MCRUER, C.J.H.C.:—This is an application by the executors of the estate of the late Henry James McIntyre, for advice. Three questions are propounded for the opinion of the Court. They are as follows:
“1. Whether upon the true construction of the said Will and in the events which have happened, the sum of $13,575 being the sum received by the Trustee upon the redemption of 13,575 non-cumulative 5% Redeemable Preference Shares of The Hamilton Jockey Club (Limited) which were issued as a stock dividend by the said Company to the Trustee on April 9, 1951, is corpus or income in the hands of the Trustee for the purpose of administering the said Estate.
2. Whether upon the true construction of the said Will and in the events which have happened, the sum of $3,000 being the sum received by the Trustee upon the redemption of 3,000 non- cumulative 5% Redeemable Preference Shares of The Hamilton Jockey Club (Limited) which were issued as a stock dividend by the said Company to the Trustee on October 25, 1951, is corpus or income in the hands of the Trustee for the purpose of administering the said Estate.
3. Whether upon the true construction of the said Will and in the events which have happened, the sum of $26,250 being the sum received by the Trustee upon the redemption of 26,250 non-cumulative 5% Redeemable Preference Shares of The Hamilton Jockey Club (Limited) which were issued as a stock dividend by the said Company to the Trustee on October 26, 1951, is corpus or income in the hands of the Trustee for the purpose of administering the said Estate.”
The Hamilton Jockey Club (Limited) was incorporated under the Ontario Compames Act in the year 1893. On March 9, 1936, the authorized capital was $500,000 divided into 5,000 shares of a par value of $100.00 each, of which 4,850 shares were issued at that date. The fiscal year of the Club ended on October 31 in each year and the balance at the credit of the Profit and Loss Account on October 31, 1935, was $9,696.98. On October 31, 1939, this had been increased to $61,236.54.
On December 1,1947, pursuant to the provisions of the Income War Tax Act the directors of the Club elected to pay a tax of $9,185.46 on the aforementioned balance and declare a dividend of $52,051.08 for division pro rate among the shareholders of the Club. This dividend was paid on December 20, 1947.
In the month of February, 1948, the Company sold ‘‘The Jockey Club Hotel’’ for $250,000.00 realizing a profit on the sale of $169,900.38. This amount was carried into the balance sheet of the Company as a liability and shown ‘‘Capital Surplus (Re- Sale of Hotel) $169,900.38”.
On October 30, 1950, the Directors of the Company by by-law authorized an application to the Lieutenant-Governor of Ontario for Supplementary Letters Patent for the increase of the capital of the Company by the creation of 500,000 5% non-cumulative redeemable preference shares of a par value of $1.00 each ranking in priority to the common shares of the Company. The bylaw was ratified and confirmed by the shareholders on December 4, 1950. In accordance with the application Supplementary Letters Patent were issued on February 9, 1951, and certificates for the preference shares which were ultimately issued were in the form set out in the material. The respective rights of the common and preference shares as endorsed on the back of the certificate included paragraphs
* ‘ (4) In the event of the winding up or the dissolution of the Company the preference shares shall, in preference and priority to any payment on the common shares, be entitled, out of the assets of the Company available for distribution to shareholders, to the payment in full at par of the amount paid up on the preference shares, together with the amount of all dividends declared thereon and unpaid, but shall not be entitled to any further participation in any assets : ’ ’
and
° (5) The directors may at any time and from time to time redeem the whole or any portion of the preference shares by compulsory redemption at a price per share equal to the amount paid thereon, together with the amount of all dividends declared thereon and unpaid; in the event that less than all the outstanding preference shares are being redeemed, the shares to be redeemed shall be selected pro rate.”
At a meeting of the directors of the Company held on April 2, 1951, a resolution was passed which recited that the Club had tax free undistributed earned income as of October 31, 1949, and that redeemable non-cumulative preference shares of a par value of $1.00 each had been created—
“And Whereas it is desirable to declare a stock dividend to exhaust the balance of the capitalized earned surplus of the Club after deducting the 15 % tax payable to the Federal Government.
A stock dividend of shares of the preferred stock of the Club of the par value of $1.00 each representing $18.10 per common share be declared and paid as of April 9, 1951 and that such shares of the Preferred Stock of this Club be issued and distributed as a stock dividend to the holders of Common shares of the Club pro rata in accordance with their respective holdings of record on the books of the Club at the close of business on April 7, 1951. Provided, however, that no fractional share of preferred stock shall be issued.’’ (Italics are mine.)
At the same meeting a resolution was passed that the Club redeem all the issued and outstanding fully paid preference shares at their face value as of April 9, 1951, and in accordance with the terms of redemption of the said preference shares.
On October 11, 1951, the Company’s auditors made a report to the directors, the opening paragraph of which reads as follows:
‘“We have been asked by Mr. J. J. Conway, your Managing Director, to report to you on the possibilities which exist of making a distribution to the shareholders of your Company of the Capital Surplus now standing on the books of the Company at $172,551.07.”’
The report proceeds to outline the steps required to be taken at the least cost to the Company and its shareholders, to effect the distribution and points out that the principal point to bear in mind is that in order to place a Capital Surplus in the hands of the shareholders of a Company tax free, the Earned Surplus Account of the Company must either have a nil or a debit balance, since if there is any undistributed Earned Surplus on hand at the time a Company proposes a distribution of Capital Surplus then in view of the Tax Department, the Earned Surplus is distributed first, and only the amount by which the distribution exceeds the Earned Surplus is deemed Capital Surplus.
The report estimates that the balance of the Earned Surplus available for distribution at the end of the fiscal year of 1951 would be $63,919.83 and states that this balance must be vacated before any tax free distribution of Capital Surplus can be made to the shareholders. In the computation a proposed annual dividend of $24,250.00 was deducted, a sum of $3,638.00 being a payment of 15% tax on an amount equal to the dividend paid in the fiscal year ending in 1950, and a transfer to tax free surplus of $20,612.00, leaving a balance of $15,419.83 which would require to be paid to the shareholders as a cash dividend if the Earned Surplus Account was to be cleared.
The payment of 15% tax and the transfer to Tax Free Surplus were made because the Company had elected, under the provisions of the Income Tax Act to pay tax on its undistributed surplus at the end of the 1949 fiscal year.
The report and seven schedules attached to it show the steps to be taken by the Company—
Schedule “A” outlined the amount required for the payment of the annual dividend, the proposed payment of 15% tax and the proposed transfer to the Tax Free Surplus, and showed a balance required to be distributed as a special dividend of $15,419.93, so as to reduce the Earned Surplus to nil.
Schedule ‘‘G’’ was entitled “Capital Surplus Adjusted for the Purpose of Distribution to Shareholders’’ and showed a balance of $172,551.07.
Schedule “B” is entitled: ‘‘Proposed Distribution of Capital Surplus’’. The Auditors’ statement is:
“Provided that the steps outlined in Schedule ‘A’ have been taken before October 31, 1951, the Capital Surplus of $172,- 551.07 may be distributed to the shareholders by way of a cash or a stock dividend, which will be tax-free if made before October 31, 1951. If made on or after November 1, 1951, the shareholders will be taxable to the extent that profits are earned in the year ended October 31,1952.” (Italics are mine.)
Schedule “ F ” sets out the adjustments of the Earned Surplus Account for the purpose of distribution of Capital Surplus.
The minutes of the Company record that on October 24, 1951, the Board of Directors had placed before it the report of the Company’s auditors ‘‘ which dealt with a method of distributing to the shareholders the Capital Surplus on the books of the Company in the sum of $172,041.07’’. (sic?)
