Addy, J:—These three actions were, on consent, ordered to be tried together on common evidence.
The plaintiffs in the first two actions who shall hereinafter be referred to as the Canadian plaintiffs, are Canadian citizens and are resident and do business in Canada. They are brothers-in-law. The plaintiff in the third action is a citizen of India and has resided there at all material times. He is the brother of the plaintiff Harkishan Sandhu.
The three plaintiffs are all appealing a third and final assessment against each of them for the taxtion year 1974.
In 1971 the Canadian plaintiffs caused a partnership to be registered, pursuant to the laws of British Columbia, under the name of Punjab Express Foreign Exchange (hereinafter referred to as Punjab Express). In the partnership declaration the Canadian plaintiffs declared that they were the sole members of the partnership.
The business of Punjab Express was carried on from 1970 to 1976 when it ceased to operate, apparently due to the fact that its assets had been seized by the defendant. It had, during that period, carried on the business of a foreign currency exchange business in the City of Vancouver, which consisted of obtaining funds in Canadian dollars from clients in this country in order to have rupees remitted on their behalf to persons in India, who were generally relatives or friends of the Canadian clients.
The operations of Punjab Express generated a very substantial profit for the year 1974 and a substantial loss for the 1975 taxation year. The defendant issued its final re-assessments of the plaintiffs on the basis that they were all in partnership and allocated one-third of this loss against all of them which loss, pursuant to paragraph 111(1)(a) of the Income Tax Act, was carried back to 1974 so as to reduce the net income previously assessed for that year, the Canadian plaintiffs claim that, as they were the only two members of the partnership, one-half of the 1975 loss instead of one-third should be allocated against their respective profits for 1974. The Indian plaintiff on the other hand claims that he is not taxable at all because he is not a Canadian citizen and has never at any time carried on business in Canada. He alleges on the contrary that he has at all material times resided in and carried on business solely in India. He therefore claims not to be taxable under either section 2 of paragraph 253(b) or any other provisions of the Income Tax Act. The relevant provisions of the above- mentioned sections are as follows:
TAX PAYABLE BY PERSONS RESIDENT IN CANADA
2.(1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.
TAX PAYABLE BY NON-RESIDENT PERSONS
(3) Where a person who is not taxable under subsection (1) for a taxation year (a) was employed in Canada.
(b) carried on a business in Canada, or
(c) disposed of a taxable Canadian property.
EXTENDED MEANING OF CARRYING ON BUSINESS
253. Where, in a taxation year, a non-resident person
(b) solicited orders or offered anything for sale in Canada through an agent or servant whether the contract or transaction was to be completed inside or outside Canada or partly in and partly outside Canada, he shall be deemed, for the purposes of this Act, to have been carrying on business in Canada in the year.
There are in effect two issues before the court:
(1) whether Punjab Express was a partnership consisting of only the two Canadian plaintiffs or of all three plaintiffs;
(2) whether, in the event of the partnership consisting only of the two Canadian plaintiffs, the Indian plaintiff was nevertheless deemed to be carrying on business in Canada.
Although during 1970 and early in 1971 Punjab Express was dealing with other brokers in England, subsequently and during all times material to this action it had dealt exclusively through a firm, which might conveniently be termed a money brokerage firm, known as Eastern Trade Corporation (hereinafter referred to as Eastern Trade). This firm which had offices in Coventry in England and also in Dubai, India, would receive from Punjab Express orders on behalf of the latter’s Canadian clients to remit certain amounts in rupees to designated persons in India. Eastern Trade would advise Punjab Express by telephone of the current amount of the exchange rate it would be charging to convert American dollars to rupees at any given time and Punjab Express would obtain from its clients in Canada, in addition to the amount required as a commission for its services, the required sums to be paid in rupees to the recipients in India.
By what was obviously some very devious channels which probably did not involve any actual transfer of funds to India, the amounts in rupees would be turned over by Eastern Trade to couriers or agents in India for delivery to the Indian beneficiaries. On confirmation of receipt by them, Punjab Express would at that time pay to Eastern Trade the amount previously agreed upon. In other words, Eastern Trade would grant Punjab Express a credit of 100 per cent of the amount of the orders until the latter was Satisfied that the money had been received in India by the various persons to whom it was to be given. The amounts were handed by the couriers or agents personally to the recipients in India and not through any bank.
Strangely enough, according to the evidence at trial, the rate of exchange charged its clients in Canada by Punjab Express, which necessarily had to include its commission, the fees to be paid the agents in India and possibly a fee for Eastern Trade, was inferior to the rate these clients would have been obliged to pay had they forwarded the money to India in a normal manner through chartered banks. The business in fact depended on this lower exchange rate and, to some extent perhaps, on the fact that the money was delivered more expeditiously and by hand to the ultimate recipients. No detailed nor direct explanation was given as to how Eastern Trade could possibly supply this service at a lower rate than the banks. As I stated previously, it was suggested that there probably never was any actual transfer of funds to India but that the amounts were paid in India from monies already available there from some unknown source. One can only speculate that possibly the source of the monies which Eastern Trade was using might account for the apparent bargain price exchange rates which included a door-to-door banking service. In any event, the business was certainly a clandestine one involving code names for the various parties and agents, as well as for the money being sent. For instance, the code word “ticket” was used to signify 100,000 rupees, the word “case” signified 200,000 rupees. Eastern Trade was referred to as “New Airlines” and the Indian plaintiff was “Inderjil” and also at times , as “Paramjil”.
