The Queen v. Friedberg, 92 DTC 6031, [1992] 1 CTC 1 (FCA)

Linden, J.A.:—This is an appeal by the Crown from a decision of the Associate Chief Justice, dated January 25, 1989, in which he decided in favour of the taxpayer in relation to two different reassessments for the 1978, 1979, 1980 and 1981 taxation years. There are two separate issues involved, one dealing with the appropriateness of deductions claimed as a result of certain donations to the Royal Ontario Museum (in 1978 and 1980) and the second concerning the method of accounting used to record profits from trading in gold futures contracts (in 1978 to 1981). I shall deal with each of these distinct matters separately.

I. Donations to the Royal Ontario Museum

(a) The Substantive Issue

The first major issue is whether the Associate Chief Justice erred in holding that two collections of ancient textiles known as the Abemayor Collection and the Wilkinson Collection were "gifts" to the Royal Ontario Museum (ROM) so as to qualify as deductions permitted by paragraph 110(1)(b.1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") which reads as follows:

Gifts to institutions.—the aggregate of gifts of objects that the Canadian Cultural Property Export Review Board has determined meet all of the criteria set out in paragraphs 23(3)(b) and (c) of the Cultural Property Export and Import Act, which gifts were not deducted under paragraph (a) or (b) and were made by the taxpayer in the year (and in the five immediately preceding taxation years, to the extent of the amount thereof that was not deductible under this Act in computing the taxable income for the taxpayer for any preceding taxation year) to institutions or public authorities in Canada that were, at the time the gifts were made, designated under subsection 26(2) of the Act either generally or for a purpose related to those objects, not exceeding the amount remaining, if any, when the amounts deductible for the year under paragraphs (a) and (b) are deducted from the income of the taxpayer for the year, if payment of the amounts given is proven by filing receipts with the Minister that contain prescribed information

The Income Tax Act does not define the word "gift", so that the general principles of law with regard to gifts are utilized by the courts in these cases. As Mr. Justice Stone explained in The Queen v. McBurney, [1985] 2 C.T.C. 214, 85 D.T.C. 5433, at page 218 (D.T.C. 5435): "The word gift is not defined in the statute. I can find nothing in the context to suggest that it is used in a technical rather than its ordinary sense." Thus, a gift is a voluntary transfer of property owned by a donor to a donee, in return for which no benefit or consideration flows to the donor (see Heald, J. in The Queen v. Zandstra, [1974] C.T.C. 503, 74 D.T.C. 6416, at page 509 (D.T.C. 6420)). The tax advantage which is received from gifts is not normally considered a "benefit" within this definition, for to do so would render the charitable donations deductions unavailable to many donors.

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax (see Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106, per Mahoney, J.A.). If a taxpayer fails to take the correct formal steps, however, tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions. Taxpayers and the Crown would seek to restructure dealings after the fact so as to take advantage of the tax law or to make taxpayers pay tax that they might otherwise not have to pay. While evidence of intention may be used by the courts on occasion to clarify dealings, it is rarely determinative. In sum, evidence of subjective intention cannot be used to "correct" documents which clearly point in a particular direction.

The learned trial judge concluded that the plaintiff taxpayer had title to the Abemayor and Wilkinson Collections and was legally in a position to donate them to the ROM. He further held that "the existence of a document purporting to pass title of the textiles from Mrs. Abemayor to the ROM does not change my view of the situation.” The trial judge also found that "the Wilkinson Collection was purchased by the plaintiff (taxpayer) and processed by the Museum . . . in the same manner as the Abemayor Collection."

With respect, this conclusion was based on an error of law, in that the trial judge failed to appreciate the importance of the"document purporting to pass title” dated March 16, 1978, which legally transferred the title of the Abemayor Collection to the ROM, not to the taxpayer. No such transfer document to the ROM existed in the case of the Wilkinson Collection, and, hence, he was incorrect in holding them to be similar transactions, but he was correct in so far as his characterization of the Wilkinson gift was concerned.

The evidence before the trial judge was that, as a result of consultations with Dr. Veronika Gervers, the Associate Curator of the Textiles Department of the ROM, Mr. Friedberg was prepared, by 1978, to assume the financial burden of acquiring the tapestries for the museum. At that time it was unclear what the tax consequences of such an acquisition would be, but Mr. Friedberg indicated that he did not wish to be “out of pocket" as a result of any donation he would make. Some discussion of what arrangements would be made if the property was not favourably characterized by the Canadian Cultural Property Export Review Board also took place, in which case both a permanent or temporary loan of the tapestries were contemplated.