By resolution of the Board of Directors the auditors’ report was made part of the Minutes of the Meeting, and it was resolved that the method of procedure outlined in the auditors’ report be followed. The Company elected to pay in accordance with Section 95(a) of the Income Tax Act, a 15% tax on its undistributed income of $24,250. A stock dividend of 19,400 shares of preference stock of the Company of a par value of $1.00 per share was declared and a resolution provided that the shares be issued and distributed ‘‘as a stock dividend to the holders of common shares’’ pro rata in accordance with their respective holdings at the close of business on October 24, 1951.
A further resolution provided that a proper notice of redemption of 19,400 shares of preference stock of the Club be sent to all shareholders of record as of the close of business on October 24, 1951.
A cash dividend of $7.50 per share was declared on the outstanding common shares of the Company as of that date.
A final resolution reads as follows :
“A stock dividend of 169,750 shares of preference stock of this Club of the par value of $1.00 per share be and the same is hereby declared and that the said 169,750 shares of preference stock of this Club be issued and distributed as a stock dividend to the holders of common shares of this Club, pro rata, in accordance with their respective holdings of common stock of record on the books of this Club at the close of business on October 25,1951.” (Italics are mine.)
It is to be noted that there is nothing in the minutes of this meeting that gives any indication as to when or how these shares might be redeemed.
Prior to May 27, 1952, negotiations had been carried on with the directors of the Company which culminated in the purchase by the Ontario Jockey Club (Limited) of all the issued and outstanding common shares of the Company at a price of $275.00 per share.
The minutes of a meeting of the directors held on May 27,1952, show that ‘‘the Chairman advised the Board of the informal discussions held with respect to the issued and outstanding preference shares.’’ The Secretary put before the Board a statement showing the requirements of the Club with respect to the cash projection to the end of the second race meet for the year. The minutes show this statement had been submitted to the Manager of the Canadian Bank of Commerce and that the Manager had advised that he would authorize credit on the Company’s note in the amount of $175,000 for the redemption of the preferred shares, and a further credit in the sum of $150,000 to $200,000 for requirements of the race meeting on an open account. The minute goes on to state :
“It was felt that the Executive Committee could determine the method of financing both redemption of the preferred shares and the two race meets.”
This was followed by the following minute :
“It was moved by Mr. Sherman and seconded by Mr. R. P. Isbister and resolved that the 169,750 Redeemable Preference Shares of the Club be redeemed as of May 27, 1952, and that proper notice of the redemption of the said shares be sent to all Shareholders of record on the books of the Club at the close of business on May 27, 1952.”
The notice was sent out accordingly, and the shares were redeemed.
Pursuant to the resolutions passed at the respective directors’ meetings, on December 20, 1947, the trustee received from the company a tax free dividend of $8,049.08, which was paid out of the undistributed income of the company on hand at October 31, 1939. On April 9, 1951, the trustee received from the company certificates in the form I have mentioned for 13,575 non-cumula- tive 5% preference shares of a par value of $1.00 each as a stock dividend, which shares were immediately surrendered for redemption at $1.00 per share. The notice from the company accompanying the stock dividend recites the by-law passed on December 4, 1950, providing for the stock dividend and the motion made to redeem the stock forthwith. The notice reads in part as follows:
44 NOTICE is hereby given that The Hamilton Jockey Club (Limited) (Herinafter called ‘the Club’) will on and after Monday, April 9, 1951, redeem the whole of the presently outstanding 5% Non-cumulative Preference Shares of the par value of $1.00 each in the Capital Stock of the Club (hereinafter called the ‘Preference Shares’) by payment to the holders thereof at their face value of $1.00 per share.’’
The shares were immediately surrendered for redemption and the trustee received $13,575. On October 27, 1951, the trustee received from the company a letter addressed to the shareholders of the company dated October 25, 1951, enclosing 3,000 non- cumulative 5% preference shares of a par value of $1.00 each as a stock dividend. A notice accompanying an enclosed cheque, a preferred share certificate and notice of redemption reads in part as follows:
‘Your Directors have been endeavouring to place in the hands of the Shareholders, free from personal income tax, a capital surplus which has been chiefly derived from the capital gain obtained at the time of the sale of the Jockey Club Hotel. To do this it is necessary to wipe out entirely the earned surplus.
To that end your Directors have elected to pay a 15% tax to the Government and to declare a preferred stock dividend of the value of $4.00 for each common share held by you, which is non-taxable income to you. ’ ’
In addition to the stock dividend, a dividend of $7.50 per share on the common stock was paid at the same time. The accompanying letter states:
“This represents the usual dividend of $5.00 per share plus $2.50 per share which latter amount was sufficient to wipe out the balance of the earned surplus. This dividend represented by the enclosed cheque is taxable income to you.
Shortly you will be advised of your Directors’ actions in placing in your hands the capital surplus of the Club by way of a further preferred stock dividend.”
Attached to the letter to shareholders was a notice of redemption of the preferred shares which reads as follows:
4 Notice is hereby given that The Hamilton Jockey Club (Limited) (hereinafter called ‘the Club’) will on October 24, 1951, redeem the whole of the outstanding 5% Non-cumulative Redeemable Preferred Shares of the par value of $1.00 each in the capital stock of the Club (hereinafter called the 4 Preferred Shares’) of date of issue October 24, 1951, by payment to the holders thereof the par value thereof.
The Club will pay the redemption price to or to the order of the registered holders of the said Preferred Shares on presentation and surrender of the certificates for such shares at the office of the Club, 21 Main Street East, Hamilton, Ontario.
And notice is also given that from and after October 24, 1951, the said Preference Shares shall cease to be entitled to dividends and the holders thereof shall not be entitled to any rights in respect thereof except that of receiving the redemption price.
Dated at Hamilton, Ontario, October 24, 1951.”
On October 27, 1951, the trustee received from the company 26,250 non-cumulative 5% preference shares of a par value of $1.00 each. The notice from the company accompanying this stock dividend reads in part as follows :
“You were advised in our letter of the 25th instant that the earned surplus had been wiped out and as a consequence the capital surplus could be distributed to you. This can only be done by way of issuance of preference shares.
Accordingly, your Directors have declared a stock dividend and the enclosed preference share certificate represents your share of the distribution among the shareholders of the capital surplus.
Your Directors do not intend, at the present time, to redeem this certificate but upon redemption at some future time it is our best present advice that the proceeds therefrom will not be taxable income to you.”’
On May 27, 1952, the trustee received a notice of redemption of the 26,250 preference shares. The notice states that the redemption price will be paid to or to the order of the registered holders of the preferred shares on presentation and surrender of the certificates for such shares. It goes on to state:
‘‘Shareholders were informed under the dates of October 25 and October 26 last, that the above Preferred Shares, now called for redemption, represented a distribution of the Club’s Capital Surplus and that the proceeds therefrom are not, we understand, taxable income to the Shareholders.’’
I prefer to deal first with the last distribution of shares as the facts surrounding it differ distinctly from those surrounding the distribution and redemption of the first two issues in the following important respects :
(1) The fund which provided the capital warranting the issue of the shares was, up until the time of the issue, treated by the company as a capital surplus. (I do not think this is a material fact, but it is a fact that has been the subject of much discussion in some of the cases to which I shall refer. )
(2) The fund had been so absorbed into the capital assets of the company that there were no funds with which to redeem the shares without pledging the general credit of the company.
(3) Certificates for the shares were issued on October 25, 1951, under the seal of the company, and from that date the holders of the shares had all the rights of preferred shareholders and the obligations relative to those rights were imposed on all the assets of the company.
(4) The shares were not redeemed until May 27, 1952.
(5) The redemption of the shares at any future date was dependent on the credit of the company or the liquidation of its assets.