The Indian plaintiff acted as one of the couriers or agents for the money which Eastern Trade made available for delivery. It appears that he looked after all of the deliveries of money ordered through Punjab Express required to be made within certain districts in the State of Punjab in India. The Canadian plaintiffs testified that he in fact took care of something over 50 per
negotiated for contracts of affreightment will be lower than rates negotiated for time charters or consecutive voyage charters, and a comparison of the rate agreed to in the contract between Associated Bulk Carriers Ltd and Murphy Oil Trading Company with the going rates for time charters and consecutive voyage charters in effect in 1968 bears this out.
While the rate in the Associated Bulk Carriers Ltd—Murphy Oil Trading Company contarct at “Intascale minus 622” appears to be low when compared to their prevalent rates for time charters or consecutive voyage charters for voyages between the Persian Gulf and US East Coast ports, it was agreed to be independent parties and thus presumably met their respective needs in March, 1968. It is therefore, in my opinion, a “fair market rate” or “fair market value” for the transportation of oil under the special conditions agreed to by the parties at that time for the 2 Zz year period specified.
2. Was the contract of February 1, 1970 (Exhibit 1, Book 1, Document 42) entered into between Murphy Oil Trading Company and Tepwin Company Limited a contract which was typical of contracts of affreightment normally entered into in the course of the tanker chartering trade?
This contract purports to be a subcontract of affreightment whereby the Murphy Oil Trading Company endeavours to charter to Tepwin Company Limited ships under charter to Murphy Oil Trading Company from Associated Bulk Carriers Ltd by virtue of the contract of affreightment of March 23, 1968.
There are, however, unusual features to this contract. In the ship chartering business the parties to a contract of affreightment are referred to as “owner” and “charterer”, respectively, and the parties to a subcontract of affreightment are referred to as “chartered owner” or “disponent owner” and “charterer”, respectively. The description of the parties employed in this contract of February 1, 1970, is not customary in the trade. The only conclusion I can come to as a person experienced in the business is that this contract was drawn by a person not familiar with the language in the trade. In fact, it appears from the transcript of Mr Monz- ingo’s examination for discovery (pp 293-294 . ..) that this contract was drawn “in house”, ie by an employee of the Murphy group of corporations.
Clause 1 of the contract provides that liftings are to be made commencing February 1,1970, and also that “the first lifting shall not be made prior to February 1, 1970”. Obviously, since the contract is to take effect on February 1, 1970, the reference to any liftings prior to that date is redundant. Also, it is patently impossible for no liftings to be made in the past, ie before February 1, 1970, and I have never seen any such clause in any contract entered into in the normal course of business.
Furthermore, one of the provisions of Clause 1 of the contract is physically most awkward to implement. Unless one assumes that the first lifting is to be made right on February 1,1970, the date of the contract, and the last on December 31,1970, the reference to a minimum of 12 liftings in thirty-day periods assumes an air of improbability. The reference to a maximum of 20 liftings in thirty-day periods certainly looks like a mathematical impossibility. Also it is difficult to understand why such awkward and unworkable lifting provisions were substituted for the straight-forward lifting provisions under the prime contract between Associated Bulk Carriers Ltd and Murphy Oil Trading Company.
Finally, the freight is, in clause 6 of this contract, expressed as “Worldscale 46.6” on Persian Gulf loadings. While it is usual in the trade to express “Worldscale” rates in fractions of .25, or .5, or .75, it is unusual to express them in other fractions, such as .6, as is done in this contract. It therefore seems to me that this “Worldscale 46.6” rate is merely a conversion factor, probably of “Intascale minus 62 /2 %”’ (the rate quoted in the Associated Bulk Carriers Ltd—Murphy Oil Trading Company contract of affreightment).
The foregoing are all features which are unusual in a contract of affreightment which are entered into by parties dealing at arm’s length in the ordinary course of business. They are of a nature which leads me to believe that whatever may have been the reasons for drafting this contract between Murphy Oil Trading Company and Tepwin Company Limited, commercial consideration could not have been paramount, so that in my opinion, this contract is not one which is typical of contracts of affreightment normally entered into in the course of the tanker chartering trade.
3. Were the freight rates charged by Murphy Oil Trading Company to Tepwin Company Limited in the contract of February 1,1970, (Exhibit 1, Book 1, Document 44) “fair market value’’?
Had Murphy Oil Trading Company or Tepwin Company Limited, on or about February 1, 1970, gone into the market to obtain a contract for the transportation of oil of 11 or 12 months’ duration, for the quantities specified in the contract of February 1, 1970, they would have sought a short-term charter, a consecutive voyage charter or a contract of affreightment. Of these three types of contract, a contract of affreightment is usually the cheapest. On or around February 1, 1970, the going market rates for voyages from the Persian Gulf to US East Coast ports for the duration in question were equivalent to about ‘‘Worldscale 88” for shortterm charters, (although it should be borne in mind that both time charters and consecutive voyage charters are usually negotiated on a world-wide trading basis, rather than merely for more restrictive voyages, such as between the Persian Gulf and US East Coast ports).
