Fraser Companies, Ltd. v. The Queen, 81 DTC 5051, [1981] CTC 61 (FCTD)

Cattanach, J:—By notice dated April 30, 1976 the Minister of National Revenue reassessed the plaintiff by including in its income an amount of $652,976.37 for its 1973 taxation year.

This increase in the plaintiff’s assessment followed upon the Minister adding the amounts of $1,172,193.26 and $358,849.86 to the plaintiff’s income in its 1971 and 1972 taxation years respectively which resulted in a reduction of the losses to be carried forward into its 1973 taxation years in the total amount of $1,531,043.12.

The Minister did so on the basis that interest on $20,000,000 in these years was properly income received by the plaintiff rather than by Fraser Paper Limited, the plaintiff’s wholly owned subsidiary. Thus there are two companies involved in this appeal.

Because of the similarity in the corporate names of the parent company, Fraser Companies, Limited, the plaintiff herein, and its subsidiary, Fraser Paper Limited, the plaintiff will be referred to as “Companies” or “Fraser Companies” and the subsidiary will be referred to as “Paper” or “Fraser Paper” in the interests of convenience and more certain identification.

Fraser Companies has its head office and principal place of business at Edmunston, New Brunswick. The subsidiary, Fraser Paper, operates a paper mill in Madawaska, Maine, just across the St John River from Edmunston, NB. Fraser Paper was incorporated under the laws of New Brunswick but carries on its business operation in Maine, one of the United States of America. Paper qualified as a foreign business corporation from the 1930’s under section 71 of the Income Tax Act then applicable until the tax reform in 1972. The effect of section 71 was that no tax was payable in Canada upon the income of a foreign business corporation, as Paper was, other than a $100 annual fee.

Fraser Companies operated a pulp mill in Canada and supplied pulp in slush form to the paper mill in the United States, operated by Fraser Paper, by means of a pipe line across the river and Companies also supplied Paper with electric power and steam for use in its paper producing operation. Paper was Companies major customer and 85% of Companies’ cash flow was from Paper in payment for pulp and power.

Both Companies and Paper were directed from management in Ed- munston. The boards of directors were composed of the same directors and the senior officers were the same except that the mill was operated by a mill manager and the sales operations were all in the United States.

Thus, though Paper was a Canadian company its mill and manufacturing facilities as well as its sales operations and customers were all in the United States.

The Fraser enterprises had come upon difficult times, in danger of losing its ocmpetitive position in a highly competitive market and going under unless they received a substantial shot in the arm.

To that end, in 1968, Mr Huer was appointed President. He had had thirty years experience in the paper industry in the United States. He brought with him selected key personnel in whom he had confidence including Mr York as Vice President in charge of Finance. Mr York had been in the paper business for thirty-five years.

The conclusion was reached that the only chance the enterprise had to survive and become viable was to modernize the pulp mill in Edmunston, NB and the paper mill at Madawaska, Maine.

Fraser Companies’ profit position was very bad and that was well known throughout the industry and all of its property had been put up as collateral for prior loans now secured by mortgage.

The only practical way in which this expansion could be financed was by the sale of a craft pulp mill located in Newcastle, NB. This mill was owned by Fraser Companies.

Mr York was charged with the responsibility of selling the Newcastle mill.

Meanwhile and before the Newcastle mill was sold the President embarked on the process of modernizing the paper mill because time was of the essence. The major item was an additional new large paper machine at a cost of between 16 to 20 million dollars. The equipment was ordered but there was considerable lead time. Mr Huer must have had implicit faith in Mr York’s ability to sell the Newcastle mill. The expansion undertaken could not be done without the money from the sale of that mill.

Mr York made certain that the word got out to companies he felt might have an interest that Fraser Companies was willing to sell the Newcastle mill. Three companies exhibited an interest but ultimately declined to buy.