(6) The company’s credit affecting its power or desire to borrow money from the bank might have been affected between the time the shares were issued and redeemed in many ways; for instance, legislative action affecting horse racing and betting on race-tracks similar to Order-in-Council 1452, June 7, 1917, which repealed for the duration of the war and six months thereafter subsection (2) of Section 235 of the Criminal Code, thereby making all betting at race courses illegal ; or an emergency appeal as was issued in the United States of America by James F’. Byrnes on January 3, 1945, with instructions to prevent the use of manpower or materials for the purpose of horse racing; or heavy taxes as were imposed in Statutes of Ontario, 10-11 Geo. V,
c. 9; or an increase in the present licence fee and tax of eight per cent imposed on bets placed at a race-track; or action taken by the proper legislative authority as was considered in Re Race- Tracks and Betting, 49 O.L.R. 339 ; or if the company had been a commercial or investment company, it might have suffered severe loss through fire, unpredicted competition or reverses in the stock market.
(7) Before the shares were redeemed, the company was negotiating for the sale of all its assets.
Counsel for the life tenants argued that the decisions in Re Fleck, [1952] O.R. 113; [1952] C.T.C. 196, 205 and Re Mills, [1953] O.R. 197; [1953] C.T.C. 115, apply to this case and that without further consideration the matter should be disposed of in favour of the life tenants. In both of those cases the shares in question were shares in a company incorporated under the Dominion Companies Act and for reasons which I shall give in due course the provisions of the Dominion Companies Act so differ from the Ontario Companies Act that it makes it necessary for me to consider this case solely in the light of the rights of the parties with respect to shares in a corporation that exists under the Act authorizing its incorporation. I find I must therefore review in some detail many of the decided cases that bear on the subject.
These cases may best be considered in their chronological order. In so far as there may be any apparent conflict in those decisions, I must regard the decisions in the Judicial Committee as binding, at the same time following any interpretation of those decisions by our own Courts, where questions of law are involved.
Three cases form the background of the discussion in later eases: Irving v. Houstoun, 4 Pat. Se. App. 521, Paris v. Paris, 10 Ves. Jr. 185, and In re Barton’s Trust, 5 Eq. 238.
In Irving v. Houstoun by a testamentary deed it was directed that the widow of the deceased should have a life interest in 144 shares held in the Bank of Scotland stock ‘ 1 to receive the dividends when due, or becoming due thereon’’. Recently before his death the testator had subscribed for a certain number of these shares and at his death a considerable part of the subscriptions, which were repayable by instalments, was unpaid. The Bank of Scotland declared a bonus or extraordinary dividend arising from accumulated capital and not as an ordinary dividend arising from profits. The bank detained this bonus to answer the instalments not then paid up of the stock which had been subscribed for, but Lord Eldon stated that the question remains the same between the life tenant and the remaindermen as if the calls or instalments had been regularly paid up when they became due. In the Court below it was held that the life tenant was entitled to the whole sum as a dividend falling due on the bank stock of her deceased husband. The House of Lords reversed the decision, holding that the bonus dividend belonged to the capital of the estate. As I read the case, and as it has been interpreted in later cases, the decision in this case turned on the fact that the Bank of Scotland had what was called a ‘‘floating capital which was laid out in the purchase of exchequer and navy bills, in discounts and in every species of property that can be turned into cash at pleasure’’. Lord Elton said at page 530:
“Every person who buys bank stock is aware of this; and if he gives the life interest of his estate to any one, it can scarcely be his meaning that the liferenter should run away with a bonus that may have been accumulating on the floating capital for half a century. ’ ’
In Paris v. Paris Lord Eldon held, following prior decisions, that an extraordinary dividend declared by the Bank of England was capital in the hands of the trustee and refused to draw a distinction between a dividend distributed in cash and one distributed by an issue of stock and he did not consider the fact that the fund out of which the dividend was declared was earned during the lifetime of the tenant was relevant.
In In Re Barton’s Trust shares in a company were settled upon trust to pay A during her life ‘ 4 the interest, dividends, share of profits, or annual proceeds, ’ ’ and after her death in trust for her children. During the lifetime of the life tenant the company by resolution applied a portion of ‘‘the net earnings during the half- year’’ to necessary works and issued new shares to represent the money so applied. Vice-Chancellor Sir W. Page Wood held that the shares so issued were capital in the hands of the trustee. This case, like others I shall discuss, dealt with an ordinary issue of shares to which surplus earnings were credited. No question of redemption arose.
These cases were carefully considered in Bouch v. Sproule (1885), 29 Ch.D. 635, and in the House of Lords, 12 App. Cas. 385. This is a much discussed case. In order to appreciate the force, meaning and effect of the language used by the learned law lords in the House of Lords, it is necessary to examine the nature of the argument before Kay, J., and the learned Lord Justices of Appeal. The directors of the company, in which the testator held shares, had power, before recommending a dividend, to set apart out of the profits such sum as they thought proper as a reserve fund, for meeting contingencies, equalizing dividends, or repairing or maintaining the works. The directors recommended that the reserve fund and ‘‘undivided profit’’ be distributed as a “bonus dividend’’ of £2 10s. per share, and that there should be created new £10 shares amounting in number to one- third of the original shares, on which £7 10s. had been paid up, so that one new share might be allotted to each shareholder for every three original shares which he held, £7 10s. per share to be paid on allotment, which £7 10s. the bonus would enable him to pay. The recommendation of the directors was adopted, and at a general meeting of shareholders a warrant was issued to each shareholder for the bonus to which he was entitled, in the following form:
i Consett Iron Company Limited
Bonus dividend warrant of £2 10s. per share, payable on the 30th of September, 1880, to the members registered in the company’s books on the 25th of September, 1880.
No. 102
Name of member : Thomas Bouch, Esq.
Number of shares: : 600.
Amount of bonus dividend : £1500.
William Cockburn, Registrar.
I hereby authorize and request you to apply the above amount in payment of the call of £7 10s. per share on the 200 new shares that have been alotted to me pursuant to the special resolutions passed etc.
Signature of member, .”
The trustee accepted the dividend warrant and the shares, signed the memorandum and returned it to the company. The 200 shares in the company allotted to the trustee were thereupon registered in his name with £7 10s. credited on each share. The argument presented before Kay, J., on behalf of the life tenant was that the form of the resolution and the form of the warrant showed that the bonus was against dividends and that the monies arising from the undivided profits were expressly divided by the directors as a bonus dividend. Kay, J., considered that the case was extremely like Paris v. Paris and it was doubtful if the bonus dividend would in any case have gone to the life tenant. He pointed out that the shares had been allotted when the bonus dividend was issued to the trustee and if the trustee had refused to accept the shares under the articles of association, the company might have cancelled the shares and the shares would have been forfeited, and accordingly he held against the life tenant. In the Court of Appeal, the argument was—Whether a bonus is capital or not, depends upon whether the company makes it capital or income; a bonus dividend is income, unless the company does something to make it capital; here the company did not, it was only the act of the trustee that made it capital; the bonus dividend came to the hands of the trustee as money, he applied it in taking up shares, and the shares therefore belonged to the life tenant. The case of Barton’s Trust was distinguished on the ground that the company simply allotted new paid-up shares. In addition, much of the argument in the Court of Appeal was addressed to whether the fund from which the distribution was made was earned during the lifetime of the testator or not and the effect of the decisions on this question. The arguments dealt with were stated by Fry, L.J., as follows :
‘ ‘ In addition to the argument from acquiescence or conduct, two other arguments have been adduced on behalf of the defendants. First, that independently of the way in which the company associated the declaration and payment of the bonus with the issue of new share capital, the bonus had become capital ; and secondly, that if not so, yet that in the present case the bonus was in fact, by the proceedings of the company, converted into share capital.”
The learned Lord Justice then reviewed in detail the relevant cases and particularly the statement of Lord Hatherley in I n re Barton’s Trust where he said:
“Where the company, by a majority of their votes, have said that they will not divide this money, but turn it all into capital, capital it must be from that time. I think that is the true principle.”
