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Citation: 2003TCC214
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Date: 20030404
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Dockets: 2000-998(IT)G
2000-999(IT)G
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BETWEEN:
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WILLIAM H. LOYENS,
HARRY P. LOYENS,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Campbell, J.
Introduction:
[1] These appeals are from assessments
in respect to the 1993 taxation year for both Appellants. They
were heard together on common evidence.
[2] The Appellants, Harry Loyens
("Harry") and William Loyens ("William"), are
involved in the business of developing and selling real estate.
This appeal arises as a result of a series of agreements dated
November 30, 1993 (the "Agreements"). The Agreements
purport to effect a sale of the beneficial interests of the
Appellants in a piece of real property (the "Harrison
Farm") to a numbered company owned by Eugene Drewlo. A
series of agreements as opposed to one agreement was necessary in
order to utilize losses in a corporation, Lobro Stables, owned by
the Appellants.
[3] The Respondent challenges the
validity of the Agreements. Specifically, the Respondent submits
that the evidence shows that the Appellants sold the Harrison
Farm to Eugene Drewlo on March 8, 1993. If the evidence
substantiates this allegation, the Appellants would have had no
interest in the Harrison Farm to sell on November 30, 1993 and
the Agreements would constitute a sham.
[4] The Respondent submits in the
alternative that if the proper sale date is November 30, 1993,
these Agreements do not achieve the tax savings purpose for which
they were designed due to two reasons. First, the Agreements
purporting to effect a section 85 rollover were invalidly
executed because real property inventory is not eligible
property. Second, the general anti-avoidance rule
("GAAR") applies, denying the Appellants any tax
benefit from the Agreements of November 30, 1993.
Issues
[5] These appeals give rise to four
issues. Three issues are common to both appeals of Harry and
William while the fourth issue - the waiver issue - is relevant
to Harry's appeal only. The issues are:
(1) Is the effective sale date of the
Harrison property, March 8, 1993 or November 30, 1993?
(2) If the sale date is November 30, 1993,
is the rollover of the Varna partnership interest to Lobro
Stables valid pursuant to the application of subsections 85(1)
and 85(1.1) of the Act?
(3) Does the general anti-avoidance rule,
section 245 of the Act, apply?
(4) Is the waiver received by the CCRA on
behalf of Harry a valid and effective waiver?
The Facts:
[6] William started building
houses in 1959. Harry became involved in land development
around 1980, when the company he managed, Walloy Excavating
Company Limited ("Walloy") went into the land
development business. Walloy had an excavating and ready-mix
concrete business. Harry and William each owned 25% of the shares
of Walloy, with another individual, Bill Wasko, who owned 50%.
Bill Wasko also had interests in a company called Ardshell
Limited ("Ardshell"). Ardshell had acquired a parcel of
land to develop ("the Rosecliffe development") but was
experiencing financial difficulties. Consequently, Walloy
purchased Ardshell and Walloy became the 100% shareholder. Eugene
Drewlo expressed interest in becoming a partner of Ardshell.
Walloy had connections to Drewlo because Walloy supplied Drewlo
with ready-mixed concrete for construction of Drewlo's
apartment buildings. In the end Drewlo acquired 50% of the shares
of Ardshell through his company, Drewlo Holdings Ltd.
Ardshell's two corporate shareholders were now Walloy and
Drewlo Holdings. The Rosecliffe development made money and
Ardshell took on several other development projects.
[7] The Appellants, together with
Bill Wasko, purchased in equal shares approximately one
hundred acres for $100,000.00 in London Township in the late
1960s or early 1970s for development. This property was the
Harrison property. It was not developed immediately but was used
to grow hay. The Appellants had a particular fondness for this
property. They indicated they would have purchased this farm
without Bill Wasko if they had been financially able to do so.
The equal shares in this property were different from the
division of the shares each held in Walloy.
[8] Eugene Drewlo, whose company
Drewlo Holdings had become a 50% shareholder of Ardshell,
also owned the adjacent farm to the west of the Harrison
property. He made an offer on the Harrison Farm but the
Appellants were not interested in selling the entire farm. After
negotiations they agreed to sell one-half of the farm for
approximately $400,000.00.
[9] 722973 Ontario Limited
("722973") was incorporated to act as trustee to hold
the beneficial interests of the owners of the Harrison property.
The corporate shareholdings of 722973, reflecting the beneficial
ownership of the Harrison property, were as follows:
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William Loyens
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16.7%
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Harry Loyens
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16.7%
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William Wasko
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16.7%
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Drewlo Holdings Inc.
