Date: 19990112

Docket: 95-1435-IT-G

BETWEEN:

ROBERT B. FURUKAWA,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on November 5, 1998, at Calgary, Alberta by the Honourable Judge G.J. Rip

Reasons for judgment

RIP, J.T.C.C.

[1] The appellant Robert B. Furukawa appealed his assessment for 1992 in which the Minister of National Revenue ("Minister") disallowed a deduction of $7,500 in respect of a purported Canadian Exploration Expense ("CEE").[1] The appeal was heard on March 13, 1996 by my late colleague Sobier, J.T.C.C. and judgment was issued on April 17, 1996 allowing the appeal. The case is reported at [1996] 2 C.T.C. 2641. Judge Sobier held that certain shares were not "prescribed shares" under subparagraph 6202.1(2)(b)(i) of the Income Tax Regulations ("Regulations”) and therefore were flow-through shares within the meaning of paragraph 66(15)(d.1) of the Income Tax Act ("Act"). The Crown appealed the judgment to the Federal Court of Appeal which, on January 20, 1997, allowed the appeal, set aside the judgment and referred the matter back

... to the Tax Court Judge for a continuation of the trial on the basis that he hears and determines the issue of whether the shares in question are "prescribed shares" under subsection 6202.1(1) of the Regulations. ...

[2] The Court of Appeal permitted Mr. Furukawa, at his election, to adduce any additional evidence in supplementation of the facts agreed to prior to trial. The following are the Agreed Statement of Facts:[2]

1. The Appellant is an individual residing at 8315 Hawkview Manor Link, Calgary, Alberta T3G 3E6.

2. Provident Ventures Corporation ("Provident") is a corporation incorporated in the province of Alberta and governed by the Alberta Business Corporations Act. Provident was listed on the Alberta Stock exchange in 1989 and ... exhibit "A" is a list of the trading activity for the 1991 calendar year in the shares of the company. The Appellant was a director and officer of Provident since its inception in the late 1980's but ceased to be a director on January 26, 1994.

3. Bearcat Explorations Ltd. ("Bearcat") is a corporation incorporated in the province of Alberta and governed by the Alberta Business Corporations Act. The Appellant has been a director of Bearcat since the late 1980's.

4. The Appellant became a shareholder in Bearcat in the late 1980's. The Appellant's holdings in Bearcat were as follows:

Prior to May 1990 58,500 common shares

At June 1991 75,500 common shares

At May 1992 75,500 common shares

At June 1993 75,500 common shares

At August 1994 94,374 common shares

4,350 preferred shares

At June 1995 137,874 common shares

5. Lumberton Mines Limited ("Lumberton") is a corporation incorporated in the province of Alberta and governed by the Alberta Business Corporations Act and has at all material times been a subsidiary of Bearcat. The Appellant became a director of Lumberton in the late 1980's. ... Exhibit "B" (is) the financial statements for Lumberton's year ended November 30, 1992 together with comparable figures for the year ended November 30, 1991.

6. In early 1991, Lumberton prepared a "Resume" outlining the terms of a $3,000,000 private placement financing ("the private placement financing") which offered investors the opportunity to participate in the financing of certain oil and gas exploration activities. Investors were offered the opportunity to participate in the venture by acquiring "unit interests". The particulars of the unit participation are outlined in the Resume attached herewith as Exhibit "C". [See Appendix to these reasons]

7. In 1991 Lumberton sold units to various subscribers including the Appellant who purchased a one-quarter unit for $7,500. The Appellant acquired his one-quarter unit as part of a joint purchase together with Messrs. Zawatski, Neustater and Maier, wherein the group jointly acquired two units which units were held in trust by Mr. Maier.

8. ... Exhibit "D" is a photocopy of the Appellant's cheque for $22,500 in respect of his one-quarter unit (for $7,500) and his spouse's purchase of one unit (for $15,000).

9. ... Exhibit "E" is a copy of the Appellant's receipt, dated March 26, 1991, in respect of the purchase and a second "Amended Receipt" received under cover of letter dated February 26, 1992. [See Appendix to these reasons]

10. As part of the purchase of the units, Lumberton agreed to issue to the Appellant "certain flow-through shares"¹ of

______________

¹ The dispute between the parties is whether these shares are in fact "flow-through shares" within the meaning of the Income Tax Act.

Lumberton and "renounce" in favour of the Appellant pursuant to paragraph 66(12.6) of the Income Tax Act (Canada) (the "Act"), Canadian Exploration Expense ("CEE") in the amount equal to the consideration of $7,500. ... Exhibit "F" is a photocopy of the share certificate of Lumberton issued to the Appellant and ... Exhibit "G" (is) the "flow-through share issuance agreement".*

11. Lumberton allocated the entire purchase price from the sale of the units to the Lumberton Shares and spent all of the proceeds from the sale of the units in carrying out CEE and renounced all of the CEE to the investors including the Appellant.