Around February 1, 1970, the spot market was about “Worldscale 100” for one voyage between the Persian Gulf and US East Coast ports. A prudent purchaser of oil transportation would go into the spot market only to supplement a basic transportation contract; he would not consider the spot market as a basis for oil transportation for anything but the shortest of periods. The spot market rates around February 1, 1970, in my view, therefore, are inappropriate when considering a transportation contract, such as that between Murphy Oil Trading Company and Tepwin Company Limited. Rather, a company with the needs of Murphy Oil Trading Company, ie to perform a contract, such as that between it and the Tepwin Company Limited, would have been interested in a time charter of an at least eleven-month duration or a consecutive voyage charter or a contract of affreightment. Since both Murphy Oil Trading Company and Tepwin Company Limited by their contract indicated that a contract of affreightment met their needs, the most relevant market rates to consider would therefore appear to be rates of similar contracts of affreightment to take effect around February 1,1970. Had such a contract been entered into in the market at that time, the rate would, in my opinion, have been about “Worldscale 78”, and this rate would most accurately reflect “fair market value” in the circumstances.
The rate of “Worldscale 46.6” charged to Tepwin Company Limited by Murphy Oil Trading Company cannot therefore be said to be comparable to market rates, but was rather below them. Bearing in mind that this was a transaction which neither was negotiated nor came into existence as a result of normal market forces, and that it is one of the basic purposes of any business transaction to charge what the market will bear, so as to maximize profits, the fixing of this rate could not have been motivated by commercial considerations. Since it cannot, therefore, be said to have had any relation to the market, it cannot, in my opinion, be said to have “constituted” ‘fair market value’ ”.
4. Did the freight element in the price of crude oil delivered CIF Portland, Maine, charged to the Plaintiff by Tepwin Company Limited under their agreement of February 1, 1970 (Exhibit 1, Book 1, Document 43), constitute “fair market value”?
Although the contract between the Plaintiff and Murphy Oil Trading Company of August 2, 1968, for the sale of oil delivered at Portland, Maine at US $1.9876 per barrel does not break down the price into its crude oil and transportation elements, it may safely be assumed that the crude oil element was no more than US $1.39 per barrrel. This is supported by the contract between BP Canada and the Plaintiff of April 1, 1966, as amended on October 23, 1968, and Mr Monzingo’s testimony in his examination for discovery, at pp 301-305 ... By simple subtraction the transportation element of the total price therefore amounted to US $0.60 per barrel. “Intascale minus 62 /2%”, as per the contract of affreightment of March 28, 1968, between Associated Bulk Carriers Ltd and Murphy Oil Trading Company, was about US $0.58. The difference between US $.0.60 and US $0.58 per barrel may possibly lie in marginal mathematical errors in the calculation of those figures.
It may also be safely assumed that the price of the type of crude oil involved in this case FOB Persian Gulf (Kharg Island) was no more than US $1.39 per barrel in February, 1970 (see the crude oil sale agreement of February 1,1970 between Murphy Oil Trading Company and Tepwin Company Limited, and Mr Monzingo’s testimony at p 301-305 of the transcript of the Plaintiff's examination for discovery,.. . Therefore, when US $1.39 is subtracted from US $2.25 (the purported sale price in the agreement of February 1, 1970, between the Plaintiff and Tepwin Company Limited), the transportation element amounts to US $0.86 per barrel, or an increment of between US $0.26 and US $0.28 per barrrel over the transportation element of the price in the Plaintiff—Murphy Oil Trading Company contract of August 2, 1968.
US $0.86 per barrel as of February 1, 1970 is about “Worldscale 69’’. At that time all the going market rates for the transportation of oil between the Persian Gulf and US East Coast ports were higher... The price purportedly charged by Tepwin Company Limited to the Plaintiff by the agreement of February 1, 1970, was therefore, at least to the extent of its transportation element, below the “fair market value” prevailing at the time.
A purchaser of oil in the position of the Plaintiff before February 1, 1970, ie having a contract for the supply of oil by Murphy Oil Trading Company at US $1.9876 per barrel for a period of time which was not to expire until April 30, 1973, would naturally seek to improve its position by seeking to lower its costs, or otherwise. The substitute of the contract of February 1, 1970, for that of August 2, 1968, however, increases the Plaintiff’s costs. Such a substitution would make commercial sense only if the Plaintiff were somehow to gain other benefits. Such benefits could not have laid in any additional transportation services to be performed by Tepwin Company, for the Plaintiff continued to buy the oil delivered at Portland, Maine with no responsibility by it for the transportation of the oil.
Mr Monzingo has stated in his examination for discovery (see pp 235-240 ...) that the Plaintiff had by December, 1969, become concerned about both the supply of the oil which it purchased from Murphy Oil Trading Company and about its transportation. Mr Monzingo has stated that the sale contract of August 2, 1968, between the Plaintiff and Murphy Oil Trading Company was only a “best efforts contracts”, under which shortages had developed apparently occasioned by interruptions in the availability of crude oil supply and slippages in its transportation, and that the new contract with Tepwin Company Limited was substituted for that with Murphy Oil Trading Compahy in order to alleviate these difficulties.