And at p. 655 he said :
“Furthermore, the question whether profits remain income or have been capitalized is in its nature a mere question of fact, and unless a series of decisions as to the effect of similar proceedings by companies, has, so to speak, turned this question of fact into a question of law, we should not regard the decisions as binding on the inquiry. ’ ’
And, after dealing with a number of decisions dealing with bank stocks, at p. 656 he said:
“These cases, however binding they may be under similar circumstances with regard to the same stocks, certainly do not appear to us to support to any extent the proposition now under investigation.”
And at p. 658 :
“These cases are sufficient to show that there has been no such continuous and unbroken current of authorities as would be required to establish such a doctrine as was contended for, viz., that payments out of accumulated profits were necessarily to be treated as payments out of capital. On the contrary, as is reasonable, the authorities leave the inquiry as one of fact upon the circumstances of each case.
The authorities appear to us further to establish this proposition, that in most, if not in all, cases the inquiry as to the time when the profits were earned by the company is an immaterial one as between the tenant for life and remainderman. Their rights have been made dependent on the legitimate action of the company, and (subject to any rights arising from the law of apportionment, with which we are not now dealing) we are of opinion that their rights are determined by the time, not at which the profits are earned by the company, but at the time at which they are by the action of the company made divisible amongst its members.’’ (Italics are mine.)
He concluded that the trustee had a right to demand the dividend and it was not contingent upon accepting the shares and they therefore accrued to the benefit of the life tenant. At p. 659, he said :
‘“The resolution of the company as to the payment of the bonus is a substantive and independent resolution, and we do not think that it authorized the directors to make the payment of the dividend contingent on the acceptance of the new shares. Nor do we think that the directors did by their acts make the payment of the dividend contingent on the acceptance of the shares. ’ ’
This statement throws in clear relief the precise problem dealt with in the House of Lords. There is was argued on behalf of the appellant that
(1) Whenever out of accumulated profits, which are part of the capital of the company, a dividend or bonus is declared in addition to the ordinary dividend, it is an accretion to the capital, and the corpus belongs to the remainderman.
(2) If it be not all capital there should be an apportionment according as the profit accrued during the testator’s life or afterwards.
On behalf of the respondent it was argued that a bonus dividend becomes income as soon as it is declared whether as bonus or dividend, unless the company makes it capital. In this case it was made capital by the trustees, not by the company, and it makes no difference that the dividend arose from accumulations made during the testator’s life.
It is to be emphasized that counsel did not argue that if the company made the dividend capital, it could in any sense be regarded as income. Lord Herschell discussed all the antecedent cases and particularly Irving v. Houstoun, 4 Pat. Se. App. 521, and at p. 397 stated that it
* 1 . . . must still be regarded as good law, unaffected by any counter-current of authority. But it is, in my opinion, an authority governing only a case similar in its facts; that is to Say, a case where the company has no power to increase its capital, but has accumulated profits and used them, in fact, for capital purposes, and afterwards distributes these profits amongst the proprietors. I think it will be seen that there is a substantial reason for the limitation I have suggested.’’
The Lord Chancellor went on to say
“I quite agree with the Court below that, apart from the authorities to which I have alluded, the general principle for for the determination of such a question as that before us, and in my opinion the only sound principle, is that which is well expressed in the judgment of Lord Justice Fry : ‘ When a testator or settlor directs or permits the subject of his disposition to remain as shares or stocks in a company which has the power either of distributing its profits as dividend or of converting them into capital, and the company validly exercises this power, such exercise of its power is binding on all persons interested under the testator or settlor in the shares, and consequently what is paid by the company as dividend goes to the tenant for life, and what is paid by the company to the shareholder as capital, or appropriated as an increase of the capital stock in the concern, enures to the benefit of all who are interested in the capital’. And it appears to me that where a company has power to increase its capital and to appropriate its profits to such increase, it cannot be considered as having intended to convert, or having converted, any part of its profits into capital when it has made no such increase, even if a company having no power to increase its capital may be regarded as having thus converted profits into capital by the accumulation and use of them as such.’’ (The italics are mine.)
He then proceeded to consider whether the company did distribute the accumulated profits as dividend or convert them into capital, and decided that in the form of the transaction it was not contemplated that any money would pass to the shareholders, and his conclusion was that the substance of the whole transaction was, and was intended to be, to convert the undivided profits into paid-up capital upon newly-created shares, and that the company did not pay, or intend to pay, any sum as dividend, but intended to and did appropriate the undivided profits dealt with as an increase of the capital stock in the concern. Lord Watson at p. 402 said :
“In these circumstances it was undoubtedly within the power of the company, by raising new capital to the required amount to set free the sums thus spent out of the reserve fund and undivided profits for distribution among the shareholders. It was equally within the power of the company to capitalise these sums by issuing new shares against them to its members in proportion to their several interests. I am of opinion that the latter alternative was, in substance, that which was followed by the company.”’
Lord Bramwell placed his judgment on the basis that the £7 10s. received for each of the three common shares could not be said to have bought a new share for the price of the new shares was that sum and the diminished value of the old shares. Lord FitzGerald did not disagree with the Court of Appeal as to the law but as to the inferences to be deduced from the admitted facts, and held that the declaration of a bonus or dividend was coupled with the creation of new capital and amounted to a capitalisation of the bonus, and the reasoning in I n Re Barton’s Trust directly applied.
Commissioners of Inland Revenue v. Blott, [1921] 2 A.C. 171, was a case involving taxation and whether the recipient of second preference shares that had been issued as fully paid in satisfaction of a bonus dividend declared was liable for super tax. Viscount Haldane said, at p. 179 :
14 What we have to decide is whether the allotment of bonus shares to the respondent was capital, or was in reality an allotment of annual profits which conferred a benefit chargeable in his hand with income tax, for if so it is not in controversy that the super-tax provisions will apply.”
After discussing Bouch v. Sproule (1887), 12 App. Cas. 385, and stating his views of the effect of corporate action he said, at page 182:
“The Company, acting with the assent so given of the shareholders, can decide conclusively what is to be done with accumulated profits. It need not pay these over to the shareholders. It can convert them into capital as against the whole world, including as I think the principle plainly applied, the Crown claiming for taxing or for any other purposes. The only question open is, therefore, whether the company has really done so.’’
And at page 184:
“My Lords, for the reasons I have given I think that it is, as matter of principle, within the power of an ordinary joint stock company with articles such as those in the case before us to determine conclusively against the whole world whether it will withhold profits it has accumulated from distribution to its shareholders as income, and as an alternative not distribute them at all, but apply them in paying up the capital sums which shareholders electing to take up unissued shares would otherwise have to contribute. If this is done the money so applied is capital and never becomes profits in the hands of the shareholders at all.”
At page 186 in discussing the effect of the judgments in Bouch v. Sproule the learned Lord Chancellor reaffirmed the principle of law to be applied as that set out by Lord Justice Fry which I have already quoted in the passage from the judgment of Lord Herschell. At page 197 Viscount Finlay considered Bouch v. Sproule and said :
“The incidence of the taxation depends upon the question, What is in fact the nature of the property on which the tax is claimed? If it is income it is liable to tax upon income; if it is capital it is not so liable. The liability follows from the nature of the property, and it seems impossible to me to say that the answer to the question whether it is income or not is to depend upon the purpose with which the question is asked. The circumstances which gave rise to the case of Bouch v. Sproule are very like those in the present case.’’
And at page 198 he points out that the option left to the shareholder to accept the dividend warrant was a nominal one and in the present case there is no option at all. The application of the bonus to increase the capital was compulsory. This last observation may be applied with emphasis to the case I am considering.
Lord Dunedin dissenting held the decision in Bouch v. Sproule did not apply where taxation was involved.
