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CONTENTS  Life Insurance Policy: How to Extract Funds from a Corporation with No Tax Impact Constructive Dismissal Analyzed in the Context of a Business Acquisition The Right of Withdrawal, a Controlled Form of Contractual Freedom Transfers of Residences Involving a Spousal Testamentary Trust LIFE INSURANCE POLICY: HOW TO EXTRACT FUNDS FROM A CORPORATION WITH NO TAX IMPACTLuc Pariseau with the collaboration of Martin Bédard, articling studentIndividual shareholders who wish to withdraw funds from a corporation can face some tax challenges that are sometimes difficult to overcome. Nevertheless, there are various ways of achieving this objective that limit or eliminate the negative tax consequences to the shareholder and the corporation, provided certain conditions are complied with. The transfer of a life insurance policy by an individual shareholder to a corporation where the two are in a non-arm’s length relationship is often an effective way of accomplishing this.The technique is simple. The individual transfers his policy to his corporation and receives a consideration equal to the fair market value of the policy, as determined by an actuary. The consideration paid by the corporation may be in the form of money or a promissory note that will be paid when the corporation has the necessary cash available. By operation of the ITA, the proceeds of disposition are deemed to be equal to the cash surrender value of the policy transferred at the time of the disposition.1The shareholder is then taxed on the difference between the cash surrender value of the policy and its adjusted cost base, and the resulting gain, if any, is considered to be income from property and not a capital gain.2 Assuming that the cash surrender value of the policy is low and that its fair market value is high, the shareholder will benefit from a significant disbursement of funds with little or no negative tax impact.The fair market value of a policy will be higher than its cash surrender value, for instance, where the insured’s health condition has deteriorated since he or she took out the policy. This will also be the case where the theoretical premium for a comparable policy would be higher than that paid for the policy in question for financial reasons attributable to the type of policy purchased or to changes in pricing.As for the corporation, it ends up making a non-deductible outlay of funds and acquiring an interest in an insurance policy with an adjusted cost base equal to its cash surrender value. Thus, upon the death of the shareholder, in addition to receiving the insurance proceeds, the corporation will also benefit from an increase in its capital dividend account equal to the indemnity received, less the adjusted cost base of the policy.3The Canada Revenue Agency acknowledges the validity of this type of planning, but seems to be uncomfortable with the result.4 It has submitted this issue to the Department of Finance which has indicated that it is studying the issue. However, no amendment has been made to the statute to date, more than 10 years after the issue was raised for the first time in 2002.In addition, there are certain advantages to the corporation holding the insurance policy and paying the premiums, particularly the fact that the after-tax cost of the premiums is often lower to the corporation than it would be to the shareholder.The foregoing analysis is obviously general in nature and a more detailed assessment is advisable for any individual who is in a position to transfer a personally owned policy to a corporation.________________________________  1 Subsection 148(7) of the Income Tax Act (“ITA”).  2 Subsection 148(1) and paragraph 56(1)(j) ITA.  3 Subsection 89(1) “capital dividend account” d) ITA.  4 CRA, Technical Interpretation 2002-0127455, “Non arm’s length disposition” (May 7, 2002); CRA, Technical Interpretation 2003-0040145, “Transfert d’une police d’assurance-vie” (October 6, 2003); ARC, Technical Interpretation 2008-0303971E5, “Transfer of a life insurance policy” (May 27, 2009).CONSTRUCTIVE DISMISSAL ANALYZED IN THE CONTEXT OF A BUSINESS ACQUISITIONGuy Lavoie and Élodie Brunet with the collaboration of Brittany Carson, articling studentIn the case of St-Hilaire c. Nexxlink inc.1 the Court of Appeal of Québec analyzed the concept of “constructive dismissal” in the specific context of a business acquisition.In this case, Nexxlink was the subject of an acquisition that resulted in a series of changes to the business, some of which affected the employment conditions of Mr. St-Hilaire. Believing that this had resulted in substantial changes to the essential conditions of his employment contract, Mr. St-Hilaire left his employment shortly after the transaction, alleging that he had been constructively dismissed. He claimed $525,000 in damages from Nexxlink.The Court of Appeal affirmed the decision of the Superior Court, holding that Mr. St-Hilaire had not been constructively dismissed.According to the criteria laid down by the Supreme Court of Canada, constructive dismissal involves [translation] “1) a unilateral decision by the employer, 2) a substantial change or changes to the essential terms of the employment contract, 3) the employee’s refusal of the changes, and 4) the employee’s departure.”2 These criteria are assessed from the perspective of a reasonable person placed in the same situation.3In the context of the transaction in this case, the change in the title of Mr. St-Hilaire’s position from vice-president, business development to vice-president, infrastructure equipment sales did not amount to a substantial change in his employment conditions nor a demotion, but rather a change in the organization of the business, which was within the management rights of Nexxlink.With respect to the changes alleged by Mr. St-Hilaire to his responsibilities and target market, these were only fears. In the context of a business acquisition, some of the senior executives’ duties may be changed or clarifi ed over time: [translation] “a period of uncertainty or adjustment is entirely foreseeable”. According to the Court, a reasonable person placed in the same context as Mr. St-Hilaire could have foreseen that he would have retained his client accounts, and that various opportunities could be expected within the new business.With regard to Mr. St-Hilaire’s compensation, it consisted primarily of a base salary of $170,000, a $40,000 bonus plan, and 20,000 stock options at the time he started his employment.Contrary to Mr. St-Hilaire’s allegations, the Court found that the criteria for awarding the annual bonus had not been substantially changed. Moreover, even if this had been the case, his employment contract expressly stated that the bonus plan could be changed simply upon the approval of the board of directors. As for the cancellation of the stock options, even if this could be considered to be a reduction in Mr. St-Hilaire’s compensation, he never complained about it before leaving the company. According to the Court, Mr. St-Hilaire undoubtedly did not feel that this was an essential condition.In conclusion, the Court of Appeal found that Mr. St-Hilaire was aware of the role that was reserved for him in the new business. The structure he complained of was temporary and uncertain. In the context of this transaction, the allegations of constructive dismissal were ill founded.The interest of this decision lies in the fact that it relativizes the concept of constructive dismissal in the specific context of a business acquisition, in addition to reiterating the principle that the structure of a business is not bound to remain static.________________________________  1 2012 QCCA 1513 (C.A.)(affi rming 2010 QCCS 2276 (S.C.)).  2 Id., para. 29, citing Farber v. Royal Trust Co., [1997] 1 S.C.R. 846 (hereinafter “Farber”).  3 Farber, para. 26.THE RIGHT OF WITHDRAWAL, A CONTROLLED FORM OF CONTRACTUAL FREEDOMCatherine MéthotThe right of withdrawal, also referred to as an “opting out” clause, is the right given contractually or by law to a party to withdraw from a transaction without justifi cation prior to it being actually entered into. Although the withdrawal clause may procure a high degree of freedom, one cannot invoke it in a cavalier manner. Indeed, a withdrawal clause cannot be used in a malicious or abusive manner, nor can it run against the requirements of good faith. Furthermore, to be valid and effective, a withdrawal clause must be enforceable and explicit.The Court of Appeal of Québec recently reminded us of these principles in the case of London v. Kyriacou.1 In this case, the owners of a day-care centre (the “Sellers”) accepted from Mrs. Kyriacou and Mrs. Teologou (the “Purchasers”) an offer to purchase the daycare centre. The sale was initially scheduled to take place on September 29, 2006. This date was thereafter postponed several times and the terms of the offer were also amended on several occasions as the months went by. Among other things, the parties agreed to increase the sale price by $150,000.00 conditionally to the day-care centre being granted a government subsidy within 15 months from the date of the sale. As soon as autumn 2006, the Sellers introduced the Purchasers to the parents of the children attending the day-care centre as being the new owners of the facility from January 2007. In May 2007, the Purchasers began operating the day-care centre and acting like true owners, particularly by having repairs made at their own cost and establishing a new educational program. From May 2007, the parties exchanged several draft sale agreements and the transaction was to take place in August 2007. However, on August 10, 2007, following receipt of a letter from government authorities confi rming that the day-care centre would be subsidized beginning in March 2008, the Sellers notifi ed the Purchasers that they were withdrawing from the negotiations. They also changed the locks of the day-care centre and denied access thereof to the Purchasers.The Purchasers brought a motion for the transfer of title before the Superior Court of Québec to force the Sellers to carry out the transaction. The Sellers opposed the