On December 12, 2008, the Federal Court of Appeal released its judgment in the case of 2530-1284 Quebec Inc. The main issue in the case, which concerned a series of transactions that the taxpayers had put in place to generate capital dividend accounts in a vertical chain of corporations, went to whether the income generated was capital or income. The Federal Court in its judgment confirmed the lower court decision that amounts paid to taxpayers were business income and not capital and that dividends distributed to the implementers of the structure were ordinary taxable dividends and not capital dividends.
The case is notable in its finding in respect of a daylight overdraft arranged by the parties with the Royal Bank of Canada for approximately $10,000,000 which funded the transactions. The lower court held that the transactions entered into by the taxpayers that created capital dividend accounts for sale to third parties were shams and amounted to an abuse of the provisions of the Income Tax Act (Canada). In so holding, the Court made some broad statements that suggested that the initial daylight overdraft might not be a real loan. However, in the Federal Court of Appeal, the Court held that the daylight overdraft was indeed a loan. The fact that the funds could not have been used for any purpose other than the particular purpose for which they were advanced, and the fact the borrowers of the funds did not have "absolute enjoyment" of the funds was not critical in determining whether the daylight overdraft could be considered a loan. The Court pointed out that a loan that is extended for only a particular purpose is not exceptional, and that the funds were used for the purpose for which the advance was authorized and the cheques were indeed certified by the Royal Bank. Additionally, the fact that the cost of the loan was paid by a service charge instead of interest did not mean the funds advanced was not a loan. The Court noted that the doctrine of sham requires an element of deceit, and it was not possible to conclude that the Royal Bank, the planners and implementers of the plan and corporation in receipt of the loan misrepresented their relationship of lender/borrower. Accordingly, the loan could not be held to be a sham. The case is significant because it refutes any suggestion reflected in the Tax Court judgment that a daylight loan is not a real or legal loan.
http://decisions.fca-caf.gc.ca/en/2008/2008fca398/2008fca398.pdf
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