However, I fail to see how, in any commercial sense, this objective could possibly have been achieved by such substitution. For Tepwin Company Limited did not have any greater control over the supply of oil than Murphy Oil Trading Company from which it purchased its oil (see the sale agreement of February 1, 1970, between Tepwin Company Limited and Murphy Oil Trading Company). So far as the alleged transportation problem is concerned, Tepwin Company Limited could not have alleviated it, in that it purported to obtain its transportation by way of its subcontract of affreightment with Murphy Oil Trading Company. It may well be that Tepwin Company Limited may have had to charter transportation at higher rates, in addition to that of its subcontract of affreightment; but this cannot, in my opinion, be viewed as an improvement over the situation prevailing up to that time, because Murphy Oil Trading Company could have chartered such additional transportation itself, and it did in fact do so twice in 1969 (see Mr Monzingo’s testimony on his examination for discovery at pp 252-253,...) In any event, Tepwin Company Limited did not pay out this US $0.26 to US $0.28 per barrel transportation increment to anyone for additional transportation efforts, but rather retained it as its profits which it then remitted to its parent company Murphy Oil Company, Ltd, of Calgary, Alberta, as a dividend.
... (Spur Oil Ltd) also alleges (see paragraph 12 of the Statement of Claim) that “Tepwin performed a bona fide and economic business function for and on behalf of both . . . (Spur Oil Ltd) US Parent Corporation and its Canadian Parent Corporation in acting as an insulator of the business operations and assets of the Plaintiff from the risk of potential liability as an owner of tanker cargoes of crude oil which could arise in the event of spillage of such crude oil on the high seas or in coastal waters while facilitating the utilization by the US Parent Corporation of its proprietary crude produced in Venezuela and the Persian Gulf area”.
. . . (Spur Oil Ltd) had purchased its oil from Murphy Oil Trading Company at Portland, Maine up to February 1, 1970. This meant that. . . (Spur Oil Ltd) was not exposed to any risks in the transportation of oil before its delivery at that port. The practice to purchase the oil at Portland, Maine continued after February 1, 1970, the only difference being the purported substitution of Tepwin Company Limited for Murphy Oil Trading Company. I therefore find it difficult to understand how the Substitution could have afforded . . . (Spur Oil Ltd) any insulation from high-seas transportation risks in addition to that under its contract with Murphy Oil Trading Company. On the other hand if one were to assume from the allegations in paragraph 12 of the Statement of Claim that from February 1, 1970 onward ... (Spur Oil Ltd) would have had to look after its own transportation of oil to Portland, Maine had it not been for the interposition of Tepwin Company Limited, such interposition could not, in my opinion, have saved . . . (Spur Oil Ltd) from being exposed to the risk of potential liability. For Tepwin Company Limited being a company without an established commercial reputation for reliability and credit, would not likely have been able to enter into any oil transportation contracts without ... (Spur Oil Ltd) guaranty of preformance.
Furthermore, assuming that what is meant by “facilitating the utilization by the US Parent Corporation of its proprietary crude oil produced in Venezuela and the Persian Gulf area” is arranging for its transportation, then Tepwin Company Limited certainly had no greater capability in this regard than Murphy Oil Trading Company. In fact, all the expertise in this regard lay with Murphy Oil Trading Company, and not with Tepwin Company Limited, a newcomer to the field. On the other hand, if what is meant by that phrase is that Tepwin Company Limited facilitated the US Parent Corporation’s ability to sell its crude oil, I find it difficult to see how . . . (Spur Oil Ltd)—Tepwin Company Limited contract was an improvement in this regard over... (Spur Oil Ltd)—Murphy Oil Trading Company contract.
I have also reviewed the documentation produced by the parties and the transcript of Mr Monzingo’s examination for discovery in a search for a commercially justifiable basis on which the increment in the transportation element of the price on which the increment in the transportation element of the price was calculated, but have been unable to discover one. In other words, the amount of this increment appears to have been arrived at arbitrarily with no reference to market factors.
It is therefore my opinion that the substitution of the contract with Tepwin Company Limited for that with Murphy Oil Trading Company was not undertaken for any valid commercial reasons. Similarly, since the transportation element of the price ostensibly agreed to between ... (Spur Oil Ltd) and Tepwin Company Limited neither reflected the going market rate for such transportation in February, 1970, nor was arrived at for any valid commercial reasons it cannot, in my opinion, be taken to have “constituted” ‘fair market value’ 99 ”’.
Taking into consideration this and the other expert evidence and the evidence of Spur Oil Ltd, as to the status of the document, Exhibit 1, Book 1, Document 21.1, it would appear that on August 1,1968 Spur Oil Ltd entered into a crude oil sales agreement and crude oil processing agreement with British Petroleum at Montreal (see Exhibit 1, Book 1, Document 1, 2 and 3). After that, the persons at El Dorado, Arkansas, having control and management of all the Murphy enterprises wanted to expand operations in Quebec, Canda, to develop what is referred to in the evidence as the Sasson Proprietary crude. For that purpose Spur Oil Ltd obtained an option from British Petroleum to bring in its own proprietary crude for refining by British Petroleum at the latter’s refinery at Montreal, Quebec, Canada. In preparation for that Murphy Oil Trading Company (US) entered into the contract of affreightment in 1968 above referred to, namely Exhibit 1, Book 1, Document 12. It appears that the intention under this contract was that Murphy Oil Trading Company (US) would supply Spur Oil Ltd with sufficient proprietary crude to fulfill the Spur Oil Ltd’s obligation with British Petroleum, that is by the shipment of such proprietary crude from the Middle East to Portland, Maine and then by trans-shipment by pipeline to Montreal, Quebec for Spur Oil Ltd’s account.
