A family holding company ("MPSI") paid a stock dividend of preferred shares, having nominal paid-up capital and a redemption amount of $48,000, on the Class B non-voting shares of MPSI, which were held by a family trust ("MFT"). MFT then sold these preferred shares to "McClarty" (the family patriarch, holder of the Class A voting shares of MPSI and sole trustee of MFT) in consideration for a demand promissory note of $48,000. The capital gain of approximately $48,000 which thus was realized by MFT was distributed to the children beneficiaries of MFT by MFT issuing demand promissory notes to them. McClarty then sold his preferred shares of MPSI to a corporation ("101 SK") of which he was the sole shareholder and director in consideration for a $48,000 demand promissory note, which 101 SK then repaid out of cash proceeds received by it on the redemption of the preferred shares. The taxpayers alleged that these cash proceeds were used by McClarty to repay another loan (not described above) that had been made to him by MFT rather than the $48,000 promissory note that had been the consideration for his purchase of the preferred shares. The parties engaged in further similar transactions.
The series of transactions did not include an avoidance transaction. Although the series resulted in a clear tax benefit (the splitting of capital gains among the minor beneficiaries), every transaction in the series furthered McClarty's bona fide non-tax purposes of making himself indebted to MFT, and eroding his interest in MSPI to the benefit of MFT. Angers J. found that these transactions all were intended to protect McClarty's assets in the event that a firm which had been his former employer brought action against him for alleged theft of its intellectual property and goodwill. Furthermore, although the transfer by MPSI of $48,000 of value to MFT could have been accomplished in a more tax-ineffective manner (by MPSI declaring a full dividend for distribution by MFT to the children beneficiaries, which would have engaged the "kiddie tax" under s. 120.4), the fact of such an alternative transaction did not detract from the actual (stock dividend) transaction being implemented primarily for creditor-proofing reasons.