Eventually negotiations with Boise Cascade Corporation, one of the three largest paper companies, resulted in the sale of the Newcastle mill to Miramichi Timber Resources Limited, a wholly owned subsidiary of Boise Cascade Corporation which was incorporated for the express purpose of acquiring the Newcastle mill.

The sale of the mill with inventory realized a price of 43 million dollars.

On November 25, 1969 the board of directors of Fraser Companies approved the sale of the Newcastle mill.

The full payment for the mill was agreed to be paid in cash because the Fraser enterprises needed immediate cash, not long term payments. Fur- ther the assets of Fraser Companies were mortgaged, including the Newcastle mill which was being sold, and the monies had to be paid to the mortagee in the first instance so the mortgage could be discharged and the remainder of the fund released to Fraser Companies.

The mortgage company paid to Fraser Companies $17,814,831 which eventually was increased to 23 million dollars on the sale of Fraser Companies’ inventory which was not subject to mortgage.

The President had ordered the paper machine, the major item for the expansion of Fraser Paper in Madawaska in April, 1969 and Fraser Paper was committed to an expenditure of 15 million or more dollars. The deal for the sale of the Newcastle mill was not made until November, 1969 and that sale was the key to the whole financing process.

The closing of the transaction was fixed for January 22, 1970.

A few days before the closing date, Mr York, the prime negotiator of the sale, received a telephone call from Boise Cascade advising that while they had arranged for all money to be in place on the closing date one lender which was to advance 10 million dollars had made a computer mistake and could not provide the 10 million dollars.

Mr York suspected this might be a prelude to the loss of the sale.

He met with officers of Boise Cascade who said that they could arrange short term borrowing of that amount from a Canadian bank provided it could be paid back within a week or ten days.

Mr York then agreed that if Boise Cascade would borrow the 10 million dollars from the bank and paid the full amount of the agreed purchase price on closing that he would arrange to loan Miramichi Timber, the purchaser, 10 million dollars on a note guaranteed by Boise Cascade subject to the condition that the institution which was to lend the 10 million dollars in the first place would lend that amount as soon as it was available so that the loan from the vendor of the Newcastle mill could be repaid. This was done and repayment turned out to be 5 million dollars in July, 1971 and 5 million dollars on September 27, 1971.

Closing then took place on January 22, 1970.

The funds for closing were paid over to Montreal Trust Company as mortgagee.

Also on closing Montreal Trust paid over to Fraser Companies 20 million dollars.

Mr York instructed the Treasurer of Companies, who was responsible to him, to deposit the 20 million dollars in the Royal Bank, which was in the same building, immediately so that it would begin to draw interest that very day.

The guarantee of Boise Cascade had been delayed until January 28,1970 so the deposit remained in the name of Fraser Companies for that period.

Mr York had estimated that five days would be sufficient time for the Boise Cascade guarantee to be received.

Ten million dollars invested on a five-day deposit matured and was then loaned by Fraser Companies to Fraser Paper. On the same day Fraser Paper loaned 10 million dollars to Miramichi. That was the programme and it was fulfilled.

Mr York directed the Treasurer that the 10 million dollars of the 20 million dollars received should be invested in a short term deposit in the name of Fraser Paper. He so instructed on January 22, 1970 but the Treasurer in the haste of the moment misunderstood the instructions and invested that 10 million dollars in a 32-day term deposit with the Royal Bank in the name of Fraser Companies rather than in the name of Fraser Paper.

Mr York had taken off on his other responsibilities either in Greenwich, Connecticut or Montreal, PQ when he learned from his Comptroller that the money had been deposited to Fraser Companies. He thereupon called the Treasurer and made it clear that while he had wanted the money deposited quickly he had also wanted it deposited in the name of Fraser Paper. It had been his intention from the outset that the entire 20 million dollars would be loaned by Fraser Companies to Fraser Paper but because 10 million dollars had to be loaned to Miramichi to complete the sale only 10 million dollars remained to be placed at the disposal of Fraser Paper.

