Judgments

[1997] 1 F.C. 79

A-14-94

Her Majesty the Queen (Appellant)

v.

Melville Neuman (Respondent)

Indexed as: Canada v. Neuman (C.A.)

Court of Appeal, Isaac C.J., Stone and McDonald JJ.A.—Winnipeg, December 14, 1995; Ottawa, August 23, 1996.

Income tax — Income calculation — Dividends — Appeal from trial judgment, affirming Tax Court’s decision allowing taxpayer’s appeal from reassessment under Income Tax Act, s. 56(2) including corporate dividend paid to wife in respondent’s income — S. 56(2) providing payment or transfer of property, made with concurrence of taxpayer, to some other person for benefit of taxpayer shall be included in taxpayer’s income — Taxpayer incorporating company to split income with wife — Taxpayer, wife officers of company — While sole director, wife declaring dividend on her shares — Taxpayer ratifying declaration — Wife neither contributing to company nor assuming risks — Immediately thereafter loaning taxpayer amount of dividend — Evidence establishing wife acted with taxpayer’s concurrence in declaring dividend — Concurrence inferred from circumstances, including degree of control taxpayer entitled to exercise over corporation conferring benefit — Four elements laid down in Fraser Companies Ltd. v. The Queen required for invocation of s. 56(2) satisfied — Minister not required to prove taxpayer’s wife not subject to tax on dividend — Taxpayer, wife not dealing at arm’s length — S. 56(2) applied.

Judges and Courts — Supreme Court of Canada in McClurg v. Canada holding Income Tax Act, s. 56(2) not applicable to declaration of dividends including those declared pursuant to discretionary power, but Dickson C.J. adding s. 56(2) may apply to exercise of discretionary power to distribute dividends when non-arm’s length shareholder making no contribution to company — Applicability of s. 56(2) to non-arm’s length transactions live issue, although unnecessary for disposition of that appeal as wife making legitimate contribution to company — That opinion, representing considered opinion of majority of S.C.C., binding on courts below.

This was an appeal from the trial judgment, which had affirmed the Tax Court’s decision allowing an appeal from a reassessment whereby the amount of a dividend paid to the respondent’s wife had been included in his income pursuant to Income Tax Act, subsection 56(2). Subsection 56(2) provides that a payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

The respondent incorporated Melru Ventures Inc. in order to split income from another company with his wife. He sold his common shares in that other company to Melru for an equal number of Class “G” shares of Melru. The respondent was appointed President and his wife was appointed Secretary. He held the only common voting share. The respondent was elected director until the first annual meeting when Mrs. Neuman was elected sole director of Melru. Both continued as officers of the company. Mrs. Neuman held Class “F” shares. On September 8, 1982, at a meeting chaired by the respondent as President, a resolution was unanimously passed to declare a taxable dividend of $5,000 on the Class “G” shares and $14,800 on the Class “F” shares. The respondent, as an officer, ratified the declaration of dividends. On the same day, Mrs. Neuman loaned her husband $14,800 on the security of a promissory note. She died in 1988. No demand was ever made on the note and no interest was ever paid on the loan. The Trial Judge found that Mrs. Neuman neither contributed to Melru, nor assumed any risks for the company. The amount of the dividends was arbitrarily chosen.

In McClurg v. Canada, the Supreme Court of Canada held that, as a general principle, subsection 56(2) does not apply to the declaration of dividends, including those declared pursuant to a discretionary power. But Dickson C.J. went on to state that subsection 56(2) may apply to the exercise of a discretionary power to distribute dividends when the non-arm’s length shareholder has made no contribution to the company. The Tax Court concluded that the facts of this case did not fall within subsection 56(2). The Trial Judge held that no distinction was to be drawn between an arm’s length and a non-arm’s length transaction, and that subsection 56(2) was not designed to prevent the type of income splitting engaged in by the respondent. He declined to decide the case on the issue of whether Mrs. Neuman acted with her husband’s concurrence.

The issues were: (1) whether Mrs. Neuman was acting pursuant to the direction of, or with the concurrence of, the respondent when she declared the dividend of $14,800 from Melru to herself; (2) whether the dictum of Dickson C.J. in McClurg was binding upon the courts below; (3) whether subsection 56(2) permitted the Minister to include in the income of the respondent for the 1982 taxation year, the dividend of $14,800 which Mrs. Neuman received from Melru.

Held, the appeal should be allowed.

(1) The Trial Judge failed to consider all of the evidence and as a result he erred in law. There was sufficient evidence to establish the respondent’s concurrence with Mrs. Neuman’s declaration of the $14,800 dividend to herself, and that Mrs. Neuman had acted with that concurrence when she declared the dividend.

The concurrence or participation of the taxpayer in the conferring of the benefit need not be active. It may well be passive or implicit and can be inferred from all the circumstances, including the degree of control which the taxpayer is entitled to exercise over the corporation conferring the benefit.

The appellant had satisfied the four elements set out in Fraser Companies Ltd. v. The Queen as being required for the invocation of subsection 56(2). (i) There was a payment or transfer of property to a person other than the taxpayer. Payment of a dividend is a transfer of property. (ii) The evidence as a whole established on a balance of probabilities that the dividend of $14,800 was declared to Mrs. Neuman with the concurrence of the respondent. Subsection 56(2) requires proof that the transfer of property be either at the direction of or with the concurrence of the taxpayer, not both. (iii) The respondent benefitted from splitting the income with his wife by reducing the income tax that he would otherwise have paid. He also enjoyed the use of the full amount of the dividend by borrowing that amount from his wife. That loan was never repaid. (iv) By the operation of paragraph 12(1)(j) and subsection 82(1), the dividend which Mrs. Neuman received would have been included in the respondent’s income for the 1982 taxation year had it not been paid to her.

The application of subsection 56(2) herein would not be contrary to the commercial reality of the declaration of the dividend to Mrs. Neuman, since there was none. The payment to her of the dividend was not the product of a bona fide business relationship.

Neither the cases nor subsection 56(2), read in the context of the Act as a whole, mandate the imposition of a requirement that the Minister prove that the respondent’s wife was not subject to tax on the dividend she received.

(2) The respondent and his wife were not dealing with each other at arm’s length. Since they were the only shareholders of Melru, they were not dealing with that corporation at arm’s length. Confronted by these facts, the Courts below were bound to consider Dickson C.J.’s statement in McClurg. The issue of the applicability of subsection 56(2) to non-arm’s length transactions was a live one in McClurg. Although not necessary for the disposition of that appeal since Mrs. McClurg had made a real contribution to the company, the opinion expressed by Dickson C.J. represented the considered opinion of a majority of the Court and was therefore binding on the courts below and on this Court. Subsection 56(2) was applicable to the transaction.

(3) The Minister was correct in including the dividend which Ruby Neuman received from Melru in the respondent’s income for the 1982 taxation year.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

Corporations Act (The), S.M. 1976, c. 40.

Federal Court Rules, C.R.C., c. 663, R. 324.