It would appear that Murphy Oil Trading Company entered into this contract (Exhibit 1, Book 1, Document 12) because it had agreed to supply Spur Oil Ltd with its crude requirements at a price of $1.9876 US per barrel to enable Spur Oil Ltd to carry on its intent by the contract with British Petroleum to put proprietary crude oil through BP’s refinery. Mr Monzingo’s evidence in effect confirms this. Otherwise, Spur Oil Ltd would be put out of business or would have to buy crude from British Petroleum, either of which alternative would be economically objectionable. (See Exhibit 1, Book 1, Document 15).
It appears further from the evidence that in 1969 Murphy Oil Limited in order to fulfill such obligation with British Petroleum chartered the ships PHANTOM and ORIENT CLIPPER at spot charter rates and did not pass on this excess cost of doing so to Spur Oil Ltd. Mr Monzingo confirms this. (See p 257 of his discovery, which was made part of the evidence.) What Mr Monzingo said was that this excess cost could not be passed on because of the agreement with Spur Oil Ltd, (that is, Agreement of August 1, 1968, Exhibit 1, Book 1, Document 21.1).
As further corroboration that the parties acted upon Exhibit 1, Book 1, Document 21.1 on the basis that it was a contract, such document should be compared with Exhibit 1, Book 1, Document 22, the Agreement with Spur Oil Ltd and British Petroleum. From such comparison it appears that the figures in Exhibit 1, Book 1, Document 21.1 are the quantities of crude oil that were to be produced to Spur Oil Ltd or otherwise Spur Oil Ltd might lose the British Petroleum processing agreement or have to buy more crude oil from British Petroleum.
It appears further from his evidence that Mr Bilger believed that he had to supply the quantities referred to in Exhibit 1, Book 1, Document 21.1 at $1.9876 US per barrel.
It therefore is conclusive from the evidence that the document Exhibit 1, Book 1, Document 21.1 was considered by the parties to be a valid contract and all parties acted upon it pursuant to its terms at all relevant times, including the taxation year 1970, notwithstanding the said Agreements dated February 1, 1970 between Tepwin and Spur Oil Ltd.
It further is conclusive from the evidence that it was never intended that the officers and directors of Tepwin at Bermuda would exercise management and control of Tepwin’s business in any aspect. Instead, they were to carry out the instructions given by officers and directors of Murphy Oil Corporation at El Dorado, Arkansas, and to a lesser degree in certain matters given by officers and directors of Murphy Oil Company Ltd, at Calgary, Canada, and Spur Oil Ltd as detailed above.
It appears also that the purpose of acquiring and operating Tepwin was to use it as a vehicle to repatriate tax free dividends to its Canadian parent company, Murphy Oil Company Ltd, at Calgary, Alberta, by causing Tepwin to declare such dividends.
The allegations and claims for relief of the parties and then authorities are now detailed hereunder.
Allegations and Claims for Relief
A. Spur Oil Ltd’s allegations and claim for relief in this action are that: “the sum of $1,622,728.55 ... which was disallowed by the Minister, is properly deductible from .. . (Spur Oil Ltd’s) income in computing its taxable income for its 1970 taxation year and (a declaration is claimed) directing the Minister to reassess ... (Spur Oil Ltd’s) income accordingly reversing to the extent necessary the consequential adjustments of capital cost allowance and exploration and development costs’’.
B. The defendant’s allegations and claims for relief are:
1. The following is the applicable statutory law in relation to the facts of this case, namely, sections 3, 4, 12, 17, 23 and 137 of the Income Tax Act RSC 1952, c 148 prior to amendments to section 1 of c 63, SC 1970-71-72.
2. Spur Oil Ltd ‘‘carried on business through a corporation in the name of Tepwin, and that at no time during ... (Spur Oil Ltd’s) 1970 taxation year did Tepwin carry on business by itself so as to earn or to otherwise be entitled to any income, and that Tepwin was a device to artificially increase the expenses of the ... (Spur Oil Ltd) for Canadian tax purposes while enabling the resulting cash flow to be returned to the Canadian Parent, Murphy Calgary, free of Canadian income tax.’’
3. Spur Oil Ltd “was not dealing with Tepwin at arm’s length and that... (Spur Oil Ltd) purchases of crude oil from Tepwin made at a price in excess of fair market value should be deemed to have been made at the fair market value thereof within the meaning of subsection 17(1) of the Income Tax Act.
4. “the amount of $1,622,728.55 claimed by the Plaintiff as a portion of the cost of its petroleum products sold was not an outlay or expense incurred for the purpose of gaining or producing income from a business and was not deductible within the meaning of paragraph 12(1 )(a) of the Income Tax Act".