Mr York’s motive in doing so was clear.

The credit of Fraser Paper was not good in the market place at that particular time and it was responsible for the very substantial sums to be expended upon the expansion undertaken. It was Mr York’s purpose to make certain that all suppliers and contractors to Fraser Paper would know that Paper had available liquid assets to that extent to promptly meet its obligations.

Mr York was the person who decided on the loans from Companies to Paper and they were made free of interest.

In loaning 10 million dollars from Companies to Paper so that Paper could loan 10 million dollars to Miramichi to enable Miramichi to pay the purchase price he was influenced by his consideration to have Paper as the lender by the fact that Boise Cascade, the guarantor, was an United States company resident there and that Paper although incorporated in New Brunswick, conducted its business entirely in the United States and was considered by those who dealt with it as an United States company as well. He felt that if litigation should arise it would be advantageous to have both parties present in the same jurisdiction.

That was not necessarily so. Miramichi and Fraser Companies were both incorporated in Canada as was Fraser Paper. But Boise Cascade, the guarantor of acknowledged substance, was not and it was the most likely litigant if litigation ensued.

However if the first 10 million dollars had been available it, too, would have been loaned by Companies to Paper for the same reason the second 10 million had been loaned to Paper, that is to bolster the creditibility of Paper which in Mr York’s opinion, as a former credit manager and wise to reactions of those engaged in commerce, was necessary.

Incidentally the necessity of the loan to Miramichi arose unexpectedly and suddenly. The completion of the sale on which the whole resuscitation plan lay was threatened. All efforts were directed to completing the sale and it was accomplished by the means adopted. Mr York specifically testified that he did not consider taxation implications but that he was solely motivated in getting the sale completed.

It could not be said that the particular money advanced to Paper was used to pay the expansion bills. When bills fell due they might have been paid from the loan account or the bills might have been paid from the current account and when monies flow back to Companies from Paper some flowed from the current account, to pay for pulp and power and some flowed back on the loan account.

There was normally an average monthly payment by Paper to Companies for pulp and power from current account (usually about 3 million dollars) but at the beginning of 1970 the current account mounted. That must mean that current account was used by Paper to pay current expansion bills. In that year its gross assets expanded by 24 million dollars.

Fraser Paper must have used current receipts to pay capital bills not Fraser Companies’ current debits.

Fraser Companies needed funds to meet its obligations and the cash flow from Paper, its major customer, was being depleted. This depletion was picked up by substantial payments in the loan account. It was a matter of bookkeeping and subsequently the bookkeeping was changed to pay capital expenditures from the loan account.

In 1970 and 1971 other loans were made by Companies to Paper. The advance in loans rose to 34.4 million dollars, all interest free.

Payments on the loan account were paid on a first in first out basis. The first loan was the 10 million dollar one so the first 10 million dollars paid back from loan account was attributed to that transaction.

In January, 1971 Miramichi paid back to Paper the first 5 million of Paper’s loan to it. Paper had 34 million at that time so the moneys were not immediately required and were paid back by Paper to Companies.

In 1971 a further expenditure of 8 million dollars was made on capital expansion. In June 1971 the bulk of the capital expansion had taken place and had been paid for.

When Miramichi paid back the second 5 million dollars of the loan from Paper it was not needed for capital expansion because that expansion which had been committed was paid. The 5 million dollars was invested by Paper in a two-month deposit and was repaid to Companies in September, 1971.

Even with the repayment of these loans the total indebtedness for all of the capital expenditures was still over 30 million dollars.

During this two years from the level of expenditures by Paper for capital expansion, from the fact that Paper held back from Companies its payments on current account it is obvious that Paper needed all the cash it could get. Fraser Companies, as parent of its major customer put as much cash as it could spare into Fraser Paper so that Paper could get the interest earned therefrom. Paper needed as much income as possible.