Income Tax Act, S.C. 1970-71-72, c. 63, ss. 12(1), 56(2),(3),(4), 82(1) (as am. by S.C. 1977-78, c. 1, s. 36), 178(2) (as am. by S.C. 1976-77, c. 4, s. 64; 1980-81-82-83, c. 158, s. 58; 1984, c. 45, s. 75), 251.

CASES JUDICIALLY CONSIDERED

APPLIED:

Fraser Companies Ltd. v. The Queen, [1981] CTC 61; (1981), 81 DTC 5051 (F.C.T.D.); Champ (W) v. The Queen, [1983] CTC 1; (1982), 83 DTC 5029 (F.C.T.D.).

CONSIDERED:

McClurg v. Canada, [1990] 3 S.C.R. 1020; (1990), 76 D.L.R. (4th) 217; [1991] 2 W.W.R. 244; 50 B.L.R. 161; [1991] 1 C.T.C. 169; 91 DTC 5001; 119 N.R. 101; Winter v. Canada, [1991] 1 F.C. 585 [1991] 1 C.T.C. 113; (1990), 90 DTC 6681; 127 N.R. 69 (C.A.); McClurg (J.A.) v. The Queen, [1986] 1 C.T.C. 355; (1986), 86 DTC 6128; 2 F.T.R. 1 (F.C.T.D.); Canada v. McClurg, [1988] 2 F.C. 356 [1988] 1 C.T.C. 75; (1988), 88 DTC 6047; 84 N.R. 214 (C.A.); Smith (D.N.) v. The Queen, [1986] 1 C.T.C. 418; (1986), 86 DTC 6196; 2 F.T.R. 137 (F.C.T.D.).

REFERRED TO:

Smith (D.N.) v. M.N.R., [1993] 2 C.T.C. 257; (1993), 93 DTC 5351; 156 N.R. 225 (F.C.A.); Canadian Aero Service Ltd. v. O’Malley, [1974] S.C.R. 592; (1973), 40 D.L.R. (3d) 371; 11 C.P.R. (2d) 206; Murphy (GA) v. The Queen, [1980] CTC 386; (1980), 80 DTC 6314 (F.C.T.D.); Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; (1984), 10 D.L.R. (4th) 1; [1984] CTC 294; 84 DTC 6305; 53 N.R. 241; Sellars v. The Queen, [1980] 1 S.C.R. 527; (1980), 110 D.L.R. (3d) 629; 52 C.C.C. (2d) 345; 20 C.R. (3d) 381; 32 N.R. 70.

AUTHORS CITED

Krishna, Vern and J. Anthony VanDuzer. “Corporate Share Capital Structures and Income Splitting: McClurg v. Canada” (1993), 21 Can. Bus. L.J. 335.

McDonnell, T. E. “Income Splitting: McClurg Obiter Dicta Not Applied” (1992), 40 Can. Tax J. 1143.

Welling, B. L. Corporate Law in Canada: The Governing Principles, 2nd ed. Toronto: Butterworths, 1991.

APPEAL from the trial judgment, affirming the Tax Court’s decision (M.N.R. v. Neuman, [1994] 2 F.C. 154 [1994] 1 C.T.C. 354; (1993), 94 DTC 6094; 72 F.T.R. 17 (T.D.); Neuman (M.) v. M.N.R., [1992] 2 C.T.C. 2074; (1992), 92 DTC 1652 (T.C.C.)) allowing an appeal from a reassessment whereby, pursuant to Income Tax Act, subsection 56(2), the Minister had included in taxpayer’s income the amount of a corporate dividend paid to his wife in a non-arm’s length situation. Appeal allowed.

COUNSEL:

Robert W. McMechan for appellant.

Joe E. Hershfield, Ralph D. Neuman and Brian D. Sexton for respondent.

SOLICITORS:

Deputy Attorney General of Canada for appellant.

Taylor, McCaffrey, Winnipeg, for respondent.

The following are the reasons for judgment rendered in English by

The Court: This is an appeal from a decision of the Trial Division, [1994] 2 F.C. 154 affirming a decision of the Tax Court (reported [1992] 2 C.T.C. 2074) which had allowed the respondent’s appeal from the reassessment of his income for the taxation year 1982 in the circumstances mentioned below.

The appeal raises the issue whether a dividend in the amount of $14,800, received by the respondent’s spouse on non-voting Class “F” shares in a corporation, was properly attributed to the respondent as income, on the basis that the amount of the dividend was a payment or transfer of property made pursuant to the direction of, or with the concurrence of the respondent within the contemplation of subsection 56(2) of the Income Tax Act [S.C. 1970-71-72, c. 63] (the Act).

The appeal also requires us to consider the following statement by the Chief Justice of Canada in his majority reasons in McClurg v. Canada, [1990] 3 S.C.R. 1020, at page 1054:

In my opinion, if a distinction is to be drawn in the application of s. 56(2) between arm’s length and non-arm’s length transactions, it should be made between the exercise of a discretionary power to distribute dividends when the non-arm’s length shareholder has made no contribution to the company (in which case s. 56(2) may be applicable), and those cases in which a legitimate contribution has been made. [Emphasis added.]

The Facts

The respondent was at all relevant times a lawyer practising with the firm of Newman, MacLean in Winnipeg, Manitoba. He and some other members of the firm each owned 1,285.714 common shares in Newmac Services (1973) Ltd. (Newmac). Newmac owned some commercial property in downtown Winnipeg, including the property occupied by Newman, MacLean. Newmac also managed that property under contract with Newman, MacLean.

On 29 April 1981, the respondent incorporated Melru Ventures Inc. (Melru) and was its sole shareholder and director. Melru was established as a tax planning vehicle with specific purposes: to split any income received from Newmac with his wife Ruby Neuman and to freeze the respondent’s equity in Newmac in order that any increase in that equity would accrue to his wife.

The authorized capital of Melru was divided as follows:[1]

5,000 common voting shares,

5,000 common non-voting shares,

10,000 Class “A” shares,

30,000 Class “B” shares,

25,000 Class “C” shares,

25,000 Class “D” shares,

300,000 Class “E” shares,

5,000 Class “F” shares, and

1,286 Class “G” shares,

all without par value, provided that the shares shall not be issued for a consideration exceeding in amount or value in the aggregate the sum of $40,000.00.

The Articles of Incorporation of Melru[2] contain the following rights, privileges, restrictions and conditions attaching to Class “F” and Class “G” shares:

(a) the holders of Class “G” shares shall in each year, in the discretion of the directors, be entitled out of any or all profits or surplus available for dividends to non-cumulative dividends at such rate as may from time to time be declared on any such shares but not exceeding the equivalent of 1% per annum on “redemption price” above the maximum prime bank rates, charged by the bankers for the time being of the Corporation for the year in question.

