to revoke the 1950 agreement had the effect of conferring a benefit to the plaintiff. On that date, there was no "transaction", the word being used in the widest possible sense, as meaning "any act having operative effect in relation to a business or property" (Dufresne v. M.N.R., supra).

As to the second alternative argument by the plaintiff that he received a gift from his father when he was told to keep the agreement in a safe place, I see no merit in that argument. From the father's previous actions in regard to the 1950 agreement, it cannot be reasonably implied, as counsel suggested, that by delivering to his son his copy of the agreement the father was indicating that he would not amend or terminate it. The father did not transfer anything to his son, and at the very most, he was then confirming the 1950 agreement, thereby indicating that his son could eventually acquire his remaining shares in the company, under the same terms and conditions.

The final alternative argument is that a “gift” or "inheritance" occurred within the meaning of paragraph 69(1)(c) at the time of the father's death since no revocation or changes could then be made.

Paragraph 69(1 )(c) states that:

where a taxpayer has acquired property by way of gift, bequest or inheritance, he shall be deemed to have acquired the property at its fair market value at the time he so acquired it.

Unfortunately for the plaintiff, I fail to see how a right to purchase shares, acquired by contract under seal and for mutual consideration can be interpreted as a gift. The essence of a gift is the intentional, voluntary and gratu- itous transfer of property. In the instance, there was no element of gratuitousness in the 1950 agreement and the will of the plaintiff's father stipulating and authorizing treatment of the shares inconsistent with the agreement belies any intention on his part to confer a gift on the plaintiff upon death.

For these reasons, the appeal is dismissed with costs.

Appeal dismissed.