2529-1915 Québec Inc. v. Canada, 2009 DTC 5023 [at at 5585], 2008 FCA 398 -- summary under Subsection 83(2)

Overview of facts. The two individual taxpayers devised a scheme to: generate artificial capital gains of $110 million in some home-grown companies; pay the supposedly resulting capital dividend accounts (CDAs) of $55 million to another company (1915); generate artificial capital losses in the home-grown companies to offset their capital gains; effectively sell negotiated portions of the CDA to 3^rd-party purchasers by having them subscribe for preferred shares at a 21% premium to their redemption amount with the shares' redemption amounts effectively being flowed out to the 3^rd parties as purported capital dividends; and then pocketing such subscription "premiums" as capital dividends paid out to them. Readers who are satisfied with this overview may skip the next three paragraphs.

Artificial generation of $55M CDA in home-grown companies. A stack of 13 wholly-owned corporations was formed (i.e., so that the 1^st to 12^th subsidiary were direct or indirect subsidiaries of the 13^th corporation), with the proceeds of a daylight loan to the first subsidiary being used by it to subscribe for $10 million of preferred shares of its immediate parent (the second subsidiary), and so on up the chain so that the 12^th subsidiary subscribed for preferred shares of the 13^th corporation. The 2^nd subsidiary the declared a stock dividend on the preferred shares held by the 1^st subsidiary consisting of "gainmaking" preferred shares with a redemption amount of $10 million and a nominal adjusted cost base, and so on up the chain so that 12 of the 13 subsidiaries were holders of gainmaking shares. The 2^nd subsidiary then sold its gainmaking shares to the 1^st subsidiary in consideration for a $10 million demand promissory note of the 1^st subsidiary (realizing a capital gain of approximately $10 million), and so on up the chain so that 12 of the 13 subsidiaries realized total gains of approximately $110 million and an addition to their capital dividend accounts of approximately $55 million. The 13^th subsidiary paid a cash dividend of $10 million to the 1^st subsidiary in order that it could repay its daylight loan. They then increased the par value of the gainmaking shares in their capital (now all held by the 1^st subsidiary) resulting in s. 84(1) deemed dividends totalling approximately $55 million being received by the 1^st subsidiary, and a purported addition to its CDA of the same amount. After they had thus paid out their CDAs, the subsidiaries offset the gains they had realized on the gainmaking shares by selling their preferred shares to one of the individual taxpayers (Faraggi) for their nominal value.

Transfer of $55M CDA to 1915. One of the corporate taxpayers (1915) subscribed for preferred shares of the 1^st subsidiary and received a purported capital dividend of approximately $55 million thereon.

"Sale" by 1915 of CDA and pocketing of 21% "commission" by individual taxpayers. At various subsequent junctures, 1915 effectively transferred negotiated portions of its CDA to 3^rd-party corporations. These corporations subscribed to different classes of preferred shares of 1915 at a premium of $210 per each $1,000 redemption amount of preferred share and received a dividend (designated to be a capital dividend) of approximately $1,000 per share on those shares (thereby reducing their redemption amounts to a nominal amount). The two individual taxpayers effectively received these premiums from 1915 as capital dividends on preferred shares.

Gains generated on income account. After finding that the daylight loan used in the transactions and the promissory notes issued in the transactions issued in the transactions generating capital gains were not shams, and finding that the share premiums generated by 1915 were business income, Noël JA found that the "gainmaking" shares which were acquired for the purpose of their immediate resale so as to give rise to such gains were acquired on income account, given that "property acquired for resale is held on account of revenue" (para. 73).

Elections were shams. Given that these shares were acquired on income account, the subsidiaries in making capital capital dividend elections to flow out their CDAs to 1915 were making a misrepresentation which rendered such elections shams, and similarly the subsequent capital dividend elections by 1915 also were shams.