…

(c) in the event of the liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the holders of Class “G” shares shall be entitled to receive before any distribution on any part of the assets of the Corporation among the holders of any other class of shares an amount equal to the redemption price for each Class “G” share and any dividends declared thereon and unpaid and no more;

(d) in the event of the liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the holders of the preference shares shall be entitled to receive, before any distribution on any part of the assets of the Corporation among the holders of Class “F” shares and common shares an amount equal to the sum of $1.00 per share and any dividends declared thereon and unpaid and no more;

(e) all dividends paid or declared and set aside for payment in any fiscal year, after making payments on Class “G” shares and preference shares of dividends declared shall be paid firstly on Class “F” shares until dividends aggregating 1ȼ per share on the Class “F” shares then outstanding have been paid and then any additional dividends shall be set aside for payment on common shares until the common shares then outstanding shall have received 1 ȼ per share and any additional dividends shall be paid on Class “F” shares until they receive that fraction of profits properly available for payment of dividends as the number of Class “F” shares then outstanding bear to the total number of Class “F” shares and common shares then outstanding and the balance shall in the discretion of the directors be paid on common shares or set aside for future payment on common shares at the discretion of the board of directors. Any monies set aside for future payment on common shares as provided in this clause (e) shall no longer be considered in computing future profits properly available for payment of dividends insofar as Class “F” shares are concerned; provided however that no dividends shall be paid on Class “F” shares or common shares so as to reduce the value of the Class “G” shares below their redemption price.

(f) subject to the prior rights of Class “G” shares and preference shares, on the dissolution of the Corporation, the Class “F” shares shall be entitled to receive an amount equal to the sum of $1.00 per share and all declared dividends which have not been paid thereon in priority to any payment on the common shares and after the holders of common shares shall have received a similar amount per share and all dividends declared thereon and unpaid and all monies set aside for payment of dividends on common shares, the holders of Class “F” shares and the holders of common shares shall participate in equal amount per share without preference or priority;

(g) the Corporation may redeem the whole or any part of the Class “F” shares on payment for each share to be redeemed of what would have been available for that class if the Corporation were then dissolved divided by the number of Class “F” shares then outstanding; provided however that no dividends shall be paid on Class “F” shares so as to reduce the value of the Class “G” shares below their redemption price.

(h) the Corporation shall have the right at its option at any time and from time to time to purchase the Class “G” shares pursuant to tenders received for a sum not exceeding the redemption price and dividends declared thereon and unpaid;

…

(j) subject to the provisions of The Corporations Act, any holder of Class “G” shares may require that the Corporation redeem all or any part of his shares upon payment for each share to be redeemed of the redemption price together with dividends declared thereon and unpaid;

…

(l) except as set out in paragraph (v) and subject to The Corporations Act, the holders of common non-voting shares, Class “D” shares, Class “E” shares and Class “F” shares shall not, as such, have any voting rights for the election of directors or for any other purpose nor shall they be entitled to notice of or to attend shareholders’ meetings. Common voting shares, Class “A” shares, Class “B” shares and Class “G” shares shall, subject to paragraphs (m) and (n), entitle their holders to one vote for each of such shares so held. Class “C” shares shall, subject to paragraph (o), entitle their holders to four votes for each share so held.

(m) except as set out in paragraph (m) [sic] and subject to The Corporations Act immediately on the happening of any one or more of the following namely:

(i) on the death of any holder of Class “G” shares;

(ii) on the transfer of any Class “G” shares (whether legally or equitably);

then the entire class of Class “G” shares shall forthwith lose all voting rights and thereafter no shares of such class shall entitle the holder thereof to vote at the election of directors or for any other purposes nor shall they entitle the holders to notice of or to attend shareholders’ meetings; [Emphasis added.]

On 29 April 1981, the respondent agreed with Melru to sell his common shares in Newmac in exchange for 1,285.714 Class “G” shares of Melru. Subsequent to this acquisition, Melru carried those shares on its balance sheet as an asset, having a value of $120,000.

On 1 May 1981, at 10:00 a.m. a meeting of the first director was held at which the respondent was appointed President, his wife, Ruby was appointed Secretary and one common voting share of Melru was issued to the respondent for $1.[3]

At a special general meeting of shareholders held on the same day at 10:15 a.m. the respondent resigned as first director of Melru and was elected a director of that corporation until the first annual meeting of the corporation or until his successor was elected. Ruby Neuman, his wife, acted as secretary of the meeting.

On the same day at a meeting of the Board of Directors held at 10:30 a.m., the respondent, as chairman of the meeting reported that his wife, had subscribed for 99 Class “F” shares in Melru and a resolution was passed authorizing the issue of such shares to Ruby Neuman at a price of $1 per share.[4]

The minutes of the annual meeting of shareholders of Melru held on 12 August 1982 at 10:15 a.m. read in part as follows:[5]

PRESENT:

Melville Neuman

Ruby Neuman

being all the shareholders of the Corporation …

The Chairman then stated that it was in order to proceed with the election of the directors and asked for nominations. The following was nominated:

Ruby Neuman

Ruby Neuman was duly elected a director of Melru to hold office until her successor was elected or appointed.

Curiously, the minutes of the meeting of the Board of Directors held on the same day at 10:30 a.m., contains the following resolution:[6]

On motion duly made, seconded and unanimously carried, the following persons were elected or appointed as officers of the Corporation to hold the office referred to opposite their respective names for the ensuing year or until their successors are elected or appointed:

President: Melville Neuman

Secretary: Ruby Neuman

                                                                                                     [Emphasis added.]

As the minutes of the meeting of the Board of Directors held on 8 September 1982 are critical to the issues in this appeal, we reproduce them in full:[7]

MINUTES of a meeting of the Board of Directors of MELRU VENTURES INC. held at the offices of the Corporation on the 8th day of September, 1982, at the hour of 10:00 o’clock in the forenoon.

PRESENT:

Ruby Neuman

being the sole director of the Corporation.

ALSO PRESENT:

Melville Neuman

The President took the Chair and the Secretary acted as Secretary of the meeting.

The sold [sic] director being present and having waived notice of the calling of the meeting, the meeting was declared to be regularly constituted.

On motion duly made, seconded and unanimously carried, it was:

“RESOLVED that a taxable dividend of $5,000.00 on the outstanding Class “G” shares in the capital stock of the Corporation be and the same is hereby declared payable forthwith and the President be and he is hereby authorized to do all things necessary for such payment.”

“RESOLVED that the said dividends on Class “G” shares be applied against any shareholders’ advances.”

The meeting discussed the payment of dividend of $14,800.00 on common shares and Class “F” shares. The meeting was further advised that the holder of common shares was prepared to have money set aside for future payment on his common shares.

On motion duly made, seconded and unanimously carried, it was:

“RESOLVED that a taxable dividend of $14,800.00 on the outstanding Class “F” shares of the Corporation be and the same is hereby declared payable forthwith to shareholders of record and any officer of the Corporation be and he or she is hereby authorized to do all things necessary for the payment of such dividends.”

The next annual meeting of the shareholders of Melru was held on 12 October 1983 at 8:15 p.m. According to the minutes of that meeting,[8] Melville Neuman acted as Chairman and Ruby Neuman as Secretary. Ruby Neuman was elected as a director. Those minutes also contain the following resolution:

On motion duly made, seconded and unanimously carried, the following resolution was passed:

“RESOLVED that all acts, contracts, by-laws, proceedings, appointments and payments passed, made, done, or taken by the directors and officers of the Corporation since the last annual meeting of the shareholders (or resolution signed in lieu thereof) as the same are set out or referred to in the minutes of the meeting of the Board of Directors or resolutions signed by the Board of Directors and the Financial Statements submitted to the shareholders for approval be and the same are hereby confirmed.”

