Mr. McClurg and Mr. Ellis each owned 400 voting and participating Class A shares and 37,500 Class C non-voting preference shares in a trucking company and Mrs. McClurg and Mrs. Ellis each owned 100 non-voting Class B shares which had a paid-up capital of $1.00 per share and were participating where so authorized by unanimous consent of the directors (who were their husbands). Each of the three categories of shares was entitled to receive dividends exclusive of the other classes.
Messrs. McClurg and Ellis declared annual dividends of $20,000 on the Class B shares, but none on the Class A's. S. 56(2) did not apply to redistribute $8,000 (= $10,000 x 400/500) of the $10,000 dividend received by Mrs. McClurg to her husband. Dickson, C.J. stated:
"The purpose of s. 56(2) is to ensure that payments which otherwise would have been received by the taxpayer are not diverted to a third party as an anti-avoidance technique. This purpose is not frustrated because, in the corporate law context, until a dividend is declared, the profits belong to a corporation as a juridical person ... Had a dividend not been declared and paid to a third party, it would not otherwise have been received by the taxpayer."
In addition, having regard to the commercial realities of the particular transaction, Mrs. McClurg had played a vital role in the financing of the formation of the company and the payments to her therefore "represented a legitimate quid pro quo and were not simply an attempt to avoid the payment of taxes".