Therefore there does not appear to be any distinction between the loans of 20 million dollars originating from the sale of the Newcastle mill and the other loans made by Fraser Companies to Paper. All loans so made were for the purpose of enabling Paper to carry out its capital expansion and to provide a cash flow to the parent company.

If Companies, rather than loaning the funds to Paper, had undertaken the expansion of the facilities of its subsidiary itself thereby increasing its efficiency and the sale of its product to its subsidiary that would have been an outlay or expense laid out by the parent for the purpose of gaining or producing income from its business that would be a deductible expense in computing its income and in similar instances has been so held.

The basic transactions as recited above and as alleged in paragraphs 10 to 18 of the statement of claim are admitted. There is no dispute between the parties as to the basic facts giving rise to the controversy herein.

Special mention should be made of paragraph 15 which is admitted.

It is there alleged that on January 28, 1970 the plaintiff made a loan to Paper of $10,000,000 without interest which was secured by a promissory note.

This admission concedes that the legal relationship between Fraser Companies and Fraser Paper is that of lender and borrower.

Paragraph 24 of the statement of claim alleges that there is no obligation under the Income Tax Act which requires the plaintiff to charge interest on loans which it makes to a resident Canadian corporation, whether or not it is a Subsidiary of the plaintiff.

That is so. There is no prohibition of or adverse consequence to a parent company lending to a subsidiary corporation without interest in the then applicable legislation except section 19 (brought forward in the present Act as section 17) where a loan by a Canadian corporation resident in Canada to a non-resident person for more than one year without interest at a reasonable rate shall be deemed to be at 5% per annum and received by the lender as income in the taxation year.

The exception is not applicable in this instance by reason of section 71 of the Act.

Further the allegation in paragraph 24 is agreed to by counsel for the defendant. In the defendant’s pleading it was alleged that paragraph 24 was illegally and irregularly pleaded because Paper was a foreign business corporation.

There was evidence that it was the normal and consistent practice of Fraser Companies to lend money interest free to its subsidiary.

The plaintiff disputes the assumption made by the Minister in paragraph 7, subparagraph (3) of the statement of defence that Fraser Paper did not need as working capital the sum of 20 million dollars it borrowed from Fraser Companies.

There is no question that Fraser Paper since 1932 was a foreign business corporation and as such none of its income was subject to tax in Canada.

Counsel for the plaintiff arranged, in summary form, the chronological order of dates of the relevant transactions in this appeal extracted in the greater part from the pleadings with explanatory interpolations where required. Counsel for the defendant concurs in the accuracy of the summary.

The summary is a convenient reference and for that reason is reproduced:

As I understand the contention on behalf of the defendant it is that the transactions between Fraser Companies and Fraser Paper brought Fraser Companies, the plaintiff, within the four corners of subsection 16(1) of the Income Tax Act, RSC 1952, c 148, which subsection is reenacted in its exactitude as subsection 56(2) of the Income Tax Act, SC 1970-1-2, c 63 and section 23 in the former statute is likewise reenacted in the later statute as subsection 56(4).

This is pleaded by the defendant in paragraph 9 of the statement of defence under heading B entitled “Statutory Provisions upon which the At- torney General on behalf of Her Majesty the Queen relies and the Reasons which He intends to submit”.

Paragraph 9 reads:

He submits that the transactions entered into by the plaintiff as described herein resulted in artificially reducing plaintiff’s income in that:

(a) they resulted in payments or transfers made pursuant to the direction or with the concurrence of, the plaintiff to some other person to plaintiff’s benefit and should be included in plaintiff’s income for its 1971 and 1972 taxation years as provided for in Section 16(1) of the Income Tax Act, RSC 1952, c 148 as amended, and Section 56(2) of the Income Tax Act, sc 1970,1971 and 1972, c 63, and/or

(b) they resulted in the transfer or assignment to a person with which plaintiff was not dealing at arm’s length of the right to amounts that would otherwise have been included in plaintiff’s income, and should be included in plaintiff’s income for its 1971 and 1972 taxation years, pursuant to Section 23 of the Income Tax Act, RSC 1952, c 148 as amended and Section 56(4) of the Income Tax Act, sc 1970, 1971 and 1972, c 63.