5. “the deduction of $1,622,728.55 in respect of an expense claimed by the Plaintiff, should not be allowed as that amount would unduly or artificially reduce the income of the Plaintiff within the meaning of subsection 137(1) of the Income Tax Act”.
Authorities
Unduly or Artificially Reducing Income
Subsection 137(1) of the Income Tax Act, RSC 1952, c 148 reads as follows:
(1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.
This statutory concept of “unduly’’ or “artifically” has been considered in many contexts, including so-called sham transaction and artificial transaction matters.
A. Sham Transactions
Sham transactions as considered in the cases appear to be transactions in which the taxpayer has used various technicalities or devices for the purpose of tax avoidance. Sham transactions have been defined by Lord Diplock in Snook v London & West Riding Investments, Ltd, [1967] 1 All ER 518 at 528, and his definition has been adopted for Canadian income tax purposes by the Supreme Court of Canada in MNR v J A Cameron, [1974] S.C.R. 1062; [1972] CTC 380; 72 DTC 6325. Lord Diplock said:
As regards the contention of the plaintiff that the transactions between himself, Auto-Finance, Ltd and the defendants were a “sham”, it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.
Seemingly expanding the definition of “sham” the Court of Appeal of the Federal Court of Canada appears to have added to this defined concept of sham for tax purpose by appending the concept of “business purpose”. See MNR v Leon, [1976] CTC 532; 76 DTC 6299, per Heald, J, and utilized by Cat- tanach, J in L Mendels v The Queen, [1978] CTC 404; 78 DTC 6267; but see contrary Massey-Ferguson v The Queen, [1977] CTC 6; 77 DTC 5013, per Urie, J.
B. Artificial Transactions
1. Lord Diplock in the Privy Council case of Seramko v ITC, [1976] STC 100, on an appeal from Jamaica based on the consideration of the Jamaica Income Tax Law 1954 subsection 10(1)* at 107 makes a distinction between “artificial” and “fictitious” (that is “sham”) transactions as envisaged by the words employed in subsection 10(1) of the above Act. That subsection is in many ways analogous to subsection 137(1) of the Canadian Income Tax Act above quoted. Lord Diplock said:
“Artificial” is an adjective which is in general use in the English language. It is not a term of legal art; it is capable of bearing a variety of meanings according to the context in which it is used. In common with all three members of the Court of Appeal, their Lordships reject the trustees’ first contention that its use by draftsman of the subsection is pleonastic—that is a mere synonym for “fictitious’. A fictitious transaction is one which those who are ostensibly the parties to it never intended should be carried out. “Artificial” as descriptive of a transaction is, in their Lordships’ view, a word of wider import.
Where in a provision of an Act an ordinary English word is used, it is neither necessary nor wise for a court of construction to attempt to lay down in substitution for it, some paraphrase which would be of general application to all cases arising under the provision to be construed. Judicial exegesis should be confined to what is necessary for the decision of the particular case. ...
2. The following categories of artificial transactions have been considered by the Courts (and undoubtedly there are many more categories):
(i) Inherently artificial transactions such as capital cost allowance transactions, depletion allowance transactions or other specific relieving provisions as for example in section 66 of the present Income Tax Act, all of which appear to take precedence over the general anti-avoidance provision in subsection 137(1) of the Canadian Income Tax Act (now subsection 245(1) under the current Act). See for example, Jackett, CJ in fl v Alberta and Southern Gas Co Ltd, [1977] CTC 388; 77 DTC 5244; [1978] CTC 780; 78 DTC 6566, and Pratte, J in Produits LDG Products Inc v The Queen, [1976] CTC 591; 76 DTC 6344, and the obiter also in L J Harris v MNR, [1966] S.C.R. 489; [1966] CTC 266; 66 DTC 5189. Because of the particular facts of the Harris (supra) case, perhaps that case should be put in the category of artificial transactions referred to in (ii) below.
(ii) Transactions proven by evidence to be artificial in which cases the Court has directly applied Part I of the Act (ie the pre-1972 Act) to uphold assessments for tax.
see for example, Judson, J in Smythe et al v MNR, [1970] S.C.R. 64; [1969] CTC 558; 69 DTC 5361 at 69 [562, 5363]:
There is only one possible conclusion from an examination of these artificial transactions and that must be that their purpose was to distribute or appropriate to the shareholders the “undistributed income on hand’’ of the old company. No oral or other documentary evidence is needed to supplement this examination. There was, however, an abundance of other evidence. This was a well-considered scheme adopted on the advice of professional advisers after other means of extraction of the undistributed income—including payment of a tax under the provisions of s 105(b) of the Act—had been weighed and rejected.