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50%
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[10] Harry and Drewlo were managing Ardshell
during these years in its land development endeavours. One of its
projects, the Hunt Club development, was struggling. It had been
purchased for $16,500,000.00 but was experiencing cash flow
problems. At this time, one of the most potentially lucrative
pieces of property in the City of London became available. The
Appellants felt that this property, if developed, could
successfully offset the financial difficulties of the Hunt Club
development. The University offered this property for sale by
tender. Since Ardshell was struggling financially, it was unable
to come up with $1,000,000.00 deposit required to accompany this
tender. The Bank advised them that there was insufficient time to
arrange a loan because of the tender deadline and suggested that
Drewlo use his line of credit. Immediately after the meeting with
their banker, Drewlo, Wasko and both Appellants discussed
borrowing $1,000,000.00 from Drewlo at their lawyer's office.
They were at the solicitor's office to execute deeds for a
number of lots that had been sold. They used the solicitor's
boardroom for this discussion but the solicitor was not present.
According to the evidence of the Appellants, Drewlo agreed to
this loan because "he really wanted that property too".
During this meeting, which occurred on March 8, 1993, three
cheques were drawn upon the account of Drewlo Holdings Inc. for a
total of $1,000,000.00. Bill Wasko, Harry and William each
received a cheque for $333,333.00. Drewlo requested security and
it was agreed that the security would be the Harrison Farm
property in exchange for these loans so that the tender could be
submitted. The evidence disclosed that there was some hesitation
in putting up this property as it was worth more than
$1,000,000.00 but the Appellants stated that they anticipated
repaying the Drewlo loan as the university land was worth
"mega bucks". Even if the tender was not accepted, the
deposit would be promptly returned. In describing this
arrangement, William stated: "... if we don't pay him
(Drewlo) back in six months he gets the land ... And we had a
handshake on it". The arrangement was to be approximately
six months in duration. According to the Appellants, since they
were borrowing personally and providing security that was worth
maybe $1,000,000.00 to $2,000,000.00, they agreed that the loan
to the Appellants and Wasko would be in the amount of
$1,000,000.00, sufficient to cover Walloy's share of the
tender in the amount of $500,000.00 which Ardshell planned to
submit. Each Appellant and Wasko received a cheque for
$333,333.00. All three cheques were endorsed and cashed at the
Bank of Nova Scotia on March 8, 1993. Each cheque contained
the following notation in the lower left hand corner:
Re sale 722923 Ont. Ltd.
[11] To the best of William's
recollection, he thought Harry completed the data on the cheques
before Drewlo signed them and that the amount was mechanically
imprinted. He stated he did not see the notation on the lower
left hand corner being affixed to each cheque and that he did not
recognize the writing. He stated that the notations were not on
the cheques when he saw them at the solicitor's office before
deposit and if they had been there he would have questioned it.
Harry deposited William's cheque for him. Eventually, when he
was informed of the existence of these cheque notations, he
questioned Harry, Wasko, Drewlo and also his bank manager.
[12] Harry confirmed that he completed the
data on the three cheques except for the amount which was stamped
by a cheque writer. He stated Drewlo signed the cheques in the
presence of himself, his brother, and Wasko. In denying that
these notations were on the cheques while in his possession, he
stated "If that had been put on the cheque I wouldn't
have cashed it".
[13] Drewlo's evidence confirmed the
testimony of the Appellants. When asked how the notation might
have appeared on the cheques he responded "No, it was news
to me when I heard about it".
[14] Each Appellant's cheque was
deposited to their personal chequing account. On the same day,
each Appellant deposited the sum of $175,000.00 in Walloy's
account for a total of $350,000.00 to offset their obligations to
Ardshell. The balance of $158,333.00 remained in each of their
personal accounts.
[15] Ardshell did have the highest bid.
However, when the University changed its mind it did not
return the million-dollar deposit immediately. When the deposit
was eventually returned, instead of repaying Drewlo, the
Appellants deposited their share to Ardshell's account to
offset its overdraft and their share of its debt load.
[16] By the fall of 1993, according to the
Appellants, Eugene Drewlo was requesting either the return of his
money or the transfer of the Harrison property. The Appellants
could not pay. Their accountant, Bill Hill, was contacted to
accomplish the property transfer to Drewlo. According to the
Appellants, the sale of the Harrison property occurred on
November 30, 1993. According to the Respondent, the sale took
place on March 8, 1993 when Drewlo gave cheques to each Appellant
and Wasko.
Issue One: Is the effective sale date of
the Harrison property, March 8, 1993 or November 30, 1993?
[17] The parties disagree on the disposition
date of the Harrison property. The Appellants submit the
disposition date is November 30, 1993 while the Respondent
submits it is March 8, 1993. If the evidence shows that the
disposition date is in fact March 8, 1993, then the November 30,
1993 sale is a sham.
Appellants' Position:
[18] The November 30, 1993 Agreements are
not a sham because there was a total absence of deceit, which is
central to the sham doctrine. The tax plan devised by Hill does
not mislead. The documents of November 30, 1993 represented
nothing more than exactly what they purported to be.