It is clear that it is possible to make a "profitable" gift in the case of certain cultural property. Where the actual cost of acquiring the gift is low, and the fair market value is high, it is possible that the tax benefits of the gift will be greater than the cost of acquisition. A substantial incentive for giving property of cultural and national importance is thus created through these benefits. But not every gift will be found to benefit from these provisions. It all depends on how the transaction is characterized, for one cannot give what one does not own.

The key document, dated March 16, 1978 and prepared by Mrs. Abemayor's lawyer, Mr. Guterman, was signed by Mrs. Abemayor and reads as follows:

KNOW ALL MEN BY THESE PRESENTS, that I, NELLY ABEMAYOR, residing at 40 Schenck Avenue, Great Neck, New York, DO HEREBY assign, transfer and set over all of my right, title and interest in and to certain Islamic Textiles listed in Schedule "A" annexed hereto, to ROYAL ONTARIO MUSEUM, 100 Queens Park, Toronto, Ontario, Canada M5S 2C6, for and in consideration of the sum of $67,500 U.S. dollars, by check subject to collection, receipt of which is hereby acknowledged, hereby warranting the title to said Islamic Textiles.

The said Museum by its curators has examined these textiles and photographed them and its curators are experts in this field, and is purchasing same without any representation by the seller or reliance upon any representation by the seller. This purchase is therefore being made without any representation or warranty by the seller with respect to authenticity, age, period, condition or any other warranty of any kind except the warranty of title as above.

IN WITNESS WHEREOF, the said Nelly Abemayor has hereunto set her hand and seal this 16th day of March, 1978.

/s/ Nelly Abemayor (L.S.) Nelly Abemayor

ACCEPTED AND AGREED TO:

ROYAL ONTARIO MUSEUM

by Veronika Gervers

This document clearly contains a transfer of title to the ROM, which obviously reflected Mrs. Abemayor's understanding of the deal, even though others may have had a different view of it. There is some doubt whether she would have agreed to transfer the title to a private individual, since it was evident to all that she wanted the collection to go to the ROM, not to an individual, and that is why she was prepared to accept in payment for it something less than she thought was its market value. The argument by counsel for the taxpayer that the purport of the sale document was merely a disclaimer is not borne out by its language. It certainly contains a disclaimer, but this document was a formal transfer of title in the goods to the ROM from Mrs. Abemayor.

The other documentation made before or at the time of sale supports this characterization of the transaction. The formal written offer to sell the Collection was to the ROM, not to the taxpayer (document dated January 27, 1978). The customs documents dated March 16, 1978, which were required to bring the collection into Canada from New York, were made out in the name of the ROM, the form containing the words "purchased by the ROM". The letter of the Chairman of the ROM dated April 4, 1978, thanking Mrs. Abemayor, used the words "you generously assisted the Museum in acquiring [the Collection]", indicating that he thought the Collection had already been acquired by the ROM, even though one might, if one tried hard, render those words more ambiguous so as to impart another possible meaning. Finally, on October 1, 1982, Mrs. Abemayor, in her letter to the Department of Revenue, reiterated her view that she sold the collection to the ROM in March 1978, although she acknowledged that the money came from the taxpayer.

In my view, the loan documentation and the gift forms that were prepared later by the ROM in an effort to repair the situation were of no legal effect. The approval of the Canadian Cultural Property Export Review Board was similarly of no significance on this issue. There was much confusion and much duplication of documentation following the transaction in order to try to make the written record conform to the wishes of the taxpayer in order to get the full tax benefit of this" gift.” Unfortunately, however, nothing was done to" rectify” the key transfer document from Mrs. Abemayor to the ROM, perhaps because she probably would not have agreed to change it. (And, if she had agreed to pass the title to the taxpayer, she would have undoubtedly insisted on a guarantee that the Collection be given to the ROM, which would also have defeated the legal conclusion that there was a gift of the textiles to the ROM from the taxpayer. (See The Queen v. Burns, [1988] 1 C.T.C. 201, 88 D.T.C. 6101 (F.C.T.D.); aff'd [1990] 1 C.T.C. 350, 90 D.T.C. 6335 (F.C.A.).)

The only legal conclusion that one can draw from the documents concerning the Abemayor Collection is that the taxpayer made a gift of the money to the ROM, with which it acquired the collection. He did not hold the title to the textiles, nor did he ever acquire the title, and one cannot give what one does not have. This may not have been his subjective intention, but the documentation points inexorably to that legal conclusion. On the Abemayor Collection issue, then, the trial judge erred and the appeal will be allowed.

On the Wilkinson Collection issue, on the other hand, the trial judge was correct in concluding that the documentation and other evidence demonstrated that the taxpayer made a gift to the ROM. All the documents indicated that Mr. Wilkinson transferred title to the taxpayer, who then loaned the material to the ROM, and finally donated it to the ROM. There never was any transfer by the seller to the ROM. In relation to the Wilkinson Collection, Friedberg gave the ROM something which he owned and he was, therefore, entitled to claim the appropriate deduction for it.