The respondent gave the following evidence concerning the reasons for electing his wife as the sole director of Melru:[9]

Q. All right. Now, what was the purpose of your wife being elected sole director?

A. I thought it would be a good idea to have my wife as sole director so she can make all the decisions.

Q. You indicated that you were sure, as I understood your words, that she would follow your recommendations?

A. If I told her what to do, she would not. If I recommended, she might.

Q. I take it that it was an element of your decision making process that if you had your wife in place as director, you would have a superior argument should you ever be reassessed?

A. I am electing my … the argument will come shortly. It’s a rule of thumb. It was my decision to elect my wife director, and I may have thought about it. I will be quite candid about it.

Q. Well, did you think about it?

A. Probably, probably. I probably recommended to other … not necessarily in this case. I may have recommended it to other clients.

Q. But the concept was that you would be one step removed from the declaration of the dividend if it were put in the hands of your wife?

A. I decided to make her the sole director so she could exercise all statutory powers. I have recommended to other clients previously that in the similar situations that they elect their wife director. Is that candid enough?

He also testified that he explained to his wife the duties of a director, that they manage the corporation, that they have a duty to the corporation and that they make the decisions, including decisions respecting the dividends that could be paid by Melru, if dividends were to be declared.[10]

Respecting the declaration of dividends, the respondent testified at trial as follows:[11]

Q. All right. Fine. Now, under tab 19, we come to minutes of the meeting of the board of directors on the 8th of September, 1982, at 10:00 a.m., which deal with the declaration of dividends; is that correct?

A. That is correct.

Q. And it’s declared that there be a taxable dividend of $5,000.00 on class G shares which you held?

A. That is correct.

Q. And a dividend of $14,800.00 on class F shares which your wife held?

A. That is correct.

Q. Now, my question is: How, by reference to document 1, the articles of incorporation and the rights, privileges, restrictions, and conditions attached to the shares are those amounts computed?

A. There was no … it seemed at that time $5,000.00 for this, when it came in, was not unreasonable. That is equivalent to $7,500.00 by way of interest. We weren’t sure. At that time, we thought the shares were worth probably about $100,000.00. We originally elected at 120.

Q. Well, my question is: Can the $5,000.00 and the $14,800.00 be tied in any way back to the articles to show how they were computed?

A. No, it was a decision of the director.

Q. Right. Just to understand correctly, what specific considerations went into the formulation of those amounts, $5,000.00 and $14,800.00?

A. I would almost say that was a nice figure to use that day. No real thought.

Q. All right. And these were amounts that you recommended to your wife?

A. That is correct.

Q. And you are sure that she acted on your recommendation?

A. On my recommendation, but I didn’t tell her what to do. I thought $5,000.00 was a nice round figure to try out.

Q. I take it it was probably influenced by the fact that by this time Melru had received from Newmac $20,000.00 in dividends?

A. That is correct.

Q. So you declared out of that $19,800.00?

A. That is right. We kept $200.00 back for miscellaneous expenses.

Q. Was the amount of dividend declared on class F shares calculated all by reference to what the taxation impact would be taking into account the dividend tax credit?

A. You want to know—my own thought, my own recommendation was that something should be paid on that. From my knowledge of what had taken place in all roll-overs and rulings of the Department, they were not concerned about what dividends paid as long as they were fully retractable, but my own opinion was something should be paid which was more than a nominal amount, and so I thought $5,000.00 would be a reasonable amount.

On 8 September 1982, the same day on which she declared the dividend, Ruby Neuman lent to her husband the sum of $14,800, the same amount she had received as dividend, on the security of a promissory note in the following terms[12]:

                                                                                                     September 8th, 1982.

FOR VALUE RECEIVED, I promise to pay, on demand, to RUBY NEUMAN, the sum of FOURTEEN THOUSAND, EIGHT HUNDRED DOLLARS ($14,800.00). Such demand may be made in whole or in part as the payee shall deem advisable. No interest shall be payable prior to demand and thereafter at prime bank rate on the amount on which interest is so demanded.

Ruby Neuman died on 2 October 1988. It is common ground that no demand was ever made and no interest was ever paid on the loan.

The learned Trial Judge made the following findings of fact:[13]

(1) Melru was incorporated for tax planning and income splitting purposes. It had no other independent business purpose.

(2) The dividends declared by Ruby Neuman on her own Class “F” shares and the defendant’s Class “G” shares were declared pursuant to discretionary dividend provisions in the Articles of Incorporation of Melru. (The Articles of Incorporation expressly conferred a discretion on the directors as to the amount of dividends to be paid on Class “G” shares. Class “F” shares were entitled to dividends only after payment of dividends declared on Class “G” shares. Dividends on Class “F” shares were pursuant to a rather complex formula but in essence the amount available for dividends on Class “F” shares had also been left to the discretion of the directors because the dividends on Class “G” shares, which were in the discretion of the directors, had to be paid first.) The dividends of $14,800 on her Class “F” shares and $5,000 on the defendant’s Class “G” shares were arbitrary numbers having regard only to the fact that Melru had earnings by way of dividends from Newmac of $20,000 available for distribution. But the allocation of $14,800 to the Class “F” shares and $5,000 to the Class “G” shares was arbitrary.

(3) Ruby Neuman made no contribution to Melru, nor did she assume any risks for the company.

The Decisions Below

a)         The Tax Court

On 19 May 1992, the learned Tax Court Judge allowed the respondent’s appeal with costs and referred the assessment back to the appellant for reconsideration and reassessment on the basis that the dividend received by the respondent’s spouse on her Class “F” shares of Melru was not to be included in the respondent’s income for the taxation year 1982.

In reaching that conclusion the Tax Court Judge noted that in McClurg, the Supreme Court of Canada established that, as a general rule, subsection 56(2) of the Act does not apply to the declaration of dividends. However, he was required, as we are in this appeal, to deal with the appellant’s contention that the dictum of Dickson C.J., which we have earlier quoted, was binding upon him and mandated the dismissal of the respondent’s appeal. He concluded[14] that the dictum was neither the ratio decidendi nor judicial dicta by a majority of the Supreme Court of Canada and, consequently, that it was not binding upon him.

He then continued [at page 2084]:

Nonetheless the opinions expressed, while not judicial dicta, are those of the Supreme Court and cannot be simply ignored. Without deciding whether the operation of subsection 56(2) was perceived or intended by the legislators to be applicable to non-arm’s length transactions and assuming for the moment, as the appellant noted, that the majority judgment may have left it open for future consideration to pierce the corporate veil to prevent complex tax avoidance schemes, I have concluded that the facts in this case would not support such an approach nor the conclusion sought by the respondent.

b)         The Trial Division

The Trial Judge dismissed the appeal from the decision of the Tax Court on the ground that subsection 56(2) of the Act was not designed to prevent the type of income splitting engaged in by the respondent and his wife. He concluded his reasons with the following statement:[15]

… subsection 56(2) is not, in my opinion, the appropriate provision for the Minister to invoke to challenge income splitting in the context of the director-shareholder relationship and the declaration of dividends.