motion, among other things alleging that the initial offer to purchase included an opting-out clause, which they were entitled to rely upon. The clause read as follows: “After due diligence is said and done and all conditions have been agreed upon, if one of the parties’ purchaser or vendor refuse to go ahead the other will be liable for professional fees occurred.”In the first instance, the Superior Court refused to apply the clause because the Sellers had acted in bad faith all along the negotiation process, that further, the clause was not explicit and that had it been explicit, the Sellers, by their actions (particularly by encouraging the respondents to operate the day-care centre and the substance of the discussions on the sale agreement) waived its application. The Superior Court found from the evidence that all the conditions mentioned in the original offer had been satisfied and that there had been an agreement on all the new elements raised thereafter by the Sellers. In short, the terms of the transaction had been agreed upon by the parties and it only remained to make it offi cial by executing an agreement. The Superior Court therefore ordered the parties to sign the agreement and the Court of Appeal affirmed that decision.Although including an opting-out clause in a contract or a letter of offer may constitute a very attractive strategy, the decision summarized in this bulletin articulates the importance of carefully drafting it and demonstrates that one is better to consult a professional before relying on it.________________________________  1 2013 QCCA 37.TRANSFERS OF RESIDENCES INVOLVING A SPOUSAL TESTAMENTARY TRUSTDiana DarilusThe sale of a house by a spousal testamentary trust and the purchase of a new residence in replacement of the former may result in adverse tax consequences if all required precautions are not taken prior to the fact.EXEMPTION FOR PRINCIPAL RESIDENCEWhen a spousal testamentary trust gains possession of a house following the death of a taxpayer and thereafter wishes to dispose of it, the availability of the principal residence exemption to reduce the taxable capital gain resulting from the transfer must be ascertained.Furthermore, the tax act1 provides for certain presumptions when a taxpayer disposed of a house in favour of a spousal testamentary trust through a tax rollover upon death so the trust can benefit from the principal residence exemption for the years during which the deceased taxpayer owned the house.Generally a spousal testamentary trust may benefit from the principal residence exemption upon the sale of the house for all the years during which the deceased taxpayer or the trust itself owned it, to the extent that several conditions are met.One of these conditions is that when the trust was the owner of the residence, the residence must have been ordinarily inhabited by a specified beneficiary, by the spouse or common-law partner or the former spouse or common-law partner of such beneficiary or a child of such beneficiary. A specified beneficiary generally means any person benefi cially interested in the trust who ordinarily inhabited the housing unit (or has a spouse or common-law partner or former spouse or common-law partner or a child who ordinarily inhabited the housing unit).Furthermore, prior to designating the house as principal residence for the years of ownership by the deceased taxpayer while he or she was living or by the trust itself, the trust must also ascertain that no principal residence designation on another property has been made in respect of these years, neither by the deceased person or his or her family unit, nor by a specified beneficiary or his or her family unit.MAINTENANCE OF TESTAMENTARY TRUST STATUSIn the context of a transaction for the sale and purchase of residences involving a testamentary trust, one must be careful not to jeopardize the testamentary trust status of this trust, which benefits from taxation at progressive rates.Therefore, in order to retain its testamentary trust status, no item of property must be contributed to the trust otherwise than by an individual on or after his or her death and as a consequence thereof. The trust could then lose its testamentary trust status and related tax benefits if, for example, it does not deal at the fair market value when acquiring the new residence: the seller may be considered as having made a contribution equal to the excess of the fair market value of the property over the fair market value of the consideration paid by the trust.Subject to certain exceptions, the testamentary trust status of the trust may also be lost if the trust incurs a debt or any other obligation owed to, or guaranteed by, a beneficiary of the trust (for example, the spouse of the deceased person) or another person with whom a beneficiary of the trust does not deal at arm’s length.CONCLUSIONThe tax consequences of transactions involving real property transferred by or to a spousal testamentary trust should always be carefully reviewed beforehand in order to avoid unpleasant surprises.________________________________  1 Income Tax Act.