(b) The Evaluations

Because of my holding that there was no“ gift” of the Abemayor Collection by the taxpayer to the Royal Ontario Museum, it is not strictly necessary to deal with the matter of its evaluation. However, in the event that I am in error, it seems prudent to give reasons in relation to that issue. The main point argued by the Crown on this issue is that the three evaluators, who were asked to evaluate the fair market value of the Abemayor Collection, did not take into account the price actually paid for the textiles. This, it is contended, was an error of law. The Associate Chief Justice accepted the evidence of the three evaluators of the Abemeyor Collection, whose figures were as follows:

The approximate average of these three amounts, $496,175, was accepted by the Associate Chief Justice as the fair market value of the Collection. He knew the actual sale price of $67,500, the circumstances of the sale and he also heard the viva voce testimony of the three experts who testified at the trial. One must note that, surprisingly and in retrospect unwisely, the Crown did not call any expert evidence on this matter, arguing simply that the sale price was the fair market value. Even though I might have concluded otherwise had I been the trial judge, I do not see any basis for interfering with the findings of fact on this issue by the Associate Chief Justice. As Mr. Justice Le Dain wrote in Century Insurance Company of Canada v. N.V. Bocimar S.A., [1987] 1 S.C.R. 1247, 76 N.R. 212, at page 1249:

. . . The limits to the scope of appellate review of the findings of fact by a trial court, which were affirmed by this Court in Stein v. The Ship "Kathy K", [1976] 2 S.C.R. 802, and other decisions, also apply in my opinion to the review of the findings of a trial court based on expert testimony . . .

As for the evaluations of the Wilkinson Collection, there is also no basis for interference. The trial judge heard the viva voce evidence of only one evaluator on this matter, FE Crane, who testified that the collection was worth $142,650. He also had before him two written appraisals by two evaluators who had died prior to the time of trial and therefore could not testify viva voce. Their evaluations, also done without knowledge of the actual sale price, were as follows:

The approximate average of these three evaluations, $229,437, was claimed by the taxpayer in 1980 and found to be correct by the trial judge, who was well aware of the purchase price of $12,000. 1 do not see any basis for altering that finding of fact, even though I might have arrived at a different figure had I been the trial judge.

II. Gold Futures Contracts

The second major issue is whether the Associate Chief Justice erred in allowing as deductions business losses arising out of trading in gold futures by the taxpayer in each of the following taxation years, as follows:

1978 — $ 512,126 1979 934,387 1980 — 72 1981 — 25,186

The Crown contends that the accounting method used to record these losses by the taxpayer was not the best one, according to the evidence; hence the losses should be allowed only in the years following the individual years in which they were claimed. Reliance was also placed on subsection 245(1), dealing with artificial transactions, which reads:

(1) In computing income for the purposes of this Act, no deductions 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.

The evidence before the trial judge indicated that the taxpayer traded in futures, including gold futures, on behalf of clients as well as on his own behalf. The evidence explained that a futures contract is an agreement for the purchase and sale of a commodity, where the delivery of the commodity is fixed for a future date and where the price and quantity are also fixed. These futures contracts have value and there has developed a sophisticated speculative trade in them. Holders of futures contracts must either take delivery or make delivery of the commodities, depending on whether they are on the buy or sell side of the contract. This eventuality does not occur normally, since most traders resell their contracts prior to the appointed delivery dates. This is referred to as "liquidating" their positions.

Buying a futures contract is termed "going long”, whereas selling a futures contract is called "going short.” If an investor buys or sells a futures contract without doing anything to hedge or protect his position, he is said to have taken an "outright position”.

It was also clear on the evidence that it is also possible for investors to take a Eosition called a commodity "spread", which involves simultaneously "going ong” (buying) and "going short" (selling) in an equivalent number of futures contracts for delivery in different months at different prices. These transactions are called “legs”. Thus, a spread transaction is composed of a long (buy) leg and a short (sell) leg. A spread transaction may be entered into simultaneously, or it may be entered into by going long outright first, and then going short afterwards. Or an investor might go short outright first and later go long. Whenever investors buy or sell particular futures contracts, there must be a corresponding buy or sell for that contract in order to avoid being forced to take or to make delivery of the commodity.

Each of these legs may be "closed out” separately. One may sell contracts obtained on the long legs or buy contracts to cover those sold on the short legs, thus taking advantage of fluctuations in the market both ways. Losses suffered in buying may thus be offset by gains made in selling.