12. With respect to the other items that Lumberton undertook, in the Resume, to provide to the investors:

(a) To date, the Palmer Golf Course had not been built and Provident has changed its business to marketing bottled water;

(b) He relinquished his right to be assigned an interest in the pipeline² to Lumberton (at no cost) as part of the share exchange outlined in paragraph 17 infra.

(c) The Appellant never received the playing privilege at the Palmer Golf Course or the option to the lot and he relinquished his right to receive these items to Lumberton at no cost as part of the share exchange outlined in paragraph 17 infra.

(d) The Appellant received 125 shares of Provident on or about August 10, 1995. ... Exhibit "H" is a copy of the cover letter [See Appendix to the reasons] and share certificate for Provident.

___________

² The pipeline was a 5-mile 8-inch gas pipeline.

13. Revenue Canada has not verified the "attributed values" in the Resume. It is neither the Appellant's or the Respondent's position that the "attributed values" on the Resume are correct.

14. By way of a letter dated May 15, 1992 from Lumberton to the Appellant, the Appellant received a cheque in the amount of $7.81 representing a portion of the Grassy pipeline unit tariff revenue for the months of January, February and March of 1992. ... Exhibit "I" is a copy of that letter. From time to time the Appellant received further amounts in respect of Grassy Hill Pipeline revenues. The total amount received by the Appellant from the time that he acquired the Lumberton shares until the time that he it [sic] relinquished his right to the [sic] receive an interest in the pipeline (May 4, 1995) was slightly in excess of $125.00.

15. In 1991 and 1992 Lumberton was subject to an investigation by the Alberta Securities Commission ("ASC") for alleged breaches of the Securities Act/Regulations/policies resulting from the private placement financing. The breaches in question, which Lumberton maintained were inadvertent were as follows:

(i) inaccurate representations made to subscribers concerning the interests making up the private placement units which Lumberton had not earned and/or was not in a position to deliver at the time of the offering;

(ii) representations made to the subscribers concerning the obtaining of a listing of Lumberton on the Alberta Stock Exchange;

(iii) reliance for private placements on a statutory exemption from prospectus and registration requirements which resulted in trades to purchasers in excess of the maximum number (50) prescribed for this exemption; and

(iv) late filing of certain forms for two private placements.

16. The dispute between the ACS and Lumberton was settled and as part of the settlement Lumberton was required to make an offer of rescission to subscribers who participated in the 1991 placement and pursuant to an offer dated December 3, 1992 Lumberton offered to buy back the Appellant's shares, and ... Exhibit "J" is a copy of that offer. The Appellant did not accept the said offer.

17. By way of a letter dated April 25, 1994, Bearcat offered inter alia to exchange the shares of Lumberton held by the investors for shares of Bearcat. The Appellant accepted Bearcat's offer and signed a Release and Discharge dated May 5, 1994, in respect of this offer. A copy of that Release and Discharge is ... Exhibit "K".

18. By way of a letter dated July 11, 1994 the Appellant received a share certificate for his Bearcat shares. ... Exhibit "L" is a copy of the letter and the Appellant's share certificate for the Bearcat shares.

19. In computing his income for the 1992 taxation year, the Appellant claimed $7,500 as a deduction from income with respect to CEE renounced to the Appellant by Lumberton.

20. By way of a Notice of Reassessment dated March 24, 1994, the Minister disallowed the deduction in the amount of $7,500 for the Appellant's 1992 taxation year in respect of CEE renounced to the Appellant by Lumberton. ... Exhibit "M" is a copy of the Notice of Reassessment.

21. The Appellant filed a Notice of Objection to the Reassessment within the time permitted by the Act and the Minister confirmed the Reassessment on January 24, 1995. ... Exhibit "N" is a copy of the Notice of Objection and ... Exhibit "O" is a copy of the Notice of Confirmation.

[3] The only additional evidence adduced at the continuation of the trial was the reading of portions of the examination for discovery of Mr. Purdy, the Revenue Canada assessor.

[4] Counsel agree that the relevant provisions of subsection 6202.1(1) of the Regulations are subparagraphs (b)(iii) and (iv), which read as follows:

6202.1(1) For the purposes of paragraph 66(15)(d.1) of the Act, a new share of the capital stock of a corporation is a prescribed share if, at the time it is issued,

...

(b) any person or partnership has, either absolutely or contingently, an obligation (other than an excluded obligation in relation to the share)

...