Earlier in his reasons, the Trial Judge commented upon the submission of counsel for the appellant that Ruby Neuman, in declaring the dividends in issue in this appeal, was acting “pursuant to the direction of, or with the concurrence of”, the respondent as those terms are used in subsection 56(2) of the Act. After reviewing some of the evidence and the relevant principles of corporation law, the Trial Judge stated:[16]

For these reasons, I would be reluctant to presume that Ruby Neuman was acting pursuant to the direction of, or with the concurrence of, the defendant [respondent] when she, as director, declared dividends on behalf of Melru. A finding that Ruby Neuman was not acting pursuant to the direction of, or with the concurrence of, the defendant would be determinative in this case. However, because this issue was not addressed in depth by counsel, I do not propose to decide the case on this issue and my comments should be considered as obiter only. Without deciding this issue therefore, I proceed with an analysis of McClurg, (supra), and its application to the case at bar.

After engaging in an extensive examination of McClurg, the Trial Judge reached the conclusion quoted at the commencement of this segment of these reasons and dismissed the appeal.

The Legislation [Subsection 82(1) as am. S.C. 1977-78, c. 1, s. 36]

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

…

(j) any amount required by subdivision h to be included in computing the taxpayer’s income for the year in respect of a dividend paid by a corporation resident in Canada on a share of its capital stock;

…

56. …

(2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

(3) For the purposes of this Part, a payment or transfer in a taxation year of property made to the taxpayer or some other person for the benefit of the taxpayer and other persons jointly or a profit made by the taxpayer and other persons jointly in a taxation year shall be deemed to have been received by the taxpayer in the year to the extent of his interest therein notwithstanding that there was no distribution or division thereof in that year.

(4) Where a taxpayer has, at any time before the end of a taxation year (whether before or after the end of 1971), transferred or assigned to a person with whom he was not dealing at arm’s length the right to an amount that would, if the right thereto had not been so transferred or assigned, be included in computing his income for the taxation year because the amount would have been received or receivable by him in or in respect of the year, the amount shall be included in computing the taxpayer’s income for the taxation year unless the income is from property and the taxpayer has also transferred or assigned the property.

…

82. (1) In computing the income of a taxpayer for a taxation year, there shall be included

(a) all amounts received by him in the year from corporations resident in Canada as, on account or in lieu of payment of, or in satisfaction of, taxable dividends,

plus

(b) where the taxpayer is an individual, other than a trust that is a registered charity, 1/2 of the aggregate of all amounts described in paragraph (a) received by him in the year from taxable Canadian corporations.

Issues

In Part II of his memorandum of fact and law, the appellant alleges that the decision of the Trial Division poses the following issues for resolution:

a)   whether Ruby Neuman was acting pursuant to the direction of, or with the concurrence of, the respondent, when she declared the dividend of $14,800.00 from Melru to herself;

b)   whether the dictum of Dickson, C.J.C. in McClurg was binding upon the courts below; and

c)   whether subsection 56(2) of the Act permitted the Minister to include in the income of the respondent for the taxation year 1982, the dividend of $14,800.00 which Ruby Neuman received from Melru.

We deal with each issue in turn.

a)         whether Ruby Neuman was acting pursuant to the direction of, or with the concurrence of, the respondent, when she declared the dividend of $14,800.00 from Melru to herself

On this issue, counsel for the appellant made several submissions. First, he said that, on the evidence, Ruby Neuman acted at the direction of the respondent in declaring the dividend from Melru to herself. In this respect he urged the findings of the Trial Judge that the respondent had incorporated Melru as a tax planning vehicle to split income from Newmac with his wife, Ruby Neuman; that one of the reasons motivating the respondent’s resignation as a director of Melru and his electing Ruby Neuman in his place was to distance himself from the decision-making in Melru, in order to provide the respondent with a superior argument, if the Minister had challenged the income splitting arrangement; and, that the respondent gave his wife expert advice and made recommendations to her concerning the declaration of dividends which he was sure she would take.

Secondly, counsel submitted that the respondent’s recommendation to Ruby Neuman that she declare the dividend to herself amounted, in the circumstances of this case, to concurrence within subsection 56(2) of the Act.

For his part, counsel for the respondent, started from the premise that a director of a corporation has the responsibility to manage the business and affairs of the corporation, including the responsibility to declare dividends. He characterized a dividend as being a distribution of corporate property which does not require the direction or concurrence of a shareholder of, or advisor to, a corporation in order to be declared or paid. For that reason, so he contended, the respondent’s direction, or concurrence was not relevant since neither could create a tax obligation under subsection 56(2) of the Act.

We are unable to accept the respondent’s contention, having regard to the uncontradicted evidence in this appeal. The minutes of the meeting of the Board of Directors dated 12 August 1982 show unequivocally that the respondent had been elected president of Melru and his wife Ruby as secretary. They thereby became officers of Melru. The next meeting of the Board was held on 8 September 1992. The minutes disclosed the following: first, that the respondent acted as Chairman and his wife as Secretary of the meeting; secondly, that as President, the respondent chaired the meeting; thirdly, that the resolution to pay the dividend of $5,000 on his Class “G” shares was passed unanimously; and, fourthly, that the meeting discussed payment of a dividend of $14,800 on common and Class “F” shares. It should be recalled that the respondent was the only holder of a common voting share in Melru; the respondent advised that he was prepared to have money set aside for the future payment of his common shares; and, that the resolution to pay a taxable dividend of $14,800 on the Class “F” shares held by Ruby Neuman was passed unanimously.

Furthermore, there was evidence before the Trial Judge that at the meeting of shareholders held on 12 October 1983, the respondent, as an officer of Melru, ratified the declaration of dividends that had been made at the meeting of the Board of Directors on 8 September 1982. For convenience, we reproduce that resolution here:

On motion duly made, seconded and unanimously carried, the following resolution was passed:

“RESOLVED that all acts, contracts, by-laws, proceedings, appointments and payments passed, made, done, or taken by the directors and officers of the Corporation since the last annual meeting of the shareholders (or resolution signed in lieu thereof) as the same are set out or referred to in the minutes of the meeting of the Board of Directors or resolutions signed by the Board of Directors and the Financial Statements submitted to the shareholders for approval be and the same are hereby confirmed.”

It is clear to us that the Trial Judge failed to consider all of this evidence in reaching his conclusion and, as a result, he erred in law.

From this examination of the evidence, we conclude that there was sufficient evidence of the respondent’s concurrence with Ruby Neuman’s declaration of the dividend of $14,800 from Melru to herself and that Ruby Neuman acted with that concurrence when she declared that dividend.

However, is the respondent’s concurrence to the declaration of the dividend to Ruby Neuman sufficient to attract the application of subsection 56(2) of the Income Tax Act? The answer to this question requires an examination of the subsection itself and of the decision in McClurg.