There are many risks involved in the trading of commodity futures, the price of which may fluctuate daily, depending on numerous factors such as interest rates, dollar exchange rates, international crises, volume of trading, the value of the commodity, etc. The amount of risk is related to the time between the two legs of the spread. Outright positions are the riskiest aspect of the trade, but trading in spreads is also quite risky. Investors win or lose depending on their ability to predict the influence of the various factors on the spread from month to month.

All futures contracts are margin transactions, in that only a small percentage (five to ten per cent) of the value of the contract has to be deposited with the broker as a guarantee. In order to ensure the adequacy of the margin, therefore, brokers calculate, on a daily basis, the changes in net value of all the contracts held by their customers. This is called "marking to the market". Thus, broker losses and broker gains are calculated each trading day to determine whether or not additional margin is required. This analysis is the same for outright positions as it is for spread positions.

The taxpayer traded extensively in gold, using both outright and spread positions, during the taxation years in issue. He did so primarily to earn profits from his speculation, but also for purposes of tax planning, in that he could achieve substantial deferral of income thereby.

For purposes of calculating his personal income tax liability in the taxation years in question, the taxpayer employed a different method of accounting, called the" lower of cost or market method”. Pursuant to this method, a gain in trading is recognized as income when it is closed out and sold, whereas an unrealized loss is immediately accounted for and debited from income. In each taxation year under appeal, the taxpayer closed out his losing legs on the spread positions but deferred closing out those that were showing a profit until after the end of the taxation year, thereby securing for himself substantial deferrals of income.

The Crown challenges this because, under the " mark to market method”, which, it contends, better reflects the economic reality, he would have had to include both the losses and the gains immediately, as is done by the brokers each day. We are told that this method of accounting is now required in the United States, but there is no such law in Canada.

Canadian law permits taxpayers to calculate their income in accordance with generally accepted accounting principles. The key issue, barring specific statutory direction, is whether "it is appropriate to the business” and whether it" tells the truth about the taxpayer's income.” In other words, the "opinion of accounting experts that is an accepted system and is appropriate to the taxpayer's business and most nearly accurately reflects his income position” may be adopted by the Court. (See M.N.R. v. Publishers' Guild of Canada Ltd., [1957] C.T.C. 1, 57 D.T.C. 1017, at pages 16-17 (D.T.C. 1026), per Thorson, P.) Two accounting experts testified before the trial judge, a Mr. Thornton, called by the Crown, and a Mr. Carscallen, called by the taxpayer. Mr. Thornton testified that he felt the mark to market method was best but he, along with Mr. Carscallen, recognized that it was acceptable, according to generally accepted accounting principles, to account for these speculative futures contracts using the lower of cost or market method. Some businesses used it but most did not. They both agreed that the mark to market method would be a more accurate reflection of the true financial position of the taxpayer, but no legislation required that this method be used. The trial judge concluded as follows:

There is no provision in the Income Tax Act requiring a particular accounting method for commodities traders comparable, for example, to the regulations enacted some years ago denying lawyers the option of reporting income on either a cash or accrual basis. In the absence of such a regulation denying this kind of a choice to the commodity trader, I see no reason why the taxpayer should not be able to conduct his affairs as he did here. Expert accounting witnesses agreed that both the marked to market or lower of cost or market methods of accounting were in use in Canada and the United States for speculative trading in futures contracts in the years in question, and that there were no standard principles requiring the use of one method as opposed to the other. Academic articles on accounting methods outlined both systems and noted a diversity in practice, and numerous public American and Canadian companies that used the lower of cost or market method for their futures contracts transactions all employed large internationally recognized accounting firms. Based on the diversity of practice at the time and the authoritative literature, it was the opinion of one expert that accounting based on the lower of cost or market method in this case was consonant with generally accepted accounting principles. I accept this evidence and conclude that it would have been appropriate for the plaintiff to choose either of the accounting methods discussed here in calculating his taxable income.

There was expert evidence before the Court permitting this conclusion. (See Le Dain, J. in Century Insurance Company of Canada v. N.V. Bocimar S.A., supra.) I can see no error in law, therefore, in the reasons expressed by the trial judge. It was open to the taxpayers to utilize this method of accounting to record this type of activity, if it was to their advantage to do so. I also agree with the trial judge that there was no artificiality here, so as to run afoul of section 245 of the Income Tax Act.

In conclusion, then, I would allow the appeal in relation to the reassessment concerning the Abemayor Collection, but in all other respects the appeal will be dismissed.

In view of the divided success on very different issues, it appears appropriate to invite written representations as to costs here and in the Trial Division. The respondent may file written representation on or before December 19, the appellant may file a response on or before January 6, 1992, and the respondent may repy, if it is felt necessary, on or before January 13. Formal judgment will not issue until after the costs issue is settled by the Court.

Appeal allowed in part.