Date: 20000307
Dockets: 98-1202-IT-G; 98-903-IT-G
BETWEEN:
DO HEE LIM, MICHEL D. LECOURS,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent,
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard on common evidence. The appeal in the case of Michel Lecours concerns the 1989 taxation year, while the taxation year in issue in Do Hee Lim's case is 1993.
[2] The point at issue in both appeals is whether, in circumstances in which shares are issued and subscribed for as fully paid in consideration of past services, this consideration must be included in the income of the person to whom the shares are issued.
[3] According to paragraph 17 of the Reply to the Notice of Appeal (the "Reply"), the facts considered by the Minister of National Revenue (the "Minister") in the case of Michel Lecours are as follows:
[TRANSLATION]
(a) The appellant was the shareholder and director of New Asia Investment Corporation Inc. and New Asia Management Corporation Inc. during the period in issue;
(b) On July 21, 1989, the appellant received 14 common shares of New Asia Investment Corporation Inc. in consideration of professional services which the appellant had rendered to the corporation;
(c) The stated capital of these 14 common shares was $100,000;
(d) Again on July 21, 1989, the appellant sold these 14 shares of New Asia Investment Corporation Inc. to New Asia Management Corporation Inc. and received as consideration 100,000 common shares of New Asia Management Corporation Inc.;
(e) The stated capital of these 100,000 common shares was $100,000;
(f) The 14 common shares of New Asia Investment Corporation Inc. were worth $100,000 on July 21, 1989;
(g) The appellant knowingly, or under circumstances amounting to gross negligence, failed to include the fair market value of these 14 common shares in his income in his return of income for the 1989 taxation year, resulting in the assessment of a penalty under subsection 163(2) of the Income Tax Act;
(h) The appellant made a misrepresentation attributable to neglect, carelessness or wilful default or committed a fraud in filing his return of income for the 1989 taxation year.
[4] The facts assumed in making the reassessment of Do Hee Lim are set out in paragraph 12 of the Reply as follows:
[TRANSLATION]
(a) The appellant provided her professional services to New Asia Investment Corporation Inc.;
(b) The commissions for the appellant's services were paid in accordance with the terms set out in the agreement signed on September 17, 1990 between the appellant and New Asia Investment Corporation Inc.;
(c) Under that agreement, on September 2, 1993, the appellant received 12 Preferred Series II shares of New Asia Investment Corporation Inc. in consideration of the professional services that she had rendered to the corporation;
(d) The stated capital of these 12 Preferred Series II shares was $200,000;
(e) The 12 Preferred Series II shares were worth $200,000 on September 2, 1993.
[5] The witnesses in this case were the appellants, Louis Lockhead, an assistant vice-president at Montreal Trust, Réjean Bouchard, trustee in the bankruptcy of New Asia Management Corporation Inc., and Dae Geun Kim, owner of an oriental grocery store in Côteau du Lac. René Parenteau, an auditor with Revenue Canada, testified at the request of counsel for the respondent. As some of the testimony was not relevant to the point at issue, I will report only the testimony that was relevant.
[6] Two books of documents were filed as Exhibits I-1 and I-2 respectively. Exhibit I-1 concerns Michel Lecours, and Exhibit I-2, Do Hee Lim. The appellant filed 13 exhibits.
[7] Michel Lecours explained to the Court that he was the sole shareholder of both corporations, New Asia Investment Corporation Inc. and New Asia Investment Corporation Inc. The two corporations had been incorporated in order to participate in the immigrant investor program introduced by the Government of Quebec. The corporations operated in the field of time-share condominium units.
[8] In 1989, Michel Lecours subscribed for the capital stock of New Asia Investment Corporation Inc. in the amount of $100,000. This $100,000 subscription is described at tab 13 of Exhibit I-1:
. . .
I hereby subscribe for and agree to take up, fourteen (14) common shares in the capital of your Corporation the amount of one hundred thousand dollars ($100,000) in full payment of the said common shares be added to the stated capital in payment for professional services which I have rendered to the Corporation.
. . .
[9] This subscription was accepted for New Asia Investment Corporation Inc. on July 21, 1989 by Michel Lecours, who was its sole shareholder (tab 13, Exhibit I-1). The appellant Lecours suggested that the shares had not been issued for past services but for future services. He explained that he had devoted a great deal of time to and made a number of trips for the business once it was incorporated. He filed no documentary evidence concerning revenue and expenditure for professional services past or future.
[10] In 1994, the appellant Lecours claimed a business investment loss in the amount of the $100,000 subscription, relying on the exhibit described in paragraph 8 of these Reasons as evidence of the purchase of the shares. At the hearing, he did not seek to amend this claim.
[11] In the case of Do Hee Lim, counsel for the respondent relied on the agreement at tab 8 of Exhibit I-2 by which New Asia Management Corporation Inc. retained the services of Do Hee Lim and confirmed the commission that would be paid to her on investments made by immigrant investors or immigrant entrepreneurs on the date the money was transferred to the project. Counsel for the respondent also relied on a resolution of the board of directors of New Asia Investment Corporation Inc. granting Do Hee Lim a certificate for 12 preferred shares in consideration of a sum of $200,000 plus other consideration. This resolution, which appears at tab 10 of Exhibit I-2, reads as follows:
. . .