This appeal falls to be determined upon the resolution of the question, in whose hands does the substantial interest income generated by the investment of the 20 million dollars loaned by Fraser Companies to Fraser Paper lie. It is income in the hands of Fraser Paper or is it income in the hands of Fraser Companies?

If the former is the case then the plaintiff is not the recipient of the income and its appeal must succeed. If the latter should be the case then the plaintiff’s appeal must fail.

Counsel for the defence contends that the latter is the case by virtue of the operation of the combination of subsections 56(2) and (4) within the provision of which the transactions engaged in by the plaintiff fall. That is the plea in paragraph 9 of the statement of defence quoted above.

Counsel for the Minister was frank to concede that the transactions between Companies and Paper were real and did not constitute a “sham” within the definition of that word in Snook v London & West Riding Investments, Ltd, [1967] 1 All ER 519 where Lord Diplock said at 528:

. . . 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.

Counsel for the defendant was right in disavowing any contention that the transactions between Fraser Companies and Fraser Paper were a “sham”. On the contrary the acts done and the documents executed created the actual legal rights and obligations that the parties intended to be created. They were, in fact, bona fide transactions fully intended, acted upon and effective.

Later Lord Diplock in Scramko v ITC, 1976 STC 100 had occasion to consider the meaning of “artificial” used in a section in the Jamaican Income Tax similar to subsection 137(1) of the Canadian Income Tax Act now subsection 245(1) of the current Act. He said that “artificial” is not a term of legal art and must be given the meaning that the context demands. He did, however, distinguish “artificial” from “fictitious” which by the language used in defining “fictitious” makes its meaning synonymous with “sham”.

Paragraph 9 is introduced by language that in the transactions entered into by Fraser Companies resulted in “artificially” reducing Fraser Companies’ income within the precise circumstances outlined in subsections 56(2) and/or 56(4).

The assumptions of fact alleged to have been made by the Minister in assessing the plaintiff as he did are those consistent with subsections 56(2) and 56(4) being the statutory taxing provisions invoked as has been pleaded.

It is curious however that, in the light of counsel’s contentions, the defendant did not allege assumptions of facts designed to bring the transactions within subsection 245(1) but this was not done. I do not overlook paragraphs 7(r) and 7(s) in the same statement of defence.

Subsection 245(1) precludes the “disbursement ... made” in a transaction that, if allowed, would “unduly or artificially” reduce the income.

Thus, in my opinion, the defendant’s reliance is exclusively on subsections 56(2) and (4) and the issue is therefore so narrowed.

The object and purpose of subsection 56(2) and its predecessor 16(1) is clear. It is to cover cases where the taxpayer seeks to avoid what would be income in his hands to have that amount received by another person when he wishes to benefit or for his own benefit.

Hence the marginal note “Indirect Payments”. That is what the subsection is designed to prevent.

Despite section 13 of the Interpretation Act to the effect that marginal notes form no part of the enactment but shall be deemed to have been inserted for convenience of reference only they do, in most instances, and in this instance, accurately reflect the general sense of the language of the Subsection and may, therefore, be referred to for that purpose.

The often repeated statement is that the subsection (both 16(1) and 56(2)) embodies a portion of the general concept of constructive receipt. The general rule is that a taxpayer is only taxed upon the receipt of income or when it becomes receivable by him in the legal sense. There are certain circumstances where income receivable may be caused not to be received by him and by that device he achieves benefits that amount to income. In those circumstances as set forth in subsection 56(2) that is income constructively received by the taxpayer. If the taxpayer had actually received the money or moneys worth and passes it on he would have been taxable on that amount. Therefore he should not be permitted to avoid tax liability by the simple expedient of directing payment to a third party without having actually received the money himself.