Lord Sumner, also dissenting, dealt at length with Bouch v. Sproule and accepted everything laid down in it but held that it did not apply to a taxing statute. At page 220, in interpretating the language of Lord Herschell in that case, he said:
“What he meant was something highly germane to the issue —namely, that the plan, which the company carried out, was not a mere plan for paying the usual dividend in a novel form, but was a more far-reaching design to bring about an increase in statutory capital without physically parting with cash. Such a design has a legal effect on those whose rights only arise on the footing that the design has been accepted and affirmed ; it has none on the officers of the revenue, whose rights are statutory and independent, and intervene before the point is reached, at which the interests of parties like those in Bouch v. Sproule become concerned.’’
In Inland Revenue Commissioners v. Fisher’s Executors, [1926] A.C. 395, Blott’s case was considered and applied in the House of Lords to the distribution of debenture stock out of earned profits. This was no doubt done so that the shareholders would not be subject to income tax on it. Lord Shaw of Dunfermline, at p. 406, said:
“Upon the legal side of the matter it must not be forgotten that all the necessary resolutions, confirmations, new articles of association, etc., required to regularize the transaction have been carried through. It is a transaction in itself unassailable in law. The result of it was to negate emphatically the idea of distribution to shareholders as income; on the contrary, it was to withdraw from each shareholder the sum which might have been given to him as income and to withdraw it definitely from an income fund. It was stamped as a capitalization transaction. Such a transaction was within the power of the shareholders of the company, and all, including the Crown, are bound by
that. Zt is incorrect in principle to attempt to get behind that transaction, legal and competent and regular in form, and to endeavour to construct a canon of liability to income tax out of conjecture as to the motive or scheme for the defeat of the revenue which underlay its various stages. The money so capitalized could not pass to a tenant for life. If the company were wound up, the whole would still be treated as its existing assets. ’ ’
At pp. 410 and 411 Lord Sumner refers to certain expressions in Bouch v. Sproule as to form and substance and at p. 411 said :
‘‘The proposition, that the substance of a transaction must be looked to and not merely the form, is generally invoked against those who have carried it out. I think it is unusual, where the form of a transaction is against those, whose transaction it is, to invoke the substance in their favour, in order to eke out what they have left defective in form. Sometimes again it is the ‘intention’ of the company that is said to be dominant: Burrell’s case ([1924] 2 K.B. at p. 68) ; sometimes it is what the company ‘desired’ to do ([1921] 2 A.C. at p.
200). In any case desires and intentions are things of which a company is incapable. These are the mental operations of its shareholders and officers. The only intention, that the company has, is such as is expressed in or necessarily follows from its proceedings. It is hardly a paradox to say that the form of a company’s resolutions and instruments is their substance.”
Any consideration of the relevant cases must involve reference to In re Mountain v. Bates, [1928] Ch. 682, a decision of Eve, J., a judge whose judgments have always carried great weight. A director of a company owning and operating steam trawlers sold some of their vessels for sums exceeding the values at which they stood in the Company’s balance sheet and carried the proceeds to a suspense account, and afterwards distributed them as cash bonuses to the shareholders with a covering letter stating that such bonuses were capital payments and not liable to income tax. In distribution of the warrants prominence was given to the statement that the payments were being made out of capital and were not in the nature of a dividend or bonus of shares. This was to protect the recipients from liability of taxation. At p. 687 Eve, J., said:
“ . .. but the mere impressing of these distributions with the appellation of ‘capital distributions’ cannot in my opinion determine their true character. One must inquire a little closer for the purpose of ascertaining whether they were in fact distributions of capital or distributions of something which, although in one sense capital, in that it originated by the realization of assets and not from the ordinary income of the company’s business, could not properly be regarded as capital for all purposes. The suspense account represented realized profit on the company’s capital assets, and inasmuch as the equilibrium between capital and liabilities on the one side and assets on the other was maintained without any necessity to resort to this fund, it represented what I think is spoken of in one of the cases as ‘the total appreciation of the capital assets’ ; that is to say, if you take on one side the liabilities of the company and on the other the whole of its assets the latter exceed the former by a sum which is in excess of the whole of this suspense fund, or, in other words, no part of it is required to satisfy either the creditors or shareholders of the company. In this state of affairs it was a fund which the company could treat as available for dividend and could distribute as profits, or having regard to its power to increase capital could apply to that purpose by, for example, increasing the capital, declaring a bonus and at the same time allotting to each shareholder shares in the capital of the company paid up to an amount equivalent to his proportion of the bonus so declared. Unless and until the fund was in fact capitalized it retained its characteristics of a distributable profit, and on the authority of the passages which have been read from Lord Herschell’s speech in Bouch v. Sproule, the only method by which a company with power to increase its capital can capitalize such a fund is to increase its capital by an amount equivalent to the sum sought to be capitalized.” (The italics are mine.)
In À. A. Hill and Others v. Permanent Trustee Company of New South Wales, Limited, [1930] A.C. 720, all cases to which I have referred were comprehensively considered by the Judicial Committee of the Privy Council and Lord Russel of Killowen, writing the judgment, appeared to endeavour to set at rest any confusion that may have arisen in the interpretation of the language used in the Sproule case and succeeding cases. At p. 730 he referred to the basis of the judgment in the Australian courts where the decision assumed the answer to the question of whether the dividend was capital or income depended upon ‘“what was the intention of the company in making the distribution.” Upon the whole evidence the trial Judge came to the conclusion that the distribution was in fact and was intended by the company to be a distribution of capital assets in anticipation of liquidation. He further held that in order to convert the profits into corpus as between tenant for life and remainderman, no conversion by the company of the profits into share capital was necessary but that profits distributed might be corpus as between tenant for life and remainderman, even though no formal part of the fund was retained by the company in a capitalized form. He realized this was in conflict with In re Bates but he felt bound by previous decisions of the High Court of Australia ; Knowles v. Ballarat Trustees, Executors and Agency Co., 22 C.L.R. 212 and Fisher v. Fisher, 23 C.L.R. 337. The learned law lord, before referring in detail to the cases, laid down five principles of law, at pp. 730 et seq.:
“ (1) A limited company when it parts with moneys available for distribution among its shareholders is not concerned with the fate of those moneys in the hands of any shareholder. The company does not know and does not care whether a shareholder is a trustee of his shares or not. It is of no concern to a company which is parting with moneys to a shareholder whether that shareholder (if he be a trustee) will hold them as trustee for A. absolutely or as trustee for A. for life only.
(2) A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorized reduction of capital. Any other payment made by it by means of which it parts with moneys to its shareholders must and can only be made by way of dividing profits. Whether the payment is called ‘dividend’ or ‘bonus’, or any other name, it still must remain a payment on division of profits.
(3) Moneys so paid to a shareholder will (if he be a trustee) prima facie belong to the person beneficially entitled to the income of the trust estate. If such moneys or any part thereof are to be treated as part of the corpus of the trust estate there must be some provision in the trust deed which brings about that result. No statement by the company or its officers that moneys which are being paid away to shareholders out of profits are capital, or are to be treated as capital, can have any effect upon the rights of the beneficiaries under a trust instrument which comprises shares in the company.
(4) Other considerations arise when a limited company with power to increase its capital and possessing a fund of undivided profits, so deals with it that no part of it leaves the possession of the company, but the whole is applied in paying up new shares which are issued and allotted proportionately to the shareholders, who would have been entitled to receive the fund had it been, in fact, divided and paid away as dividend.
(5) The result of such a dealing is obviously wholly different from the result of paying away the profits to the shareholders. In the latter case the amount of cash distributed disappears on both sides of the company’s balance sheet. It is lost to the company. The fund of undistributed profits which has been divided ceases to figure among the company’s liabilities; the cash necessary to provide the dividend is raised and paid away, the company’s assets being reduced by that amount. In the former case the assets of the company remain undiminished, but on the liabilities’ side of the balance sheet (although the total remains unchanged) the item representing undivided profits disappears, its place being taken by a corresponding increase of liability in respect of issued share capital. In other words, moneys which had been capable of division by the company as profits among its shareholders have ceased for all time to be so divisible, and can never be paid to the shareholders except upon a reduction of capital or in a winding up. The
fully paid shares representing them and received by the trustees are therefore received by them as corpus and not as income.’’ (The italics are mine.)