THAT, in consideration of a sum of 200 000 $ plus other consideration transferred to the corporation, a certificate of twelve (12) Preferred Series II shares be issued to and in favour of Mrs. Do Hee Lim and that the proper corporate inscriptions be done to that effect.
. . .
[12] This resolution was accepted by the corporation's sole shareholder, Michel Lecours, on September 2, 1993 (Exhibit I-2, tab 10). Counsel for the respondent also relied on the transcript of an examination of Do Hee Lim conducted in another legal proceeding. This was an examination conducted under article 544 of the Code of Civil Procedure, in which Do Hee Lim admitted that the shares had been assigned to her for $200,000 in payment of commissions which were owed her under the aforementioned agreement.
[13] The Minister added this amount of $200,000 in computing Ms. Lim's income for 1993. However, the Minister's office considered that, under paragraphs 50(1)(b), 39(1)(c) and 38(c), the appellant Lim had incurred for 1994 a deductible business investment loss of $131,648 out of the $200,000 amount of the subscribed shares. This loss was considered in computing Ms. Lim's income for 1993. Despite this loss carry-back, the appellant Lim's taxable income for 1993 increased from $11,075.96 to $77,289. The appellant Lim did not claim the loss for 1994.
[14] According to the financial statements of New Asia Investment Corporation Inc., which were filed at tabs 11 and 12 of Exhibit I-2 and tabs 15 and 17 of Exhibit I-1, in 1992 and 1993, the corporation incurred net losses of $2,096 and $44,893 respectively. For the period ending on October 23, 1994, the loss was $34,733. There was no expert report to prove the $100,000 and $200,000 values stated in subparagraphs 17(f) and 12(e) of the Replies. The appellants both asserted that the shares had no actual or market value in 1989 and 1993. No evidence was adduced to the contrary.
[15] The appellant Lecours claimed that if he had handed over an immovable in exchange for the shares, the cost of the shares would not have been added to his income. In addition, he continued to contend that the shares were not issued to him for past services but for future services.
[16] The appellant Lim stated that she had in fact rendered services to the corporation. She had accepted the issued shares because they were a form of recognition of the value of the services she had so provided. (It may be useful to note that she was the spouse of the appellant Lecours at the time.) However, the appellant Lim knew perfectly well that the issued shares had no actual value. She also asserted that it was not she who had claimed the business investment loss in 1994 and that she had in fact objected to that claim.
[17] Counsel for the respondent argued that, in 1989, the appellant Lecours had received shares issued and subscribed for in the amount of $100,000 as consideration for services rendered. The appellant Lecours never filed a statement of his revenue and expenditures with respect to his professional services. In those circumstances, the total amount of $100,000 must be included in his income. It should also be noted that the appellant Lecours claimed the acquisition cost of the shares as a business investment loss in 1994. As to the appellant Lim, counsel for the respondent argued that she had accepted the issued shares as payment for services she had rendered to the corporation and that that payment must therefore be included in her income.
Analysis
[18] The corporations concerned were incorporated under the Canada Business Corporations Act. Subsections 25(3) and (4) of that Act read as follows:
25(3) [Consideration] A share shall not be issued until the consideration for the share is fully paid in money or in property or past services that are not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.
25(4) [Consideration other than money] In determining whether property or past services are the fair equivalent of a money consideration, the directors may take into account reasonable charges and expenses of organization and reorganization and payments for property and past services reasonably expected to benefit the corporation.
[19] In La compagnie au Québec, Volume I, Wilson & Lafleur, Martel Ltée publisher, the paragraph entitled [TRANSLATION] "Shares issued for consideration other than money", reads as follows, at page 14-16:
[TRANSLATION]
. . . the company may also accept property or services in lieu of money as consideration for the shares it issues. In that case, the directors must determine by resolution that the property or services offered represent the "fair equivalent" of money up to the total nominal amount of the shares to be issued. Only if the goods or services constitute this "fair equivalent" can the company issue the shares as fully paid. . . .
. . .
The company may issue fully-paid shares only for a consideration of actual and present property or actual past services. It may not issue shares in return for future services, for example. . . .
[20] As just stated, a corporation may accept property or services in lieu of money as consideration for the shares it issues. I will first summarily dispose of the matter regarding an immovable or property, since this is an argument to which the appellant Lecours appeared to be attached. The appellant Lecours referred to no provisions of the Income Tax Act (the "Act") and, from my reading and understanding of the Act, I am not certain there are no tax consequences when ownership of an immovable or property is transferred from an individual to a corporation.
[21] As to the issuing of shares for services, the passage cited in paragraph 19 of these Reasons states that, in corporate law, shares may not be issued as fully paid unless the services have actually been rendered. I did not see any discussion in that text of the tax consequences of such an issue, and at the hearing I was not informed regarding accounting practice with respect to this practice which is common in corporate law.
