The recent decision of the Tax Court of
Canada (the “TCC”) in Twomey v. Her
Majesty the Queen (2012 TCC 310) highlights the importance of strict
compliance with the technical provisions of the Income Tax Act (Canada) (the “Act”), as well as the Canada Revenue
Agency’s (“CRA”) approach to enforcement in the absence of such compliance. The
decision involved a taxpayer’s claim for the lifetime capital gains exemption
(“LCGE”) in respect of a capital gain realized on the sale of his shares in a
corporation. Miller Thomson represented the taxpayer in this case and was
successful in having the reassessment vacated.
Although the taxpayer was successful in
establishing his entitlement to the LCGE, the decision serves as a cautionary
tale to taxpayers and advisors alike to ensure the accuracy of corporate
records. The TCC also expressed its “frank” views on the unyielding position
adopted by the CRA in the face of perceived technical irregularities in
Mr. Twomey and Mr. Kaytor each owned shares
of a holding company, 1154477 Ontario Ltd. (“Holdco”), which in turn owned
shares of a company that operated an HVAC business. Holdco was incorporated in
1995 and had been used to purchase certain shares that had been held by former
business partners who left the business in 1995.
The accountant who planned the buy-out of
the former partners and the incorporation of Holdco wrote a letter to the
lawyer instructing that Holdco issue 100 shares to each of Mr. Twomey and Mr.
Kaytor. However, the lawyer who incorporated Holdco never received these
instructions, and drafted the corporate documents on the basis of 1 share being
issued to each of Mr. Twomey and Mr. Kaytor. The error was not noticed and
financial statements and tax returns were prepared and filed by the accountant
on the basis of 100 shares of Holdco issued to each of Mr. Twomey and Mr.
In 2005, Mr. Kaytor agreed to purchase the
shares of Holdco owned by Mr. Twomey. In the course of preparing the documents
relating to the share purchase, it was discovered that Holdco’s minute book did
not correctly reflect the initial incorporation instructions or the number of
shares shown in Holdco’s financial statements and tax returns. Mr. Twomey and
Mr. Kaytor, the directors of Holdco, resolved that they had intended to issue
100 shares to each of them in 1995, and resolved to issue 99 shares to each of
them for no additional consideration.
Mr. Towney then sold 100 Holdco shares to Mr. Kaytor and certain related
holding companies. Mr. Twomey sought to claim the LCGE in respect of the
capital gain realized on the sale of his Holdco shares.
A LCGE of up to $750,000 can be claimed in
connection with capital gains realized on certain properties, including
qualified small business corporation (“QSBC”) shares. The Act provides that a
particular share will qualify as a QSBC share if it has not been held by an
unrelated party within the last 24-month period. Shares issued from treasury
are deemed for the purpose of determining whether a particular share is a QSBC
share to have been held by an unrelated party immediately before their
Following an audit, the CRA determined that
99 treasury shares of Holdco had been issued to Mr. Twomey in 2005, and that
such shares were not QSBC shares. Accordingly, the CRA disallowed Mr. Twomey’s
claim for the LCGE in respect of a capital gain realized on the disposition of
99 Holdco shares.
TCC Analysis and Decision
The Minister took the position that the
documents contained in Holdco’s minute book, including share registers, share
certificates, and directors’ resolutions, spoke for themselves. These documents
purported to show that only 1 Holdco share had been issued to Mr. Twomey in
1995, with 99 Holdco shares having been issued to Mr. Twomey in 2005.
The taxpayer asked the TCC to consider all
of the surrounding facts and circumstances, including the intentions of the
parties as reflected in their testimony at the hearing and in the initial
instruction letter from the accountant, as well as the information provided in
Holdco’s annual financial statements and tax returns. According to the taxpayer, these circumstances
supported the conclusion that 100 Holdco shares were issued to Mr. Twomey in
The taxpayer also relied on section 139 of
the Ontario Business Corporations Act
(the “OBCA”), which states that a corporation’s minute book “is admissible in
evidence as proof, in the absence of evidence to the contrary, of all
facts stated therein […]” [emphasis added].
The irregularities that may constitute “evidence to the contrary” for
purposes of section 139 of the OBCA may consist of “any evidence […] that could
rebut the presumption that the corporate records stand as proof of the facts in
them.” The taxpayer argued that the intentions of the parties and the
preparation and filing of financial statements and tax returns constituted
“evidence to the contrary” within the meaning of this provision.
The TCC concluded that the presumption of
the accuracy of the minute book in section 139 of the OBCA had been rebutted by
the evidence presented by the taxpayer, and that 100 Holdco shares had been
issued to Mr. Twomey in 1995. The
intention had been to issue 100 Holdco shares to Mr. Twomey in 1995, and Holdco
had substantiated this intention by preparing financial statements and tax
returns on this basis. The resolution of
the directors of Holdco in 2005 was also held by the TCC to have amended
Holdco’s records to give effect to the true facts, being that 100 Holdco shares
were to have been issued to Mr. Twomey in 1995.
The TCC also voiced its concern over the
assessing position taken by the CRA. The
TCC held: “Frankly, I must say I am somewhat surprised the Respondent, in the
face of what I consider overwhelming evidence to the contrary, has taken the
position only one share was issued and forced the Appellant into this appeal.
The Respondent’s reliance on a purely technical argument that in my opinion
flies in the face of substantial evidence to the contrary was simply not
reasonable in the circumstances. There was a simple error in the initial
records of 115 that was corrected when it was discovered.”
The TCC’s candid assessment of the CRA’s
uncompromising insistence on the correctness of the CRA’s initial assessing
position reflected what the taxpayer had experienced throughout the entire
audit, objection and appeal process. Although there were irregularities in
Holdco’s records, this appeared to be a case where the taxpayer was clearly
entitled, in principle, to the benefit of the LCGE on the sale of his 50%
interest in a Canadian small business corporation.
As noted by the TCC, there was no evidence
of retroactive tax planning, improper conduct or any bad faith on the part of
the taxpayer or any of his advisors.
Nonetheless, there was a technical argument in support of the CRA’s
assessing position, and Mr. Twomey was fortunate to have oral and documentary
evidence to counter the CRA’s conclusions resulting from having taken the
contents of the minute book at face value.
Although the taxpayer was successful in his
appeal, the result in Twomey is
unlikely to deter the CRA from pursuing strict enforcement of the technical
provisions of the Act in the future, particularly in the absence of any
documentary evidence to support a taxpayer’s assertions as to what really
happened over the course of a transaction. Taxpayers and their advisors would
be well advised to ensure that their corporate records and other documents are
accurate and up-to-date and properly reflect the intention of the parties. This
case has shown that irregularities in corporate records may result in
significant tax reassessments in the future.
The Minister has decided not to appeal the
decision in Twomey.