Bouch v. Sproule was referred to at p. 732 where Lord Russell stated
“It is not an authority which touches a case in which a company parts with moneys to its shareholders. The essense of the case was that the company, not by its statements, but by its acts, showed that what the shareholders got from the company was not a share of profits divided by the company, but an interest in moneys which had been converted from divisible profits into moneys capitalized and rendered for ever incapable of being divided as profits. In those circumstances it was held that shares which were issued to a trustee shareholder, and which represented the moneys so capitalized, were as between his cestuis que trust corpus and not income, because the company had decided that the profits in question should be permanently added to the company’s capital.”
The ratio decidendi of that decision as I conceive it to be is that where a shareholder is a trustee what is in the minds of the directors or shareholders when a distribution is made is not relevant in considering what are the respective rights of life tenant and remainderman. The company manifests its intention by its acts and its acts only. Injustice may result but if a testator makes no provision in his will with respect to this aspect of his estate, the law must take its course and it is not for the Court to do other than give effect to the legal acts of the company. In the ease before the Judicial Committee there was no issue of shares and no increase in capital and it was decided that, notwithstanding that there was a declaration that the company was paying a dividend for the purpose of making a distribution of its capital assets in advance of winding up, the dividend nevertheless belonged to the life tenant.
The last judgment of the Judicial Committee dealing with the subject matter is Commissioner of Income-Tax, Bengal v. Mercantile Bank of India, Limited, [1986] A.C. 478. This was a revenue case and was decided under the provisions of the Indian Income Tax Act, but certain statements of Lord Thankerton are relevant to the question here under consideration. He referred to Blott’s case at p. 493 and adopted the interpretation of the principle of that case placed on it by Lord Cave in Fisher’s Case, [1926] A.C. 325, who quoted from the opinion of Lord Haldane which I have already quoted in considering the Blott case, and at p. 495 said:
‘* Lastly, their Lordships are clearly of opinion that the personal motive or purpose of the individual shareholders, even if they hold a controlling interest in the company, is irrelevant, if it is made out that the company has in fact capitalized the accumulated profits.” (The italics are mine.)
And at p. 496:
‘ 4 It is hardly a paradox to say that the form of a company’s resolutions and instruments is their substance.’’
Aykroyd v. Commissioners of Inland Revenue, [1942] 2 All E.R. 667, is another revenue case and the decision of a single Judge. Counsel for the life tenants relies on the statement of the learned Judge where he said at page 668, ‘‘ . . . the question whether the debentures issued by the Firth Carpet Co. should be regarded as capital or as income depends to some extent on the prospect of their redemption—a matter which Lord Sumner considered to be immaterial.’’ The learned Judge was referring to the opinion of Lord Sumner in the Fisher case. With great respect, I cannot entirely agree with the interpretation that the learned Judge put on the judgments of the learned law lords in the Fisher case, nor do I treat the language of Lord Sumner in the same manner. It is not clear to me that the other learned law lords were in disagreement with him. The passage quoted from the judgment of Viscount Cave at p. 668, in my view tends to support the view of Lord Sumner where it is said :‘ ‘ The company was, therefore, master of the situation, and it elected definitely and irrevocably not to distribute the fund as income, but to impound and apply it as income-producing capital; and that election, if made (as I do not doubt that it was made) in good faith, was binding on the shareholders and could not be questioned by the Crown . . . The whole transaction was ‘bare machinery’ for capitalizing profits and involved no release of assets either as income or as capital. ’ ’
In In re Doughty, [1947] 1 Ch. 263, a company having power by its articles of association to distribute dividends in specie, and, in particular, dividends by way of capitalization of profits by the distribution of paid-up shares, debentures or debenture stock of the company, did not act under this power but under another power given by its articles of association that ‘‘ . . . the company in general meeting of the directors . .. may . . . pass a resolution . . . that any surplus capital moneys or capital profits in the hands of the company whether arising from the réalisa- tion of capital assets . . . or received in respect of any capital assets . . . shall be divided among the members of the company by way of capital distribution in proportion to their rights.’’ It was held that the power under which the company acted, on its true construction, merely authorized the distribution of capital profits and did not purport to fix their character as between tenant for life and remainderman; and that accordingly the sums received by the executors were to be treated as income. Lord Justice Choen at page 270 set out in full the principles that I have already quoted from the judgment of Lord Russell of Kil- lowen in Hill v. Permanent Trustee Co. of New South Wales, and at page 271 emphasized that the moneys were clearly not capitalized under the first paragraph of the articles to which I have referred. From a careful reading of the judgment it would appear that if they had been, no difficulty would have arisen in the ease.
In In re Harrison’s Will Trusts, [1949] 1 Ch. 678, Roxburgh, J., considered a case where a company, having no power in its articles to increase its capital, adopted an article enabling it at any time to resolve that any surplus moneys in its hands representing moneys received or recovered in respect of or arising from any of its capital assets or investments representing them to be distributed among its members on the footing that they receive them as capital. The company made distributions under the article and the question was raised as to whether the proceeds were held by the trustees as capital or income. The learned Judge followed In re Doughty.
In In re Sechiari, Deceased: Argenti v. Sechiari (1950), 66 T.L.R. (Part 1) 531, Romer, J., held that where a company has sold its assets and taken shares in payment therefor in another company, and distributed the same to its shareholders in specie, in proportion to their holdings, the trustees held the shares as income in their hands. He relied on the second principle enumerated by Lord Russell of Killowen in the Hill case.
In re Duff’s Settlements : National Provincial Bank Ltd. v. Gregson and Others, [1951] 1 Ch. 923, is the most recent decision of the English Court of Appeal and it contains reasoning that I think is very applicable to the case before me, notwithstanding the fact that the facts are dissimilar. The trustees were holders of shares in a company from which from time to time allotted shares at a premium and, in accordance with Section 56 of the Companies Act, 1948, transferred the aggregate of the premiums to a share premium account. In 1950 the company passed a resolution to pay thereout 2s. 6d. in respect of each fully paid share. The resolution was sanctioned and the trustees received a proportionate sum in respect of the shares held by them. Section 56 of the English Companies Act reads as follows :
“56. (1) Where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account, to be called ‘the share premium account’, and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the share premium account were paid up share capital of the company.
(2) The share premium account may, notwithstanding anything in the foregoing subsection, be applied by the company in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares . . .
(3) Where a company has before the commencement of this Act issued any shares at a premium, this section shall apply as if the shares had been issued after the commencement of this
Act... ”
At page 926 Jenkins, L.J., giving the judgment of the Court, stated that had it not been for the provision of Section 56 of the Companies Act, if the company had distributed among its shareholders any of the sums representing premiums received on the distribution of shares, the proportion of such distribution attributable to any trust holding of shares would have been income and not capital as between persons successively interested under the trust, following In re Bates, Hill v. Permanent Trustee Company of New South Wales Ltd., In re Doughty and In re Sechiari. He however went on to say :
“The share premiums would have been profits available for dividend (see Drown v. Gaumont-British Picture Corporation, [1937] Ch. 402), and if any part of them had been distributed by the company otherwise than in liquidation the amount received by trustees in respect of a trust holding would necessarily have been income in their hands, because it was neither a payment in reduction of paid up share capital nor an addition to the shareholders’ capital investment in the company, but
simply a cash distribution which, no matter how described, and notwithstanding that in the hands of the company it bore the character of a capital, not an income, profit could not in law be anything else in the hands of the recipients than income derived from their shareholdings.’’ (The italics are mine.)