The classic example is: A owes B $100. C owes A $100 which is business debt taxable as income. A directs C to pay B $100. C does so. Therefore A’s debt to B is paid but A did not actually receive $100 taxable income from C. By virtue of subsection 56(2) the money is deemed to have been constructively received by A and so taxable.

I said in another context (see Murphy v The Queen, [1980] CTC 386; 80 DTC 6314):

Subsection 56(2) is to impute receipt of income to the taxpayer that was diverted at his instance to someone else. It is to cover cases where the taxpayer seeks to avoid the receipt of what in his hands would be income by arranging to transfer that amount to some other person he wishes to benefit or for his own benefit in doing so. Apart from any moral satisfaction the practical benefit to the taxpayer is the reduction in his income tax.

For the transactions between the plaintiff and its subsidiary to be taxable in the hands of the plaintiff each essential ingredient set out in subsection 56(2) to taxability must be present.

These ingredients are fourfold:

(1) there must be a payment or transfer of property to a person other than the taxpayer;

(2) the payment or transfer is pursuant to or with the concurrence of the taxpayer;

(3) the payment or transfer must be for the taxpayer’s own benefit or for the benefit of some other person on whom the taxpayer desired to have the benefit conferred, and

(4) the payment or transfer would have been included in computing the taxpayer’s income if it had been received by him instead of the other person.

In my view there has not been ‘‘a payment or transfer” within the meaning of those words as used in subsection 56(2) by the plaintiff to Fraser Paper.

The words “payment” and “transfer” are not terms of art nor do they have a technical meaning. Their meaning is that they have in common parlance.

The man in the street if obliged to categorize the two transactions involving first the dealing with 10 million dollars on January 28, 1970 and secondly January 30,1970 between Fraser Companies and Fraser Paper would, in my view, unhesitatingly describe them as “loans” and not as “payments” or transfers”. Money was made available by Companies to Paper but repayment was expected. These are the attributes of a “loan”. There is a borrower and a lender.

It is admitted by the pleadings that the legal relationship between Fraser Companies and Fraser Paper is that of lender and borrower.

In paragraph 15 of the statement of claim it is alleged that the plaintiff loaned 10 million dollars to its subsidiary without interest secured by a promissory note.

In paragraph 17 of the statement of claim the allegations that the plaintiff instructed the Royal Bank on January 30, 1970 to change the name of the holder of the investment certificate in the amount of 10 million dollars issued on January 22 from Fraser Companies to Fraser Paper and the change was recorded in the books of both companies as a non-interest bearing loan and which was secured by a promissory note.

Paragraphs 15 and 17 are admitted in paragraph 1 of the statement of defence.

In my view the admission of paragraph 15 is conclusive of that transaction being a loan.

Different considerations might prevail with respect to paragraph 17. What is admitted is that the transaction was treated and later recorded in the books of both companies as a loan. However there are no material distinctions in result between the transaction described in paragraph 15 and that described in paragraph 17 and if the transaction in paragraph 15 is admitted to be a loan, I fail to follow how the transaction described in paragraph 17 can be anything but a loan.

Even assuming that there had been a payment by or transfer of property from Fraser Companies to Fraser Paper, which was not the case for the reasons expressed, it is the payment or transfer of property that remains taxable in the hands of the transferee under subsection 56(2) and not the income therefrom (see Murphy v The Queen, (supra)).

Neither is the payment or transfer (if it existed) for the benefit of the plaintiff or Fraser Paper.

In Miller v MNR, [1962] CTC 199; 62 DTC 1139, Thurlow, J (as he then was) in commenting on subsection 16(1) (which is identical to subsection 56(2)) has this to say:

In my opinion, Section 16(1) is intended to cover cases where the taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount received by some other person whom he wishes to benefit or by some other person for his own benefit. The scope of the subsection is not obscure for one does not speak of benefiting a person in the sense of the subsection by making a business contract with him for adequate consideration.