For convenience, we repeat the text of subsection 56(2). It reads:

56. …

(2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

In Winter v. Canada, [1991] 1 F.C. 585(C.A.), Marceau J.A. writing for a unanimous Court referred to the subsection [at page 587] as “This well-known tax-avoidance provision, which gives effect to the indirect benefits principle, has a long legislative history dating back to 1948”. He continued at page 593:

It is generally accepted that the provision of subsection 56(2) is rooted in the doctrine of “constructive receipt” and was meant to cover principally cases where a taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount paid to some other person either for his own benefit … or for the benefit of that other person …. There is no doubt, however, that the wording of the provision does not allow to [sic] its being confined to such clear cases of tax-avoidance.

As will be discussed more fully below, the majority of the Supreme Court in McClurg held as a general principle that subsection 56(2) does not apply to the declaration of dividends including those declared pursuant to discretionary power. Of particular significance for the case at bar, however, is that the majority did not foreclose the possible application of this subsection to instances where a discretionary power exists to distribute dividends to the non-arm’s length shareholder who “has made no contribution to the company”.[17]

It has been well accepted since Fraser Companies Ltd. v. The Queen, [1981] CTC 61 (F.C.T.D.), at page 71, that in order to invoke subsection 56(2) successfully, the appellant must demonstrate that the payment or transfer of property:

1. must have been made to a person other than the taxpayer;

2. must have been at the direction or with the concurrence of the taxpayer;

3. must be for the taxpayer’s own benefit or for the benefit of some other person on whom the taxpayer desired to have the benefit conferred;

4. would have been included in computing the taxpayer’s income if it had been received by the taxpayer instead of the other person.

See Smith (D.N.) v. M.N.R., [1993] 2 C.T.C. 257 (F.C.A.), at page 261 and McClurg, supra, at pages 1074-1075, per La Forest J. dissenting.

We need hardly add that in applying subsection 56(2) to the facts of a particular case, the concurrence or participation of the taxpayer in the conferring of the benefit need not be active. It may well be passive or implicit and can be inferred from all the circumstances, not the least of which is the degree of control which the taxpayer is entitled to exercise over the corporation conferring the benefit. See Smith (D.N.) v. M.N.R., supra, at page 261.

As they apply to the circumstances of this case, we are all of the view that the appellant has satisfied the four elements laid down in Fraser, supra, for the successful invocation of subsection 56(2).

First, it has been held that the payment of a dividend is a transfer of property. See, Champ (W) v. The Queen, [1983] CTC 1 (F.C.T.D.) where it was held that the declaration of dividends to a wife by a corporation in which she and her husband were the only shareholders, contrary to the provisions of the Articles of Association, was a transfer of property within the meaning of subsection 56(2) of the Act. In our respectful view, the reasoning in Champ applies with equal force to the dividend of $14,800 that was declared to Ruby Neuman in this case.

Secondly, as we have already noted, the learned Trial Judge found that Melru was incorporated for one purpose only, namely, income splitting of dividends received from Newmac. Furthermore, the minutes of the meeting of the Board of Directors of Melru, held on 8 September 1982, show clearly, in our view, that the respondent had concurred in the declaration of the dividend to his wife, Ruby Neuman, for the following reasons. As an officer of Melru, the respondent chaired the meeting at which his wife, also an officer, was present. These two officers discussed payment of a dividend on common shares, of which the respondent was the sole holder, and on Class “F” shares of which the respondent’s spouse was the holder of 99. The minutes indicate that the respondent, as holder of one common voting share in Melru, advised the meeting that he “was prepared to have money set aside for future payment of dividends on his common share”. In other words, the respondent advised his wife that he was prepared to forego his entitlement as the holder of the only issued common share in Melru in order that the corporation might declare a dividend to her in an amount that was out of all proportion with her entitlement pursuant to Article 8(e) of the Articles of Incorporation.[18] It would seem that, in doing so, the respondent was in breach of his fiduciary duty to Melru.[19] The resolution respecting the payment of the dividend of $14,800 to the respondent’s wife was passed unanimously and the minutes were signed both by the respondent and his wife, as Chairman and Secretary, respectively of the Board of Directors of Melru.

We note, from the minutes of the annual meeting of shareholders of Melru held on 12 October 1983, that the respondent and his wife, as the only shareholders of that corporation ratified the resolution of 8 September 1982 at which the dividend was declared on the Class “F” shares held by the respondent’s spouse. This evidence, arguably of marginal relevance on the issue of concurrence standing alone, does, when taken together with that which is contained in the minutes of the meeting of the Board of Directors held on 8 September 1982, negate the respondent’s testimony that his role was that of adviser only. In our view, the evidence, taken as a whole, was sufficient to prove on a balance of probabilities that the dividend of $14,800 was declared to Ruby Neuman with the concurrence of the respondent.

It should be noticed here that subsection 56(2) does not require proof that the transfer of property be both at the direction of and with the concurrence of the taxpayer. The phrase is expressed disjunctively. It follows that proof of either is sufficient. Here, as we have said, there was sufficient proof that the dividend was declared with the concurrence of the respondent.

Thirdly, the benefit that the respondent derived from splitting the income with his wife is obvious. It enabled him to reduce the incidence of income taxation by the amount of the dividend she received. But the respondent received an additional benefit. On the same day on which his wife received the dividend of $14,800, the respondent borrowed from her the entire amount and gave as security a promissory note at interest which was never paid. The respondent therefore benefitted in two ways: by splitting the dividend from Newmac in the way he did, he reduced the amount of income tax he would otherwise have paid and, furthermore, he enjoyed the use of the full amount of the dividend which his wife had received.

The final element that the appellant must satisfy is that the property transferred would have been included in computing the taxpayer’s income if it had been received by the taxpayer instead of the other person. In our view, the appellant has also satisfied this element, since, by the conjoint operation of paragraph 12(1)(j) and subsection 82(1) of the Act, the dividend which Ruby Neuman received would have been included in the respondent’s income for the 1982 taxation year, if it had not been paid to her. In reaching this conclusion, we are not unmindful of the following passages taken from the reasons of Dickson C.J. in McClurg, supra, at pages 1052-1053:

The purpose of s. 56(2) is to ensure that payments which otherwise would have been received by the taxpayer are not diverted to a third party as an anti-avoidance technique. This purpose is not frustrated because, in the corporate law context, until a dividend is declared, the profits belong to a corporation as a juridical person: Welling, supra, at pp. 609-10. Had a dividend not been declared and paid to a third party, it would not otherwise have been received by the taxpayer. Rather, the amount simply would have been retained as earnings by the company. Consequently, as a general rule, a dividend payment cannot reasonably be considered a benefit diverted from a taxpayer to a third party within the contemplation of s. 56(2) ….