In this connection, while recognizing that corporations are distinct and separate legal persons (see Salomon v Salomon, [1897] AC 22; Pioneer Laundry & Dry Cleaners Limited v MNR, [1940] AC 27; [1938-39] CTC 411; 1 DTC 499-69 and Inland Revenue Commissioners v Duke of Westminster, [1936] AC 1), it is always necessary to consider the essential realities of transactions done by separate legal persons, individuals or corporations, to determine whether or not the execution of the transactions entered into by them is within the principles of the Duke of Westminster (supra) case or whether the execution is akin to a theatrical performance. Templeman, LJ put the matter of this consideration in this way at p 978 in W T Ramsay v IRC, [1979] WLR 974:
... The facts as set out in the case stated by the special commissioners demonstrate yet another circular game in which the taxpayer and a few hired performers act out a play; nothing happens save that the Houdini taxpayer appears to escape from the manacles of tax. The game is recognisable by four rules. First, the play is devised and scripted prior to performance. Secondly, real money and real documents are circulated and exchanged. Thirdly, the money is returned by the end of the performance. Fourthly, the financial position of the actors is the same at the end as it was in the beginning save that the taxpayer in the course of the performance pays the hired actors for their services. The object of the performance is to create the illusion that something has happened, that Hamlet has been killed and that Bottom did don an ass’s head so that tax advantages can be claimed as if something had happened. The audience are informed that the actors reserve the right to walk out in the middle of the performance but in fact they are the creatures of the consultant who has sold and the taxpayer who has bought the play; the actors are never in a position to make a profit and there is no chance that they will go on strike. The critics are mistakenly informed that the play is based on a classic masterpiece called “The Duke of Westminster’, but in that piece the old retainer entered the theatre with his salary and left with a genuine entitlement to his salary and to an additional annuity.
(iii) Some transactions that are not at arm’s length. Prima facie, the conclusion is that such transactions are artificial.
(iv) Some transactions that are entered into by so-called off-shore corporations where the management and control of such off-shore corporations is elsewhere than in such off-shore locations. Prima facie, the conclusion is that the transactions entered into by such off-shore corporations are artificial.
3. As to determining the residence of a corporation and how a corporation operates, the following should be recalled for the purpose of considering whether or not any transactions that may be entered into by a corporation are artificial within the meaning of subsection 137(1) of the Income Tax Act:
In the Income Tax Act, persons resident in Canada are taxable upon their world-wide income; whereas taxpayers not resident in Canada are taxable only upon income earned in Canada. A corporation is a person for the purpose of the Income Tax Act. A corporation may not consolidate its income from subsidiary corporations for the purpose of the Canadian income tax.
If a corporation is resident in Canada, it must file returns and pay Canadian income tax. The basic test of corporate residence is established in the English jurisprudence in the case of De Beers v Howe, [1906] AC 455 namely, “the company resides for the purpose of income tax where its real business is carried on ... and the real business is carried on where central management and control actually abides”.
Ordinarily, the central management and control of a corporation is found to be where the directors of the corporation meet and exercise management and control of the corporation and its affairs.
It has been held that a corporation may be resident in more than one jurisdiction if the central management and control of the corporation is exercised in more than one country: Swedish Central Railway Company v Thompson, [1925] AC 495. It may be that such dual residence should be found infrequently: Egyptian Delta Land and Investment Company v Todd, [1929] AC 1 and Kiotaki Para Rubber v CIT (1940), 64 CLR 15.
The said English test with respect to the determination of the residence of a corporation for tax purposes based on its management and control is applicable in Canada. In BC Electric Railway Company Ltd v R, [1946] AC 527; [1946] CTC 224; 2 DTC 839, the Privy Council on an appeal from the Supreme Court of Canada held that a company incorporated in the United Kingdom was resident in Canada on the basis of control exercised in Canada.
The state of mind of directors and managers of a company is treated in law as being the directing mind and will of such a company and control of what it does. Lord Justice Denning in H L Bolton (Engineering) Co Ltd v TJ Graham & Sons Ltd, [1956] 1 QB 159 at 172 said:
... A company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such. So you will find that in cases where the law requires personal fault as a condition of liability in tort, the fault of the manager will be the personal fault of the company. That is made clear in Lord Haldane’s speech in Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd, ([1915] AC 703, 713-14; 31 TLR 294). So also in the criminal law, in cases where the law requires a guilty mind as a condition of a criminal offence, the guilty mind of the directors or the managers will render the company itself guilty. That is shown by Rex v /CR Haulage Ltd, ((1944), KB 511: 60 TLR 399; [1944] 1 All ER 691) to which we were referred and in which the court said: ([1944] KB 551, 559) “Whether in any particular case there is evidence to go to a jury that the criminal act of an agent, including his state of mind, intention, knowledge or belief is the act of the company ...
An example of the affirmation of this principle is the case of The Lady Gwendolen, [1965] 1 Lloyd’s Rep 335 at 345.
Useful guidance on how the mind and will of a company may be manifested is also to be found in the judgment of Lord Justice Denning (as he then was in H L Bolton (Engineering) Company, Ltd v T J Graham & Sons, Ltd (1957), 1 QB 159, at pp 172 and 173. The learned Lord Justice there said:
... A Company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such. So you will find that in cases where the law requires personal fault as a condition of liability in tort the fault of the manager will be the personal fault of the company. That is made clear in Lord Haldane’s speech in Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd. ...
A little later Lord Justice Denning said:
So here, the intention of the company can be derived from the intention of its officers and agents. Whether their intention is the company’s intention depends on the nature of the matter under consideration, the relative position of the officer or agent and the other relevant facts and circumstances of the case.