The Courts have considered the concept of constructive dismissal on many occasions. Generally, the expression “constructive dismissal” refers to situations in which an employee does not agree to a substantial change made unilaterally by his employer to one or more essential terms of his employment contract, and leaves his employment for this reason. In the case of St-Hilaire v. Nexxlink inc.,1 The Quebec court of appeal analyzed the concept of constructive dismissal in the specific context of a business acquisition. ST-HILAIRE V. NEXXLINK INC.When he began his employment in June 2004, the Plaintiff, Louis St-Hilaire, held the position of vice-president, business development with Nexxlink Inc. (hereinafter “Nexxlink” or the “employer”). Mr. St-Hilaire was responsible for major accounts and his contract provided for, in particular, a base salary of $170,000, a $40,000 bonus plan and 20,000 stock options of Nexxlink.  On December 9, 2004, Mr. St-Hilaire was notified that Bell PME, a subsidiary of Bell Canada, had acquired all the shares of Nexxlink. On December 24, 2004, Mr. St-Hilaire and all the other stock option holders learned that their stock options were cancelled as a result of this transaction. On January 31, 2005, the senior executives were informed of the functions that would be assigned to them in the new business. Mr. St-Hilaire’s new position was as vice-president, infrastructure equipment sales (responsible for the purchase and sale of infrastructure equipment). On February 4, 2005, less than two months after the transaction was completed, Mr. St-Hilaire notified the employer that he was leaving his employment because he felt that the conditions of his employment had been substantially changed. He blamed the employer for having excluded him from the integration committee, contrary to most of Nexxlink’s other senior executives. He also asserted that his new position was unrelated to his skills, that his responsibilities had been substantially reduced, and that he had not originally been hired for this type of position. He claimed that he had been constructively dismissed. In response, the employer indicated that the acquisition had no effect either on Mr. St-Hilaire’s role in the business, his responsibilities, compensation, benefits or client accounts. Since no changes to his responsibilities had been under consideration, the employer felt that Mr. St-Hilaire did not have to participate in the integration committee. Finally, the employer regarded Mr. St-Hilaire’s departure as a resignation. In June 2005, Mr. St-Hilaire filed a motion to institute proceedings in the Superior Court alleging that he had been constructively dismissed by Nexxlink and claimed $525,600 in damages2. The Superior Court dismissed this claim on the grounds that Mr. St-Hilaire had failed to show that the essential terms of his employment contract had been substantially changed, although there had been some changes to his employment conditions in certain respects.3 Mr. St-Hilaire was dissatisfied and appealed the decision. THE COURT OF APPEAL’S DECISION To begin with, the Court referred to the criteria developed by the Supreme Court of Canada in the case of Farber v. Royal Trust Co.4 to define the concept of constructive dismissal: [translation] “(1) a unilateral decision of the employer, (2) substantial changes to the essential terms of the employment contract, (3) the employee’s refusal of the changes, and (4) the employee’s departure.”5 In its analysis, the court must ask itself whether a reasonable person in the same situation as the employee would have considered there to have been a substantial change to the essential terms of his employment contract.6. The court added that in order to distinguish between the employer’s management rights and a unilateral and substantial change to an essential term of the employment contract, one must consider all the circumstances and specific features of the situation. In the context of a transaction involving two businesses, it is neither surprising nor unusual that some of the employee’s responsibilities will be modified.7. The Court then analyzed the various changes raised by Mr. St-Hilaire. Change in his title, target market and responsibilities The Court acknowledged that the demotion or loss of prestige and status of an employee within a business may be regarded as a substantial change to the essential terms of his employment contract. Mr. St-Hilaire complained that he was subjected to such treatment and referred, in this regard, to the promotion obtained by one of his colleagues and the additional responsibilities assigned to another colleague. The Court found that Mr. St-Hilaire could not claim, in the context of the sale of a business, that there was a right to maintain the entire organizational structure of the business prior to the acquisition, and that the changes made to the company’s organization were within the management rights of the employer. According to the Court, unlike the situation in the Farber case, Mr. St-Hilaire had not