However, in discussing the use of the discretionary dividend clause, I have already concluded that its validity rests, in part, on the fact that allocations made pursuant to the clause are substantively no different from allocations made pursuant to a mathematical formula in the articles of incorporation of a company. Given that determination, it would be formalistic in the extreme to reach the conclusion that but for the payment to a third party shareholder, a director-shareholder would be the recipient of a portion of the payment. Instead, my view is that an allocation pursuant to a discretionary dividend clause is no different from the payment of a dividend generally. In both cases, but for the declaration (and allocation), the dividend would remain part of the retained earnings of the company. That cannot legitimately be considered as within the parameters of the legislative intent of s. 56(2). If this Court were to find otherwise, corporate directors potentially could be found liable for the tax consequences of any declaration of dividends made to a third party. I agree with both Urie J. and Strayer J. in the courts below that this would be an unrealistic interpretation of the subsection consistent with neither its object nor its spirit. It would violate fundamental principles of corporate law and the realities of commercial practice and would “overshoot” the legislative purpose of the section.

However, unlike McClurg, the application of subsection 56(2) in the circumstances of this case would not be contrary to the commercial reality of the declaration of the dividend to Ruby Neuman, since there was none. In McClurg, the Trial Judge [McClurg (J.A.) v. The Queen, [1986] 1 C.T.C. 355] found that Wilma McClurg had made a real contribution to the establishment of the company and the business; and, in his majority reasons, the Chief Justice said that she played a vital role in the formation of the company and made a very real contribution to the company both financially and operationally. As we read his reasons, it was this contribution by Wilma McClurg which led the Chief Justice to say at page 1054:

… in my view there is no question that the [dividend] payments to Wilma McClurg represented a legitimate quid pro quo and were not simply an attempt to avoid the payment of taxes.

And later:

Furthermore, the efforts expended by Wilma McClurg in the operation of Northland Trucks, while not dispositive of the issue raised in this appeal, do provide further evidence that the dividend payment was the product of a bona fide business relationship.

By contrast, in this case, the learned Trial Judge found that Melru was incorporated for tax planning and income splitting purposes and had no other independent business purpose,[20] that the amount of dividends declared were arbitrary and that Ruby Neuman had made no contribution to Melru and did not assume any risks for the company. In light of these facts and of the other evidence to which we have referred earlier, we are of the view that the payment of the dividend of $14,800 to Ruby Neuman cannot be said to be the product of a bona fide business relationship.

Counsel for the respondent, relying on the obiter dictum of Marceau J.A., in Winter, also contended, that the successful invocation of subsection 56(2) required the appellant to satisfy a fifth element, namely, proof that the respondent’s spouse was not subject to tax on the dividend she received. Since that obiter dictum received subsequent approval in Smith, we consider it desirable to deal with it.

In Winter, the majority shareholder in an investment company caused the company to sell some of its shares to his son-in-law, himself a shareholder in the company. The Minister of National Revenue reassessed the majority shareholder, pursuant to subsection 56(2), by adding to his income an amount equal to the difference between what the son-in-law had paid for the shares and the amount by which the Minister had valued them, some $648,368. This amount, the Minister contended, was a benefit which the majority shareholder had conferred upon his son-in-law.

At pages 592-593, Marceau J.A., writing for a unanimous Court, addressed the arguments advanced by counsel for the taxpayer (majority shareholder) as follows:

2. Besides, counsel continued, Dick Winter, as a shareholder, was already subject to tax for the benefit conferred on him by the transaction pursuant to subsection 15(1). Even if it could be said that, broadly interpreted, the conditions of application of the provision as it reads were present, an assessment pursuant to it could not, in those conditions, be valid. Here is how he put the submission in his factum:

8. In the alternative, it is submitted that under the scheme of the Income Tax Act shareholder A should not be taxed pursuant to subsection 56(2) in respect of a benefit conferred on shareholder B when shareholder B can be taxed pursuant to subsection 15(1) in respect of that same benefit. There is a natural order to the provisions of the Income Tax Act, with technical rules such as subsection 15(1) at the base, specific anti-avoidance rules like subsection 56(2) one level higher, and the general anti-avoidance rule in section 245 at the apex. As a matter of assessment practice, a specific anti-avoidance rule should be resorted to only when a particular transaction is not caught by any technical rule, just as the general anti-avoidance rule should not be invoked except in the absence of a specific anti-avoidance rule.

9. In the specific context of shareholder benefits, the scheme of the Income Tax Act is made even clearer by the presence of subsection 52(1). This provision provides that a taxpayer who has had an amount in respect of the value of property he acquires added to his income shall add this same amount to his cost base for the property. Where a taxpayer is taxed under subsection 15(1) on property acquired from a corporation in which he is a shareholder, subsection 52(1) thus operates automatically so as to make the consequential modification to adjusted cost base for purposes of computing the future capital gain or capital loss. Where subsection 56(2) is invoked, by contrast, subsection 52(1) cannot operate since the taxpayer suffering taxation has not himself acquired any property. If any party to the subject transaction was to attract taxation, it should have been Mr. Winter pursuant to subsection 15(1) and not the Deceased pursuant to subsection 56(2).

I would be prepared to go along with that line of thinking. As was so often pointed out, again by both the Trial Judge and the Court of Appeal in the McClurg decision, the language of subsection 56(2) cannot be taken in its broadest possible meaning without leading to results obviously untenable, particularly in the context of corporate management. Some qualification suggested by the aim and purpose for which the rule was adopted must be read into it so as to avoid those unreasonable results.

He then continued at pages 593-594:

It is generally accepted that the provision of subsection 56(2) is rooted in the doctrine of “constructive receipt” and was meant to cover principally cases where a taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount paid to some other person either for his own benefit (for example the extinction of a liability) or for the benefit of that other person (see the reasons of Thurlow J. in Miller, supra , and of Cattanach J. in Murphy, supra). There is no doubt, however, that the wording of the provision does not allow to its being confined to such clear cases of tax-avoidance. The Bronfman judgment, which upheld the assessment, under the predecessor of subsection 56(2), of a shareholder of a closely held private company, for corporate gifts made over a number of years to family members, is usually cited as authority for the proposition that it is not a pre-condition to the application of the rule that the individual being taxed have some right or interest in the payment made or the property transferred. The precedent does not appear to me quite compelling, since gifts by a corporation come out of profits to which the shareholders have a prospective right. But the fact is that the language of the provision does not require, for its application, that the taxpayer be initially entitled to the payment or transfer of property made to the third party, only that he would have been subject to tax had the payment or transfer been made to him. It seems to me, however, that when the doctrine of “constructive receipt” is not clearly involved, because the taxpayer had no entitlement to the payment being made or the property being transferred, it is fair to infer that subsection 56(2) may receive application only if the benefit conferred is not directly taxable in the hands of the transferee. Indeed, as I see it, a tax-avoidance provision is subsidiary in nature; it exists to prevent the avoidance of a tax payable on a particular transaction, not simply to double the tax normally due nor to give the taxing authorities an administrative discretion to choose between two possible taxpayers. [Footnotes omitted.]

In the end, he rejected the appellant’s alternative argument on the basis that the son-in-law was not liable to tax and dismissed the appeal.

