In HLB Smith Holdings Limited v R, 2018 TCC 83, each of Holdco and a family trust (“Trust1”) held 50% of the shares in the capital of Opco. Another family trust (“Trust2”) held all of the issued shares in the capital of Holdco. Trust1 was for the benefit of W’s family; it appears Trust2 was for the benefit of M’s family. W and M were unrelated. They were the directors of Opco at all times. Opco paid dividends to its shareholders at a time when it owed income tax. Holdco paid dividends to Trust2, which allocated the dividends to M and his wife. Were the recipients of the dividends liable under section 160? Put another way, did Opco deal at arm’s length with its shareholders, who were unrelated to it?
The Tax Court held that the shareholders of Opco acted in concert, one supposes because each of the shareholders was controlled by M and W respectively, who were the only directors of Opco. Because the shareholders acted in concert to direct Opco to pay dividends, they were not at arm’s length with Opco per s 251(1)(c) of the Income Tax Act (Canada). The Court cited with approval the following passage from Fournier (F) v MNR, [1991] 1 CTC 2699, 91 DTC 746 (TCC), at 748 (DTC):
I cannot find a situation more suited to application of the concept of a non-arm’s length transaction between unrelated persons, in that the company’s two principal directors and shareholders apparently acted in concert and with a common economic interest to decide how they would withdraw the profits made by the company for their personal use. Acting both as directors of the company and its shareholders, they were in a position where the concept of not being at arm’s length in fact as established by our courts could hardly be better applied. In this sense, therefore, I consider that Les Évaluateurs Fra-Mic Inc. was not at arm’s length with the appellant at the time of the property transfer made during its 1983 taxation year, and that accordingly the respondent was right to apply subsection 160(1) of the Act to this transaction.