(iii) to transfer property, or

(iv) otherwise to confer a benefit by any means whatever, including the payment of a dividend,

either immediately or in the future, that may reasonably be considered to be, directly or indirectly, a repayment or return by the corporation or a specified person in relation to the corporation of all or part of the consideration for which the share was issued or for which a partnership interest was issued in a partnership that acquires the share;

[5] The status of the flow-through shares under section 6202 of the Regulations was discussed by Bonner, J.T.C.C. in Esplen v. The Queen.[3] He stated, at p. 1276, that:

... The statutory provisions now in question were enacted with a view to encouraging investment in the exploration and development of mineral resources. The statutory scheme permits an investor to subscribe for flow-through shares of a corporation. It was intended that the subscription funds be used by the corporation for exploration, that the corporation's exploration expenses be renounced to the investor and that the exploration expenses be treated for purposes of the Act as the expenses of the investor. Plainly the objective of the scheme would not be attained if the subscription price were diverted from exploration and used to make provision for some sort of arrangement designed to permit the investor to recover some or all of his money in the event that the financial performance of the share was disappointing. ...

[6] Judge Bonner's comments are in keeping with the submission of the Minister that the purpose underlying subsection 6202.1(1) of the Regulations is to ensure that the monies invested in flow-through shares are actually used as risk capital in the resource industry. Prescribed shares are excluded from the definition of flow-through shares for the purposes of paragraph 66(15)(d.1) of the Act.

[7] In order to qualify as a prescribed share pursuant to subparagraph 6202.1(b)(iii) or (iv) of the Regulations several requirements must be met: at the time the shares are issued a person must have an absolute or contingent obligation to transfer property or confer a benefit on the taxpayer, the transfer of property or conferral of a benefit may be immediate or may be performed in the future, and the transfer of property or conferral of a benefit must reasonably be considered a direct or indirect repayment or return of the consideration paid for the shares issued.

[8] The first matter before me is to determine whether Lumberton had an absolute or contingent obligation to transfer property or confer a benefit upon Mr. Furukawa at the time the Lumberton shares were issued. The Minister submitted that the items outlined in the Resume included as Exhibit "C" to the Agreed Statement of Facts ("Resume") represent such obligations. At times during the trial it was not clear what unit package the appellant acquired and, therefore, what additional property he was to receive with the shares.[4] However, a review of the Agreed Statement of Facts and the evidence adduced at both parts of the trial indicate that the appellant acquired a one-quarter interest of a single unit purchased in conjunction with a group of investors who together purchased two units which is sometimes referred to as a "double unit". The attachments in issue are those associated with a double-unit purchase. This is indicated in a letter to the appellant from Lumberton, dated August 10, 1995, that in order to resolve an inequity between investors who purchased one unit and those who purchased two, Lumberton would be issuing 1,000 common shares of Provident to investors who purchased two units. Consequently, the appellant received a certificate for 125 Provident shares (1,000 shares/2 x 25 per cent).

[9] The Resume indicates that investors could subscribe for one unit of 60,000 common voting shares or two-units of 120,000 common voting shares. Upon making such an acquisition, the Resume indicates that the investor would receive additional attachments, two lifetime playing privileges at Palmer Bar Golf Course, once it became operational; one one-quarter acre building lot at Palmer Bar Golf Course, once it became operational; and a 1.4 per cent interest in Grassy Pipeline.

[10] The Resume also provides that new shareholders were to "receive additionally at no cost out of the asset holdings of Lumberton Mines Limited..." the attachments described above. It therefore appears that the shareholder was acquiring an investment in 120,000 common voting shares of Lumberton and that the additional attachments were merely add-ons.

[11] But are the attachments an obligation? The appellant has argued that they were not and stated that he did not receive many of the promised items and those he did receive had little intrinsic value. The fact that the appellant did not receive all of these items is irrelevant to the analysis because subsection 6202.1(b) of the Regulations provides that the person must have an obligation existing at the time the Lumberton shares were issued. And the obligation may be absolutely or contingent, immediate or in the future. The Resume is undoubtedly an offer that was intended to cause investors to act in reliance on the representations made therein. The Alberta Securities Commission was apparently of this view since it found that Lumberton had breached the Province's Securities legislation and made inaccurate representations to investors. The legal obligation created by the Resume is further supported by the receipts issued by Lumberton, which confirms that the appellant would receive the attachments.

[12] Appellant's counsel submitted that Mr. Furukawa did not think he was entitled to receive the benefits outlined in the Resume because he did not purchase a whole unit. I do not agree. The appellant knew that he was part of a group purchasing two units. He knew the group may receive the attachments associated with a double unit purchase and that he would receive his proportionate share of the attachments. Although he did not enter the transaction for the purpose of acquiring the attachments, he hoped to receive, if he did not reasonably expect to do so, his share of the attachments.

[13] I do not give much weight to the appellant's argument that he did not receive some of the attachments such as the golf course lot or the lifetime playing privileges. These were undoubtedly contingent upon the completion of the golf course and hence, were intended to be conferred in the future. Subsection 6202.1(b) of the Regulations provides that the obligation may be contingent and that the transfer of property or conferral of a benefit may occur in the future. The fact that the contingent obligation was only that, does not bring the appellant outside the application of the regulation.