The appeal in Smith was from a judgment of the Trial Division [Smith (D.N.) v. The Queen, [1986] 1 C.T.C. 418] and was concerned with funds or property assumed by the Minister to have been diverted from one company to another for the benefit of the appellant or the second company. The trial judgment, decided before Winter, dealt with the issue as if the Minister was required to satisfy only the four elements laid down in Fraser. The Court concluded that the Minister had satisfied each of them.

On appeal, Mahoney J.A., speaking for a unanimous Court, differently constituted, concluded [at page 262] that Winter had “added another precondition to the application of subsection 56(2)”, which seemed to him to be relevant in the circumstances of the appeal before him. He allowed the appeal on the basis that the appellant taxpayer in that case had no entitlement to any of the payments made to or for the benefit of a company in which the appellant had an interest and which were clearly taxable in the hands of the second company.

We do not read either Winter or Smith as laying down a fifth element or pre-condition applicable in every case in which subsection 56(2) is invoked. Indeed, Marceau J.A. in his obiter dictum, acknowledged an exception when the doctrine of constructive receipt is clearly involved. Moreover, in that case, the Court had before it for consideration, its recent judgment in Canada v. McClurg [[1988] 2 F.C. 356 in which Urie J.A. for the majority acknowledged at page 362, the four ingredients laid down in Fraser and first developed by Cattanach J. in Murphy (GA) v. The Queen, [1980] C.T.C. 386 (F.C.T.D.). Marceau J.A. did not consider the decision of this Court in McClurg to be binding on him, saying at pages 591-592 that he did “not see [McClurg ] as having authority beyond the particular type of situation with which it was dealing”. Furthermore, even though McClurg was decided in the Supreme Court subsequent to the decision of this Court in Winter, the reasons in McClurg contain no reference to a fifth element or pre-condition. Indeed, La Forest J. in his dissenting reasons referred expressly to the four elements or pre-conditions laid down in Fraser. Finally, we see nothing in subsection 56(2), read in the context of the Act as a whole, which mandates the imposition of a fifth element or pre-condition in a case such as this which is concerned with the declaration of dividends designed solely to reduce the tax payable by the respondent.

b)         whether the dictum of Dickson C.J. in McClurg was binding upon the courts below

In this case, there can be no dispute that the respondent and Ruby Neuman were not dealing with each other at arm’s length. They were related persons (husband and wife) and by section 251 of the Act are presumed not to be dealing with each other at arm’s length. Furthermore, since they were the only shareholders of Melru, neither was dealing with that corporation at arm’s length. Confronted by these undisputed facts, the Courts below were bound to consider the final paragraph of the reasons of the Chief Justice of Canada in McClurg, at page 1054:

In my opinion, if a distinction is to be drawn in the application of s. 56(2) between arm’s length and non-arm’s length transactions, it should be made between the exercise of a discretionary power to distribute dividends when the non-arm’s length shareholder has made no contribution to the company (in which case s. 56(2) may be applicable), and those cases in which a legitimate contribution has been made. In the case of the latter, of which this appeal is an example, I do not think it can be said that there was no legitimate purpose to the dividend distribution.

As we have already said, the learned Tax Court Judge considered this paragraph to be less than judicial dicta.[21] As he put it, it was an opinion expressed by the Supreme Court of Canada which “cannot simply be ignored”. He, nonetheless, refused to decide whether subsection 56(2) was intended to apply to a non-arm’s length transaction. Furthermore, on assumption that it was, he concluded that the facts of this case did not fall squarely within that subsection.

For his part, the learned Trial Judge faced with the difficulty of reconciling the opinion expressed in that passage with opinions expressed by the Chief Justice of Canada earlier in his reasons in McClurg, relied on dicta of Urie J.A. in Canada v. McClurg, [1988] 2 F.C. 356 at page 362 and of Estey J. in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, at page 172 to reach the following conclusion:[22]

Based on the decisions of the Federal Court of Appeal in McClurg and the Supreme Court in Stubart, I must conclude that the threshold question, whether a distinction is to be drawn between an arm’s length and a non-arm’s length transaction in the application of s. 56(2), must be answered in the negative.

In our respectful view, the issue of the applicability of subsection 56(2) to non-arm’s length transactions was a live one in McClurg, both before this Court and in the Supreme Court of Canada. That is why Urie J.A. dealt with the issue when McClurg was before this Court and the Chief Justice dealt with it in the final paragraph of his reasons. It is true that in McClurg the Supreme Court found that Wilma McClurg had made a contribution to Northland Trucks. For that reason, the dictum of the Chief Justice could not be considered part of the ratio decidendi of that case. Although not necessary for the disposition of that appeal, the opinion expressed by the Chief Justice represented the considered opinion of a majority of the Court and was therefore binding on the Courts below and on this Court. See Sellars v. The Queen, [1980] 1 S.C.R. 527.

In this case, the declaration of the dividend to Ruby Neuman was made in the exercise of a discretionary power to distribute dividends to a non-arm’s length shareholder who, as the learned Trial Judge found, made no contribution to the company and assumed none of the risks for it. In these circumstances, and paying heed to the majority opinion in McClurg, it is our opinion that subsection 56(2) of the Act is applicable to the transaction.

c)         whether subsection 56(2) of the Act permitted the Minister to include in the income of the respondent for the taxation year 1982, the dividend of $14,800 which Ruby Neuman received from Melru

It follows from what we have already said that subsection 56(2) has application to the facts of this case and that the Minister was right in including the dividend which Ruby Neuman received from Melru in the income of the respondent for the 1982 taxation year.

Conclusion

For all the foregoing reasons, we would allow the appeal, set aside the decisions of the Trial Division and of the Tax Court and affirm the Minister’s assessment.

Costs

Paragraph 65 of the memorandum of fact and law filed on behalf of the respondent reads:

65. The Respondent submits, regardless of the determination of this Honorable Court on this appeal, costs are to be awarded to the Respondent under former subsection 178(2) as the amount of tax in controversy does not exceed $10,000.00.

Subsection 178(2) [as am. by S.C. 1976-77, c. 4, s. 64; 1980-81-82-83, c. 158, s. 58; 1984, c. 45, s. 75] reads:

178. …

(2) Where, on an appeal by the Minister, other than by way of cross-appeal, from a decision of the Tax Court of Canada, the amount of

(a) tax, refund or amount payable under subsection 196(2) (in the case of an assessment of the tax or determination of the refund or the amount payable, as the case may be) that is in controversy does not exceed $10,000, or

(b) loss (in the case of a determination of the loss) that is in controversy does not exceed $20,000,

the Federal Court, in delivering judgment disposing of the appeal, shall order the Minister to pay all reasonable and proper costs of the taxpayer in connection therewith.

As no oral submissions were addressed to us on this issue, it is our opinion that the award of costs in this appeal should not be made until the appellant files and serves a motion respecting the award of costs of the appeal pursuant to Rule 324 of the Federal Court Rules [C.R.C., c. 663]. Counsel for the respondent shall file and serve his submissions within 20 days from the date of service of the appellant’s submissions and counsel for the appellant shall file and serve his submissions in reply, if any, within ten days of the receipt of the submissions filed on behalf of the respondent.

---