In my view, the loan from Companies to Paper, admitted to be such, is a contract between two separate entities in the course of business and is accordingly a business contract. As Thurlow, CJ has indicated a commercial transaction is not the conference of a benefit by Companies on Paper in the sense of subsection 16(1) or its successor, subsection 56(2). I refer to the loan of $20 million dollars in the singular for convenience in this context although it was made in two stages.

The fourth condition precedent to taxability under subsection 56(2) as above enumerated is that the payment or transfer would have been included in the taxpayer’s income if it had been received by him instead of the other persons.

It is fundamental under subsection 56(2) that the payment or property transferred, in this instance the 20 million dollars as proceeds received by Fraser Companies from the sale of the Newcastle mill, must have been included in its taxable income in its 1970 taxation year when the proceeds of that sale were received.

Indubitably the sale of the Newcastle mill by Fraser Companies was the sale of a capital asset and the proceeds were not taxable in its hands. The circumstance that there may have been adjustments with respect to capital loss recovery does not alter the fundamental principle expressed. Neither is there need to consider the possibility of taxation on a capital gain which did not come into effect until later.

Accordingly there has been no diversion of income (and avoidance of tax) by Fraser Companies to Fraser Paper for the simple reason that the proceeds of the sale were not taxable in Fraser Companies hands and subsection 56(2) does not apply.

Subsection 56(4), identified in the marginal note as “Transfer of Rights to Income” as contrasted with income in subsection 56(2) with which subsection (4) is usually joined as the basis of taxation and was done in this instance, differs from subsection 56(2).

First it relates to persons not dealing at arms length, which is clearly the relationship between Fraser Companies and Paper.

Secondly subsection 56(4) relates to the transfer or assignment of a right to an amount. That is not the fact in this case. Fraser Companies did not transfer to Fraser Paper the right to an amount. What Companies did was to loan Paper an amount.

However, as in subsection 56(2), the amount to which the right is transferred or assigned under subsection (4) must have been taxable in the hands of the transferor or assignor. For the identical reasons expressed on the identical question considered under subsection 56(2) the proceeds of the sale of the Newcastle mill received by Fraser Companies was a capital receipt, not a revenue receipt, and not taxable in its hands.

For the reasons expressed the plaintiff is not brought precisely within the provisions of either subsection 56(2) or subsection 56(4).

Counsel for the defendant pointed out that the promissory notes by which the notes were secured did not come into existence until August, 1970. The loans were made in January 1970. The loans were repaid by Paper to Companies in January 1971.

The notes were executed and dated in August, 1970 some seven months after the transactions but with the notation that the effective dates were in January 1970. That does not alter the transactions. The loans were made when alleged. The execution of the notes was at the insistence of Mr MacDougall, the Manager of Taxation for Fraser Paper was the mere two-way conduit, first by which Fraser Companies and its subsidiaries to serve as documentary evidence of a bookkeeping entry.

As I understood the contention on behalf of the defendant it was with respect to the loan of $10 million dollars by Fraser Companies to Fraser Paper and then by Fraser Paper to Miramichi that Fraser Paper was the mere two-way conduit, first by which Fraser Companies lent the money to Miramichi and secondly through which Miramichi repaid the loan to Fraser Companies.

That contention is not open to the defendant on the pleadings.

In paragraph 15 of the statement of claim the allegation is that on January 28, 1970 Companies made a loan of $10 million dollars to Paper without interest.

In paragraph 16 of the statement of claim the allegation is that Paper loaned $10 million dollars to Miramichi on the security of a promissory note bearing interest at 10.5% interest per annum.

Those allegations are admitted in the statement of defence.

