Moore
April 2015 Newsletter

Rectification of corporate articles allowed − stock dividend was legally effective

The recent Lau decision is one of several cases that have dealt with the legal remedy of “rectification” and its relevance for income tax purposes. The case involved a complex series of transactions and corporate reorganizations that took place in British Columbia.

Simplified, the facts were as follows. A corporation (the “Company”) issued stock dividends of $17.6 million to one of its major shareholders G, who sold the stocks for a $17.6 million promissory note. After another series of transactions, G became the owner of another promissory note (“new note”) of the same value that had been effectively issued to another party in consideration for the first note. G then transferred the new note to another corporation to which he owed $17.6 million and in which he was a shareholder, to pay off that loan.

The CRA assessed G and added the $17.6 million to his income on the basis that the other corporation had provided him with an unpaid shareholder loan. The CRA took the position that the articles of the Company did not give its directors authority to set redemption values for its issued stock unless it received property for the stock (which it did not receive on the issuance of the stock dividend). As a result, the stock dividend was legally invalid, which meant the subsequent transactions were invalid and G therefore never repaid his shareholder loan to the other corporation.

G appealed the CRA assessment to the Tax Court. He also petitioned the Supreme Court of British Columbia, arguing that it was always intended that the articles of the Company should allow the directors to issue stock dividends and set redemption values, even if it did not receive consideration for the issued shares. The Supreme Court allowed the petition, holding that it was clear from the evidence that all of the involved parties intended that the stock dividend shares could be issued by the Company. The Court therefore issued a rectification order, which amended the articles of the Company retroactively to give its directors the authority to issue the stock dividend shares.

As a result, G’s appeal to the Tax Court will take into account the effect of the rectification order. Presumably, this will result in the $17.6 million not being included in G’s income, although there may be other tax consequences (the Tax Court decision has not yet been issued).

No capital loss on loss of employee’s client base

In the recent Martin case, the taxpayer was a financial advisor and broker from 1996 through 2010. He was quite successful and established a large and loyal client base, which followed him even when he changed brokerage firms. However, in 2010, his employment with his brokerage firm (“Peak”) was terminated and he was unable to find another position. His clients decided to stay with Peak. Unfortunately, the taxpayer’s financial position worsened to the point that he subsequently had to claim insolvency and lost many of his personal assets.

In his tax return for 2010, the taxpayer made the interesting claim for a capital loss on the “disposition” of his client base. His position was that the client base was a valuable asset, which was taken from him by Peak. He computed the loss, using an assumed cost base equal to the estimated present value of his lost future revenues, and zero proceeds of disposition. In addition, he increased the amount of the loss, claiming that his disposition costs included the value of his assets that were seized by creditors upon his insolvency.

Not surprisingly, the CRA disallowed the entire loss. On appeal, the Tax Court confirmed the CRA position and also denied the loss. The Court held that the taxpayer did not own the client base, and therefore it was not his property to dispose of. In any event, the Tax Court held that the taxpayer did not pay for the client base and therefore it had no cost to him; it was not appropriate to estimate the cost using an estimated value. Furthermore, it was not proper to include the value of his assets seized on insolvency as taxable disposition costs.

Last modified on May 1, 2015 12:00 am