Digests

Canada v. Kruco Inc.

A-577-01

2003 FCA 284, Noël J.A.

26/6/03

16 pp.

Appeal from Tax Court decision (Kruco Inc. v. The Queen, 2001 DTC 668) allowing taxpayer's appeal from 1989 assessment on basis adjustments totalling $23,518,455 with respect to investment tax credits of Kruger Inc. and subsidiary and attributable to shares of Kruger's capital stock held by respondent not authorized by Income Tax Act (ITA), s. 55(2) --Issue turning on notion of safe income as arising from s. 55(2)--Safe income designating amount up to which tax-free intercorporate dividends may be paid without triggering capital gain pursuant to s. 55(2)--Generally speaking reflecting corporation's "income earned or realized" after 1971, subject to certain refinements--Prior to August 1989, respondent minority shareholder of Kruger, private corporation, holding 3,627,100 common shares (32.493 percent) and 100 preferred shares of its capital stock--Dispute between respondent, Kruger's senior management led to settlement whereby Kruger purchased all common, preferred shares held by respondent for $99,000,000 and $100 respectively, thereby giving rise to dividend under Act pursuant to s. 84(3)--In 1989 taxation year, respondent took position that dividend of $73,000,000 had been paid out of safe income and reported capital gain of $17,027,105 pursuant to s. 55(2)--Minister made negative adjustments to respondent's safe income on ground reduced amount on which capital cost allowance could be claimed gave rise to phantom income (income recognized in computation of income under Act, Division B of Part I although not supported by corresponding cash inflow)--First negative adjustment of $66,024,068 resulted from change, 32.493% or $21,453,200 of which was attributed to shares held by respondent--Second adjustment resulted from application of ITA, s. 12(1)(t), which requires direct inclusion in income of investment tax credits where s. 13(17.1)(e), (21)(vii) do not apply--Minister of view that inclusion not supported by corresponding cash inflow, thereby giving rise to "phantom income"--Out of adjustment of $6,355,999 resulting from change, $2,065,255 attributed to shares of respondent--Tax avoidance officer relied on text of presentation by John R. Robertson of Revenue Canada at annual conference of Canadian Tax Foundation in 1981 (Robertson rules)--Officer acknowledged that first adjustment not strictly speaking function of phantom income, but consequence of denial of deduction of expense actually incurred by reason of ITA, s. 13(7.1), (21)(vii)--Officer explained that rationale behind adjustment nevertheless analogous to that applicable to phantom income--Tax Court Judge (T.C.J.) found words "income earned or realized" in s. 55(2) must be taken to mean income for tax purposes-- Pursuant to ITA, s. 55(2), (5)(c), T.C.J. found adjustments to safe income at computation of income stage limited to those provided in s. 20(1)(gg) or s. 37.1; if Parliament had intended there to be other adjustments, would have so provided--T.C.J. expressly rejected Minister's argument that negative adjustments could be made for phantom income, i.e. income resulting from investment tax credits claimed by taxpayer-- Here, T.C.J. found adjustments made by Minister affected computation of income, thereby acting directly contrary to wording of s. 55(5)(c)--Also found adjustments led to double taxation--Appeal dismissed--T.C.J. came to correct conclu-sion, for correct reasons--Goal in enacting ITA, s. 55(2) to ensure capital gain inherent in shares of corporation attributable to unrealized appreciation since 1971 in value of underlying assets of corporation not avoided by use of intercorporate tax-free dividends--At same time, Parliament did not want to impede tax-free flow of dividends attributable to income already taxed--In making apportionment in ITA, s. 55(2), (5)(f), "income earned or realized" "deemed" to be income otherwise computed (under ITA), subject only to two exceptions mentioned in s. 55(5)(c) (in case of private corporation)--Not open to Minister to modify amount which Parliament has deemed to be corporation's "income earned or realized" for purposes of s. 55(2)--Assumption underlying s. 55(2) requires that credit be given to full amount deemed by Parliament to be private corporation's income "earned or realized" in computation of safe income--Once this is accepted, T.C.J.'s conclusion that adjustments proposed by Minister would result in taxing amounts already taxed as income becomes self-evident--Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 12(1)(t), 13(7.1), (21)(vii), 55(2)(c), (f), (5), 84(3).