At page 928 the learned Lord Justice deals with the effect of Section 56 of the Compames Act and holds that the section takes the share premium account out of the category of divisible profit and prevents it from being distributed by way of dividend. After referring to the cases I have already quoted, he said :
4 'Moreover, the terms of the section seem to us to show that where (as in the present case) the transaction in question is a distribution amongst shareholders of the share premium account, or part thereof, that transaction is to be treated as if the company was reducing its capital by paying off paid up share capital.’’
And at page 929:
‘What reason is there for holding that the capital character with which the trustees’ proportion of the amount was thus impressed when it left the company was effaced and replaced by an income character when it reached the hands of the trustees? For our part we can see none. We think the hypothesis enjoined by the section must follow the amount received by the trustees and determine its character and destination in their hands also. The cases to which we have referred show that the character, as a matter of company law, of any given distribution as it leaves a company determines its character in the hands of the recipient. The relevant company law in the present case seems to us to require that the distribution here in question should be treated from the point of view of the payer, that is, the company, as a distribution by way of return of capital. It follows, to our minds, that the trustees’ proportion of the distribution should similarly be treated in their hands as paid up capital returned by the company.” (The italies are mine.)
At page 930 the learned Lord Justice makes a comment very relevant to the case before me:
"The section, as we read it, produces the same result on a direct distribution of a share premium account as if the company had first gone through the formality of actual capitalization by bonus shares and then paid off the bonus shares by way of reduction of capital.”
And on the same page he dealt with the argument with reference to the ‘‘mechanics’’ (provided by Section 56) in these words:
“ . . . still the 'mechanics’ are, in our judgment, an essential factor in determining the character as between capital and in- come of the sum distributed. A company, having an artificial person, can (as it has been laid down) make a distribution amongst its members (otherwise than in a winding up) in one of two ways—but only in one of two ways: that is, by a distribution of divisible profit, that is by way of dividend; and by way of a return of capital pursuant to an order of the court upon a petition for reduction of capital in accordance with the Act.”
Under Section 61 of the Dominion Companies Act, 25 Geo. V, c. 33, the redemption of fully paid up preference shares in accordance with the letters patent or supplementary letters patent or by-laws, shall not be deemed to be a reduction of capital in certain defined circumstances, and in these circumstances alone. They are these :
(1) If the redemption is made out of the proceeds of an issue of shares made for the purchase of such redemption; or
(2) Where no cumulative dividends on preferred shares or shares of the same class are in arrears, and
(a) the redemption is made without impairment of the com- payn’s capital out of ascertained net profits of the company that have been set aside by the directors for the purposes of the redemption, and
(b) Such net profits are available to be applied for the redemption of the shares in liquid form as certified by the company’s last balance sheet being made up to date not more than ninety days prior to the redemption, after giving effect to the redemption.
Where shares are so redeemed, the surplus resulting therefrom shall be designated as a capital surplus and shall not be reduced or distributed by the company except as provided in Sections 49 to 58 which deal with means of reducing capital.
It is to be noted that what Section 61 provides for is the redemption or purchase for cancellation of fully paid preferred shares. At page 330 the learned author of Masten & Fraser, Company Law of Canada, 4th ed., comments on this and states that “By implication the section appears to require compliance with Sections 49 and following in respect of a reduction of capital in the case of a redemption or purchase for cancellation of preferred or other redeemable shares, made otherwise than in accordance with the conditions set out in the section.’’ It is stated :
“It will be noted that the shares to be purchased or redeemed must be fully paid and that, unless the redemption or purchase is made out of the proceeds of a fresh issue of shares, there must be no arrears of cumulative dividends and the redemption or purchase must be made out of ascertained net profits, available as liquid assets, set aside by the directors for the purpose. In order to comply with the section it is necessary to have a balance sheet certified by the company’s auditors made up to a date not more than ninety days prior to the redemption or purchase showing the requisite available net profits and that the directors should have set aside ascertained net profits of the company for the purpose.”
The question was not argued before me and has no bearing on the subject I have to decide except as to whether Re Fleck and Re Mills are binding upon me in this case, but in the absence of argument if this procedure is followed it is difficult for me to see how a company can appropriate from its profits a fund to be applied as the capital of fully paid preference shares and so draw its balance sheet and then use the same fund to redeem the shares without reduction in capital in compliance with Sections 49-58 of the Act. On the other hand, the provision in Section 61 is that the redemption of preference shares is not to be taken as a reduction of capital, if in fact the shares after having been fully paid up are redeemed out of profits that have not been appropriated to create the fully paid up preference shares.
There is, however, no similar provision in the Ontario Companies Act to that contained in Section 61 of the Dominion Act. Sections 78 to 82 deal with preference stock. Section 78(2) states :
“The directors of a company may make by-laws,
(a) for creating and issuing any part of the capital as preference shares.”
Section 80 provides for the creation or issuance of preference shares and that the by-law ‘ 1 may provide for the purchase or redemption of such shares by the company as therein set out.’’ The limitation of the rights of holders of the shares must be fully set out on the certificate. Subsection (2) is important:
4 No such by-law which has the effect of increasing or decreasing the capital of the company, or increasing the amount of the preference stock authorized by the special Act, letters patent. . . shall be valid or acted upon until confirmed by supplementary letters patent.’’ (The italics are mine.)
Subsection (3) qualifies subsection (2) in that it does not apply to a by-law which creates or attempts to create redeemable or con- vertible preference shares, but a certified copy of the by-law must be filed forthwith with the Provincial Secretary
Coupled with these sections is to be read Section 96 :
“For the amount of any dividend which the directors may lawfully declare payable in money, they may declare a stock dividend and issue therefor shares of the company as fully paid or partly paid, or may credit the amount of such dividend on the shares of the company already issued but not fully paid, and the liability of the holders of such shares shall be reduced by the amount of such dividend. ’ ’
This brings me to consider the two cases bearing on the subject in our own Courts. Re Fleck, supra, a decision of Hogg, J.A., affirmed in the Court of Appeal, [1952] O.W.N. 260; [1952] C.T.C. 205. Some of the facts in this case are similar to the case I have under consideration and some are dissimilar. There Hogg, J.A., was dealing with a so-called dividend of a Company incorporated under the Dominion Companies Act. A resolution of the directors recited (a) that the company had on hand $606,488.60 ‘ ‘ undistributed income ’ 9 at the end of the taxation year of 1949 ; (b) that dividends of $606,000.00 had been paid since the commencement of business in 1943 to 1950 ; and (c) the provisions of the Income Tax Act whereby upon the payment of 15% of the amount of undistributed income at the end of the 1949 taxation year the balance of such undistributed income might rank as tax paid on distributed income in the form of redeemable shares which will be tax free to the shareholders and the company may thereafter redeem the said shares subject to the powers of the Companies Act; and (d) :
“And whereas the Company may, after first paying the aforementioned special tax in respect of its undistributed income as at December 31, 1949, pay a like special tax on that portion of income earned in 1950 and subsequent years that is equivalent to the amount of ordinary dividends paid in such years and thereby have the balance of said portion of income rank as tax paid undistributed income which may thereupon be distributed in the form of redeemable shares tax free to the shareholders and be thereafter redeemed subject to the provisions of the Companies Act. "
The company then passed a by-law authorizing the issue of a stock dividend and passed a resolution declaring a stock dividend out of the undistributed income and on the same date passed a resolution reciting that the company had issued 1,000 non-cumu- lative, redeemable 5% preferred shares of the par value of $100.00 each and resolved that the shares be redeemed and they were accordingly redeemed. It does not appear that any share certificate was actually issued or any evidence of title to the shares ever came into the hands of the shareholders.
The learned Judge, after discussing some of the cases to which I have referred, stated the principal of law to be applied in all these cases at p. 119 :
‘“The principle to be deduced from these judgments is that there must be, in fact, a conversion by the company of its profits or surplus into share capital in order that they shall be regarded as corpus and not income in the hands of a trustee, or as between a life tenant and a remainderman. Furthermore, that where a company has the power to deal with profits by converting them into capital of the company such exercise of its power is binding upon the person interested under a trust of the original shares set up by the testator’s will.”