[22] Must a person include in his income the consideration for the past services for which the shares were issued?
[23] Subsection 25(1) of the Canada Business Corporations Act reads as follows:
[Issue of shares] Subject to the articles, the by-laws and any unanimous shareholder agreement and to section 28, shares may be issued at such times and to such persons and for such consideration as the directors may determine.
[24] The text cited in paragraph 19 of these Reasons states at page 12-17:
[TRANSLATION]
1 — Freedom as to the issue price. There can be no discount or premium on the sale of this share since its issue price is not determined by the company's instrument of incorporation. The setting of this price is left to the board of directors' discretion.
[25] The setting of the issue price of the shares is left to the directors' discretion. It therefore seems clear that the setting of the issue price of the shares does not determine the market value of the shares issued. In any case, counsel for the respondent ignored the notion of actual or market value. Certainly, in my view, if the market value of the issued shares had been equal to their issue price, the parties would not be before this Court.
[26] When the shares have a definite market value, the answer to the question under consideration will without a doubt be affirmative. In the case of shares having no value, I believe the reasoning that must be used to decide this kind of question will depend on the taxpayer's conduct. If the shareholder shows by his actions that the acquisition cost of the shares is the amount of the consideration given for past services, he will have to include in his income the amount he received for past services at the time the shares were purchased. If he has incurred expenses in order to earn this income, the onus will be on him to establish their amount, if those expenses are deductible. I will say here that whether payment was made for future services as the appellant suggests (although this is not permitted in corporate law, as stated in paragraphs 19 and 21 of these Reasons) or for past services, there would be no difference in the tax treatment of the transaction.
[27] If, however, at the time of disposition of the shares, either actual, or deemed as a result of the corporation's bankruptcy or insolvency, a shareholder does not report an acquisition cost of the shares which is equivalent to past services, he will not have to include the consideration for past services in his income. It seems to me that one way to proceed for a shareholder wishing to ensure that an issue of shares for past services has no tax consequences would be to state in the share purchase document that, for tax purposes, the cost of the shares is nil. That was not done in this case. However, this omission does not necessarily determine the outcome of these appeals: in my opinion, the taxpayer's subsequent conduct must be considered.
[28] I used this type of reasoning in Beck v. M.N.R., [1992] 2 C.T.C. 2085, and in Orlando v. The Queen, 99 DTC 1201. In the first decision, the taxpayer asked that no account be taken of the payment of a claim which he held against a corporation, which payment was made by the issue in 1984 of shares of that corporation which, according to him, were of no value. In 1983, the taxpayer had deducted the amount of that claim as a bad debt. The Minister added it to his income for 1984 since, according to a document signed in 1984, the taxpayer had accepted the share issue in payment of his claim. In 1989, the appellant claimed, in respect of those shares, a business investment loss in the amount of the debt paid by their issue. I held that, as a result of the appellant's conduct in claiming the loss in 1989, the consideration paid to the appellant through the shares issued indeed represented the value of the cancelled debt. However, in the second decision, Orlando, supra, I held that, by his actions, the appellant had shown that he considered as nil the acquisition cost of shares issued and subscribed for in payment of advances made by the taxpayer to the corporation. The normal principle would have been that shares of no value cannot constitute payment of a debt unless, as a result of the taxpayer's actions, the acquisition cost of the shares becomes the consideration for which the shares were issued and subscribed.
[29] In the instant cases, we are dealing with one situation, that of Mr. Lecours, which is similar to that in Beck, supra, and another, that of Do Hee Lim, which is similar to that in Orlando, supra. In 1994, Mr. Lecours claimed a business investment loss based on the amount of $100,000. He thus felt that he had actually paid $100,000 to acquire the shares, namely the consideration he received in 1989 for his services. Do Hee Lim did not act in the same manner. Although she received shares with an issue price of $200,000 in 1993, she claimed no business investment loss in the year of the corporation's bankruptcy. It was the Minister's officer who included a claim for that amount for her in 1994. He did so, one might think, in view of the enormity of adding $200,000 to the appellant's income in 1993 for shares which had no market value.
[30] In the case of Mr. Lecours, I must also decide whether the penalty assessed for 1989 under subsection 163(2) of the Act is justified. Having heard the evidence, I am of the view that what was involved was more a lack of understanding on the appellant's part, of the effect that the issue of these shares in payment of past services would have on his personal income than any genuinely malicious intent. It is therefore not appropriate to apply subsection 163(2) of the Act. However, the appellant made a misrepresentation in 1989 and the Minister thus had the power to reassess for that year, which otherwise would have been outside the normal assessment period.
[31] The appeal of Mr. Lecours is allowed to the extent of setting aside the penalty but in no other respect. Do Hee Lim's appeal is allowed. The whole without costs.
Signed at Ottawa, Canada, this 7th day of March 2000.
"Louise Lamarre Proulx"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]