been demoted per se. Other employees obtained promotions due to their good work, and these changes did not amount to a substantial change to Mr. St-Hilaire’s conditions of employment. With respect to the changes to his responsibilities and target market pleaded by Mr. St-Hilaire, the Court indicated that Mr. St-Hilaire’s fears failed to materialize. In the context of a transaction, some of the senior executives’ duties may be changed or clarified over time and [translation] “a period of uncertainty or adjustment is to be fully expected.” Based on several elements in the file, it could be concluded that a reasonable person placed in the same context as Mr. St-Hilaire could have anticipated that he would have retained his client accounts, and that there would likely be various opportunities within the new business. The alleged substantial changes to the essential terms of the employment contract must be real and not only based on apprehensions. In the instant case, the Court held that a reasonable person would have concluded that he essentially retained, for the most part, the responsibilities he had previously held in his former position. Minor changes to a senior executive’s responsibilities following the acquisition of a business by a new owner are insufficient to conclude that there was a constructive dismissal. Change in the criteria for awarding his annual bonus and cancellation of his stock options The Court noted that Nexxlink had not terminated the bonus plan. However, Mr. St-Hilaire pleaded that the objectives contained in the plan had become impossible to achieve, particularly due to the changes to his responsibilities and position. The Court dismissed this argument, adding that even if the criteria for awarding the annual bonus had actually been changed as a result of the transaction, these changes could not form the basis of Mr. St-Hilaire’s action because his employment contract expressly provided that the bonus plan could be amended by approval of the board of directors alone. As for the stock options, these were part of the variable compensation and had been negotiated by Mr. St-Hilaire as an integral part of his compensation package at the time he was hired. The stock option plan expressly provided for the fair and equitable compensation of the stock options in the event of an acquisition of the business. However, even if the cancellation of the stock options could be regarded as a reduction in his compensation, before he left Nexxlink, Mr. St-Hilaire never mentioned that he considered the cancellation thereof, without compensation, to be a substantial change to the essential terms of his employment contract. Since Mr. St-Hilaire had never voiced his disagreement with the changes, the Court therefore concluded that he probably did not regard the stock options as an essential term of his contract. CONCLUSION This case is interesting mainly because it provides perspective on the concept of constructive dismissal and analyzes it in the particular context of a business acquisition. In such a context, it is reasonable to expect that there will be uncertainty and instability for a number months and changes to the business. In addition, the Court of Appeal drew an interesting parallel with the facts in Corriveau v. Sedgwick Ltd.8, in which the resignation of an executive was found to be premature in the context of a business merger. Indeed, although Mr. Corriveau had been informed that his position would become redundant after the merger, his employment conditions had not yet been changed and the employer had assured him of the possibility of employment with the new business. In the instant case, Mr. St-Hilaire was aware of what his role was intended to be in the new business and the structure he complained of was temporary and uncertain. The allegations of constructive dismissal in the context of this transaction were ill-founded. The judgment in St-Hilaire should encourage employees affected by structural changes in a business to think twice before jumping to the conclusion that they have been constructively dismissed, lest they fail the test of the “reasonable person in the same situation”. Businesses, for their part, must ensure that the changes made to an employee’s terms of employment and compensation meet the criteria of the test formulated by the Supreme Court of Canada in the Farber case._________________________________________   1 St-Hilaire v. Nexxlink inc., 2012 QCCA 1513 (C.A.).  2 The damages claimed included his base annual salary, bonuses, allowances, pay in lieu of notice, severance pay and the loss caused by the cancellation of his stock options.  3 See the judgment of the Superior Court: St-Hilaire v. Nexxlink inc., 2010 QCCS 2276 (S.Ct).  4 [1997] 1 S.C.R. 846 (hereinafter “Farber”).  5 Para. 29 of the Court of Appeal’s decision.  6 Farber, para. 26, cited by the Superior Court in para. 81 of its decision.  7 Lemieux v. Marsh Canada ltée., 2005 QCCA 1080 (C.A.).  8 D.T.E. 2003T-232 (C.A.).

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