In applying the principle he said at p. 120 :
“These shares did not form part of the paid-up capital of the Company and therefore the surplus profits represented by them were not capitalized. The steps taken by the Company were induced because of the provisions of the Income Tax Act. When redeemable preferred shares are issued pursuant to Section 59 of The Companies Act, 1934 (Can.), c. 33, Section 61 provides that the redemption of such shares is not to be deemed a reduction of the paid-up capital stock of the company if such redemption is made according to the conditions stipulated.”
The fund in the hands of the trustees as a result of the redemption of the shares was held to be for the benefit of the life tenant. In the Court of Appeal the cases are not discussed by the Court but it was held that the money constituted income in the hands of the trustees and went to the life tenant. It is to be observed that Hogg, J.A., placed his decision squarely on the provisions of the Dominion Companies Act and held that the shares coming into the hands of the trustees did not form part of the paid-up capital of the company.
In Re Mills, supra, my learned brother Gale followed Re Fleck with respect to the issue and redemption of shares in a Dominion company where the circumstances were somewhat different. If I felt the Fleck case and the Mills case applied to the facts before me I would unquestionably follow them, but, with respect, I do not think they do. Whether the procedure followed in those cases complied with Section 61 of the Dominion Act is not for me to discuss as the point was not argued before me and does not appear to have been argued in those cases. The Ontario Act is, however, as I have pointed out, distinctly different from the Dominion Act. In the ease before me the directors applied to the Provincial Secretary for, and obtained, Supplementary Letters Patent which,
(a) designated the 5,000 shares of the capital stock of the company of $100.00 each as 5,000 common shares of $100.00 each; and (b) increased the capital stock of the company from the sum of $500,000.00 to the sum of $1,000,000.00, by the creation of $500,000.00 5 % non-cumulative redeemable preference shares of $1.00 each ranking in priority to the common shares. The rights and conditions attached to the preference shares were set out in the letters patent and the share certificates were evidence of an interest in the capital of the company. The balance sheet for the year 1950 showed among the liabilities a capital surplus (re sale of hotel) of $169,900.38, a share capital of 4,850 shares of $100.00, amounting to $485,000.00. Following the issue of the Supplementary Letters Patent on February 9, 1951, the balance sheet as of October 31, 1951, showed on the liability side:
‘ ‘ Capital
Authorized
500,000 Non-Cumulative Redeemable Pre-
ferred Shares of $1.00 par value $ 500,000.00 5,000 Common Shares of $100 par value _- 500,000.00 $1,000,000.00 Issued 276,935 Non-Cumulative Redeemable Pre ferred Shares $ 276,985.00 Less 107,185 Shares Redeemed 107,185.00 $ 169,750.00 4,850 Common Shares 485,000.00 $ 654,750.00”
In the light of the authorities which I have discussed it seems to me clear that the company in fact and in law capitalized the capital surplus and when the certificate for 26,250 shares came into the hands of the trustee it was evidence of a capital interest in the company to the extent of its holdings. Adopting the language of Griffith, C.J., in Knowles and Haslem v. Ballarat Trustees, Executors and Agency Company Limited, 22 C.L.R. 212: a share in a joint stock company is a legal entity which connotes a right to an ascertained part of the property of the company and is evidenced by documents, which include a share register and share certificates. When the trustee received the certificate for the shares which I am now considering that is precisely what it had. If by reason of any unforeseen circumstances such as I have heretofore referred to, the shares had not been redeemed and the company had been wound up, the holders of the preferred shares could not have been denied their right to be paid in full the amount “paid up on the preferred shares’’ together with all the dividends declared and unpaid, out of the assets of the company, as set out in paragraph 4 of the endorsement on the certificates.
In fact, the company was doing nothing more than capitalizing its capital surplus until it should be in liquid funds so that the shares might be redeemed without any question arising as to taxation. In fact, as I read the Income Tax Act, the capital surplus might have been distributed in the circumstances in cash without being taxable. To apply the language of Jenkins, L.J., in In re Duff’s Settlements, and the language of Lord Russell of Killo- wen in the Hill case, the character, as a matter of company law, of any given distribution as it leaves the company determines its character in the hands of the recipient, and, therefore, when these preferred shares were issued as against the fund in question, the fund had been rendered incapable of being distributed as profits.
As between tenant for life and remainderman the corporate acts of the company determine their rights, and when I say this I use the words advisedly and I mean the corporate acts having regard to their legal consequences in relation to the corporate structure as distinct from a resolution or declaration which does not affect the corporate structure of the company as was considered in many of the cases to which I have referred. I, therefore, come to the conclusion that the answer to the third question is that the sum received by the trustee upon redemption of the shares referred to therein is corpus of the estate.
That brings me to deal with the first two dividends. Here, the directors were seeking to do two things—(1) to take advantage of the powers conferred under the Income Tax Act to place in the hands of the shareholders the earned surplus so that it would reach them in an untaxable form; and (2) to reduce the earned surplus to nil or a debit balance so that the capital surplus might be released for distribution in some form without attracting taxation.
Much argument was addressed to me with reference to the provisions of the Dominion Income Tax Act and their effect. It is not necessary for me to point out that no provision of a Dominion statute could affect the rights as between life tenant and remainderman (unless some action taken under emergency powers), with respect to shares in a company incorporated under the laws of a Province. I am refraining from entering upon any discussion with reference to shares held in a company incorporated under Dominion laws. Whether the provisions of the two Dominion statutes may in any way be read together is not for me to discuss in this case. The matter before me is to be determined by provincial law and provincial law alone. It may be that if one is permitted to go behind the corporate acts for the purpose of determining the motive of those responsible for the corporate acts, the provisions of the Dominion Income Tax Act have some relevance but no provision in it as to what is to be deemed “capital” or “income” has any bearing on the rights of the parties in this case.
With reference to the shares referred to in questions 1 and 2 the corporate steps taken were precisely the same. Acting under the provisions of Section 96 of the Ontario Act, a stock dividend was declared and shares were issued as fully paid up shares. In order to do this the funds from the surplus account must necessarily have been appropriated to the capital account and credited on these shares. When this was done, the trustee was made the holder of fully paid shares in the company and the certificates issued were evidence of that interest. There was not the lapse of time during which circumstances might have changed making it impossible for the directors to carry out their plan of redeeming the shares. But I cannot see how the fact that the share certificate was accompanied by the notice of redemption and the cheque alters the corporate character of the transaction. ‘‘The form of a company’s resolutions and instruments is their substance.” In this case the form and substance was that the trustee was made the holder of fully paid up shares as soon as they were issued. That being true, the company had, by its acts, concluded the question of whether the shares were in fact and in law corpus or income. The fund against which the shares were issued as fully paid up shares could not thereafter be by judicial decision recast into distributable profits. In every case in British jurisprudence which I have been able to find, except Re Fleck and Re Mills, which I regard as decisions not binding on me, where shares have been issued as against accumulated profits it has been held that they were capital and not income. The Barton case, the Blott case and the Fisher case are all clear examples. On the other hand, much argument has revolved around the question as to whether distribution of profits in any other form has been capital or income, depending on the declaration by the company of “intention” or ‘‘the substance’’ of the transaction as in the Sproule case and the Bates case. On the facts of the case before me I find that the company, by the issue of the preferred shares, determined the answer to both questions 1 and 2 and my conclusion is that the sum received by the trustee referred to therein is corpus of the estate.
The costs of all parties will be out of the estate, those of the executor on a solicitor and client basis.
I may add that this is a matter of very great importance, not only in the administration of estates but in the drafting of wills, and it is to be hoped that the law to be applied in all its aspects is settled with finality and clarity at an early date by the highest Court in Canada.