On the principles stated in these cases I should be disposed to say that actual fault on the part of Mr Boucher, as registered ship’s manager and head of the traffic department, would be sufficient in the particular circumstances of the present case to constitute actual fault or privity of the company. But I do not find it necessary to reach any final conclusion upon this point—for it seems to me that in the particular circumstances of this case all concerned, from the members of the board downwards, were guilty of actual fault, in that all must be regarded as sharing responsibility for the failure of management which the facts disclose. Certainly I would not dissent from the view expressed by the learned Judge that Mr D O Williams, the responsible member of the board, must be regarded as guilty of actual fault.
The following are the considerations which impel me to that conclusion. I agree with the submission made on both sides that the test to be applied in judging whether shipowners have been guilty of actual fault must be an objective test. A company like the plaintiff company, whose shipping activities are merely ancillary to its main business, can be in no better position than one whose main business is that of shipowning. It seems to me that any company which embarks on the business of shipowning must accept the obligation to ensure efficient management of its ships if it is to enjoy the very considerable benefits conferred by the statutory right to limitation.
4. In reference to the transactions listed in paragraph 2(iii) and (iv) above, (namely certain non-arm’s length transactions and transactions entered into by so-called off-shore corporations) there is an onus to adduce evidence to rebut such prima facie conclusion. If is is not rebutted, then a finding that the transactin is artificial will result; and taxation will be determined by a direct application of Part I of the Act. (The reference to Part I of the Act is to the Income Tax Act prior to the Act as amended by Statutes of Canada of 1970-71, c 63 which came into force on January 1, 1972.)
Conclusions
The question therefore for determination in this case is whether or not the transactions entered into as of February 1, 1970, namely:
(a) the “sub-charter of affreightment” between Tepwin and Spur Oil Ltd (Exhibit 1, Book 1, Document 42);
(b) the crude oil sales agreement between Murphy Oil Trading Company and Tepwin Company Limited (Exhibit 1, Book 1, Document 43); and
(c) the delivery of crude oil agreement between Tepwin and Spur Oil Ltd (Exhibit 1, Book 1, Document 44)
are artificial transactions within the meaning of subsection 137(1) of the Income Tax Act.
On the facts in this case such a determination must be based on either (1) the residence of Tepwin and what it did at the material times; or (2) the validity or not of the so-called contract dated August 2, 1968, Exhibit 1, Book 1, Document 21.1 between Spur Oil Ltd (formerly Murphy Oil Quebec Ltd) and Murphy Oil Trading Company (the Delaware Corporation); or (3) both basis.
The evidence established that the management and control of the offshore corporation Tepwin was not in Bermuda. And instead of evidence being adduced to rebut the prima facie conclusion arising from that fact, the evidence adduced established conclusively that the management and control of Tepwin was divided between El Dorado, Arkansas and Canada and Tepwin was therefore resident in those locations and not in Bermuda at all material times. As a consequence, it was proven that al! decisions by Tepwin to enter into the three contracts, Exhibit 1, Book 1, Documents 42, 43 and 44 by Tepwin with Spur Oil Ltd and the actual execution of these contracts by Tepwin were made and done by Tepwin while resident in both El Dorado, Arkansas and Canada.
The evidence further established that the officers and directors of Tepwin at Bermuda had nothing to do with the purchase of crude oil from the Persian Gulf area or from the spot market or with the delivery of it to Portland, Maine for on-going pipeline delivery to Montreal or with the sale of the crude oil to Spur Oil Ltd; and specifically also that Tepwin did not do so at Bermuda by way of any of its officers or directors qua Tepwin who personally were resident in El Dorado, Arkansas or in Canada either.
The evidence further establishes that what the officers and directors and the solicitors at Bermuda did was act merely as scribes under the direction of Mr Watkins from El Dorado, Arkansas for the purpose of having Directors’ meetings declaring dividends, which dividends were passed tax free to the Canadian parent company and which dividends as to the amount of each were based on the quantum of the so-called Tepwin charge times the number of gallons of crude oil in each shipload which left the Persian Gulf for delivery to Portland, Maine and then by pipeline to Montreal, Canada. Other that that, they did practically nothing because Tepwin did not carry on the business of buying, selling and delivering crude oil in 1970.
The evidence also conclusively established that Murphy Oil Trading Company (the Delaware Corporation) prior to and up to February 1, 1979, did in fact sell crude oil to Spur Oil Ltd at $1.9876 US per barrel under the so-called contract between them (Exhibit 1, Book 1, Document 21.1); and this contract document was never formally or informally abrogated.
Exhibit 1, Book 1, Document 21.1, therefore, at all material time was a valid and subsisting contract.
As a consequence, these three transactions evidenced by the three contracts, Exhibit 1, Book 1, Documents 42, 43 and 44, are artificial within the meaning of subsection 137(1) of the Income Tax Act. Accordingly by direct application of Part I of the Income Tax Act, the finding is that the excess cost of petroleum products sold, the excess being the total of the so-called Tepwin charge, in computing the net income from the 1970 taxation year of Spur Oil Ltd is not an allowable expense.
The appeal is therefore dismissed with costs, but the assessment is referred back for re-assessment not inconsistent with these reasons.
Counsel may prepare in both official languages an appropriate judgment to implement the foregoing conclusions and may move for judgment in accordance with Rule 337(2)(b). Judgment shall not issue until settled by the Court.