To contend that those transactions were fictitious and that Paper was a mere vehicle is incompatible with the admissions and is tantamount to the contention that the transactions were for an ulterior purpose and were thus a “sham”, a contention which counsel for the defendant specifically disavows. I do not think that the allegation in paragraph 7(f) of the Statement, that the loan was not evidenced by a formal deed, detracts from the transaction being what it is.

With respect to the transactions involving the 20 million dollars made available to Paper by Companies by way of interest free loans the contention on behalf of the defendant, as I understood it to be, was that this was a designed plan to put aside that amount in a place where the interest income earned on that amount would be tax free on both sides of the border.

In paragraph 7(r) it is alleged that no income taxes were paid by Fraser Companies to Canada or by Fraser Paper either to Canada or the United States on the income derived from the money loaned.

That is true. Fraser Companies divested itself of that amount in the manner herein recited in detail. The interest income in the hands of Fraser Paper was not taxable in Canada because it was exempted therefrom by being a “foreign business corporation’’. The evidence was that Fraser Paper paid not tax in the United States on the interest income as being foreign source income.

That allegation, by itself, does not support the assessment. I know of no provision in the Income Tax Act nor any moral obligation that, if courses are open to a taxpayer which if followed would result in no tax being exigible or if one course would attract a lesser tax than another, dictates that the taxpayer must select the course which attracts a tax or the maximum tax.

The further contentions were made on behalf of the defendant that no legitimate, commercial or business purpose was served by the loans being made by Fraser Companies to Paper, that Companies could have made the loan directly to Miramichi without the interposition of Fraser Paper, that presumably Fraser Companies could have contracted for the expansion of the Fraser Paper plant following from which Paper stood in the relationship of an agent to Companies as the principal with the overall result that the sole purpose was to reduce tax.

In my view these contentions are untenable.

Ever since Salomon v Salomon, [1897] AC 22 it has been a well established principle, which has not been eroded during the passage of almost a century, that a company is an entirely different entity from its shareholders. Its assets are not their assets and its debts are not their debts. It is only upon evidence forbidding any other conclusion can it be held that acts done in the name of the company are not its acts or that profits shown in its accounts do not belong to it.

There has been no evidence here adduced which forbids the conclusion that the acts of Paper were its acts and not those of Companies.

There is no relationship of principal and agent between the shareholders of a company and the company. The fact that the sole shareholder of a company is another company, as is the case here, does not alter that.

In order to contend otherwise it must be accepted that the company is a “mere sham, simulacrum or cloak’’.

In my opinion there is no evidence to this effect.

Neither do I accept that the allegation in paragraph 7(s) of the statement of defence implying that Fraser Paper did not need for working capital the sum of $20 million dollars it borrowed from its parent has not been “demolished” as a fact.

I do accept the allegation in that paragraph that Fraser Paper did not have $10 million dollars surplus that it could lend to Miramichi but there were cogent reasons advanced, which have been recited previously, why It was a sound business expedient for Fraser Companies to loan the money to Paper so that it might loan that amount to Miramichi.

The constant theme in the contentions on behalf of the defendant, as I conceive to be the case, is directed to the end that the sole purpose that the manner in which the transactions were conducted as they were between the plaintiff and its subsidiary was that if the loans are allowed to stand as the bona fide transactions that would unduly or artificially reduce the income.

That being the case it seems to me that resort ought to have been had to subsections 137(1) (now 245(1)) as the statutory provision upon which to predicate the assessment.

This has not been done.

Assuming that it had, in my opnion, the transactions were not artificial, the reduction of tax was not the purpose but resulted incidentally from bona fide transactions in the course of business and acordingly subsection 137(1) would not have been applicable if that subsection had been relied upon as the provision upon which to base the taxation.

On the contrary the provisions relied upon as the basis for assessing the plaintiff as was done are subsections 56(2) and 56(4).

However for the reasons expressed neither the provisions of subsection 56(2) or subsection 56(4) is applicable to the transaction herein.

Accordingly the appeal is allowed with costs to the plaintiff.