[14] Hence, in my view, there was an obligation to transfer property to the appellant at the time the Lumberton shares were issued. I must now decide whether this was a repayment or return of all or part of the consideration paid by the appellant for the shares.

[15] In his reasons for judgment, Sobier, J.T.C.C. held that the attachments were "sweeteners", used to market the flow-through shares. Indeed the auditor for Revenue Canada considered them such. Appellant's counsel argued that this conclusion foreclosed the Minister's argument that they were a return of consideration. This is not necessarily so. Depending on circumstances a sweetener may or may not be a return of consideration. For example, when a manufacturer offers a rebate to the end consumer of its product upon the consumer mailing a coupon to the manufacturer or its agent indicating he or she purchased the product, the manufacturer is offering a sweetener to its potential customers to promote the product. To the consumer the rebate is a return of a portion of the purchase price; that is, a return of the consideration he or she paid for the product.

[16] The parties acknowledge that the full amount invested by Mr. Furukawa and received by Lumberton on the issuance of the shares was a CEE. This being so, these funds could not be returned to the shareholders. As the Minister's counsel argued, the attachments would have to be paid for by Lumberton out of its profits or assets and, therefore, the attachments would constitute an indirect return of the consideration. He submitted that it did not matter that the specific funds received as consideration were used to make the repayment as long as the company's assets or profits were depleted as a result of the repayment. This is true but it is not determinative of the issue before me given all the circumstances surrounding the issuance of the shares and the attachments.

[17] According to paragraph 6202.1(1)(b) of the Regulations the transfer of property or conferral of a benefit must "reasonably" be considered a return of the consideration paid. The term "reasonably" implies an objective, rather than a subjective, examination of the facts. One must ask whether a reasonable person appraised of the circumstances would think that the attachments were a return of the consideration paid for the shares. Although Lumberton was legally obliged to provide these attachments, an examination of its financial statements clearly indicates that Lumberton was not in a position to fulfill the obligation at that time or in the near or reasonable future. Hence, a reasonable person would probably attach little significance in the whole scheme of things to the attachments. Realistically, the person would have very little expectation of getting any of the sweeteners. Further, as Sobier, J.T.C.C. found, the benefits had little intrinsic value. Although Judge Sobier reached his conclusion in considering subsection 6202.1(2) of the Regulations, it is equally applicable to the issue before me. The attachments associated with the Lumberton shares, while they are owed to the appellant, did not appear to influence the appellant's decision to purchase the shares and cannot reasonably be considered a return of the consideration of the sum of $7,500 paid for the shares. The Lumberton shares are not prescribed shares within the definition of subparagraph 6202.1(1)(b)(iii) or (iv) of the Regulations. The appeal is allowed with costs.

[18] During the continuation of the appeal, appellant's counsel submitted that the Deputy Attorney General did not allege in the Reply to the Notice of Appeal that in reassessing the appellant the Minister assumed that the property transferred or benefit conferred was a repayment or return to the appellant of the consideration he paid for the Lumberton shares. The reason for this omission, he concluded, was because the Minister did not make that assumption. The Minister did not assess the appellant on the basis that the transfer of the property or the conferral of the benefit was a repayment or return of the consideration. This was the conclusion of Sobier, J.T.C.C. The assessment before the Court, counsel stated, was clearly based on the premise that the mere transfer of property or the conferral of the benefit makes shares prescribed shares and that the property or benefit was a marketing feature.

[19] Counsel referred to the recent decision of the Supreme Court of Canada in Continental Bank of Canada v. Canada, [1998] 2113 E.T.C. which held that the Deputy Attorney General was not entitled to assert an alternative basis to sustain an assessment being litigated. As McLachlin, J., declared:

The Minister should not be allowed to advance a new basis for reassessment after the limitation period [subsection 152(4)] has expired.

(See also Bastarache, J.'s opinion shared by McLachlin, J.)

[20] Appellant's counsel, therefore, asked me to ignore the claim by the Deputy Attorney General that the transfer of property or conferral of the benefit was a repayment or return of the consideration since that was not the basis of the assessment. Since I have considered the issue as directed by the Federal Court of Appeal and since the appellant is successful, it is not necessary at this time to consider counsel's submission with respect to Continental Bank, supra. I am satisfied that I could give, and have given, effect to the direction of the Federal Court of Appeal.[5] There is no need to call any new evidence to decide whether the Minister relied on subsection 6202.1(1) of the Regulations as the basis of the assessment.

Signed at Ottawa, Canada, this 12th of January 1999.

"G.J. Rip"

J.T.C.C.

Appendix to Reasons for Judgment

[Omitted]

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