[19] The Appellants did not terminate their
interest in the property on March 8, 1993 because only specific
events can result in such termination (Shepp v. The
Queen, 99 DTC 510 (T.C.C.)). There is no evidence of any
enforceable or firm commitment to purchase this property prior to
November 30, 1993. Nor was there any change in possession, use or
risk, as contemplated in Johnson et al. v. The Queen, 99
DTC 603 (T.C.C.).
[20] The Statute of Frauds, R.S.O.
1990, c.s. 19, required written documentation to support a sale
of real property. The cheque notation relied upon by the
Respondent to support a disposition date of March 8, 1993 is
insufficient according to case law.
Respondent's Position:
[21] The March 8, 1993 transaction was in
fact the sale of 722973 shares held by the Appellants and Wasko
to Drewlo for $1,500,000.00, which included the assumption of the
$500,000.00 mortgage. This represents the actual transaction and
relationship between the parties.
[22] The effective sale of the Harrison
property occurred on March 8, 1993, as evidenced by the three
cheques from Drewlo Holdings to each Appellant and William Wasko
for $333,333.00, the Bank's microfiche, the share registry
plus supporting directors' resolutions and the corporate
bookkeeping records of Drewlo Holdings.
[23] Acceptance and endorsement of the
cheques are evidence that the sale occurred on March 8, 1993
because each cheque had a memo, written in the lower left hand
corner which read: "Sale of 722973 Ont. Ltd.". The
cheques plus the other documentation, relied on by the
Respondent, support a sale date of March 8, 1993 and amount to
"consensus ad item" between the parties. In
addition the bank's microfiche copies of these cheques
contain the same notation.
[24] The facts do not support the allegation
that Ardshell required the money to finance $1,000,000.00 tender
on a property because each of the cheques for $333,333.00 was
deposited in each of the Appellants' personal accounts and on
the same day, each Appellant then deposited $175,000.00 for a
total of $350,000.00 to Walloy. Amounts loaned to the Appellants
and the cash requirements of Ardshell do not match with their
proportionate share of the corporate debt. Ardshell's
shareholders, Walloy and Drewlo Holdings, were required to inject
equal amounts, i.e. $500,000.00 each. Walloy however injected
$700,000.00.
[25] The share registry and corporate
resolutions of 722973 made no reference to the Varna partnership
or Lobro Stables. In addition, the corporate bookkeeping records
of Drewlo Holdings contained an original journal entry which
labelled the $1,000,000.00 paid to the Appellants and Wasko as an
investment. On November 30, an adjusting entry was made which
removed the $1,000,000.00 out of investments and into accounts
receivable. This amounts to a deliberate recharacterization from
an investment to an account receivable. The November 30, 1993
Agreements were tax-planning after-thoughts.
Analysis
[26] The term "sham" is defined in
Stubart Investments Limited v. The Queen, 84 DTC
6305. That case referred to the parameters of a sham transaction
at paragraph 50 where the Court quoted from the case of Snook
v. London & West Riding Investments, Ltd., [1967] 1 All
E.R. 518 at page 528, which found that no sham existed because no
acts had been taken:
...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.
[27] The disposition date of the Harrison
property will ultimately determine whether a sham transaction
occurred in this case. The existence of sham was crucial to the
Respondent's position. The Respondent argued that the
November 30, 1993 transactions did not represent the actual
relationship between the parties and were in fact a sham.
Shell Canada Ltd. v. R., [1999] 4 C.T.C. 313 at
paragraph 39 referred to legal relationships in relation to
sham:
This Court has repeatedly held that courts must be sensitive to
the economic realities of a particular transaction, rather than
being bound to what first appears to be its legal form:
Bronfman Trust, supra, at pp. 52-53, per
Dickson C.J.; Tennant, supra, at para. 26, per
Iacobucci J. But there are at least two caveats to this
rule. First, this Court has never held that the economic
realities of a situation can be used to recharacterize a
taxpayer's bona fide legal relationships. To the
contrary, we have held that, absent a specific provision of the
Act to the contrary or a finding that they are a sham, the
taxpayer's legal relationships must be respected in tax
cases. Recharacterization is only permissible if the label
attached by the taxpayer to the particular transaction does not
properly reflect its actual legal effect: Continental Bank of
Canada v. R., [1998] 2 S.C.R. 298 (S.C.C.) at para. 21,
per Bastarache J.
[28] Before looking at the documentary
evidence, it will be useful to summarize the evidence of both
Appellants and Drewlo as to their explanation of the March and
November events. The oral evidence of both Appellants and Eugene
Drewlo confirmed that they formed a business relationship when
Drewlo purchased a 50% interest in Ardshell. The other 50%
interest was owned by Walloy Excavating. Ardshell successfully
completed a development called Rosecliffe. However, by March 1993
one of the subsequent developments, Hunt Club, was not
financially successful. When a potentially lucrative property
came up for tender through the University, Ardshell wanted to bid
but did not have the $1,000,000.00 deposit required to accompany
the bid. The Bank advised the Appellants, Drewlo and Wasko, that
there was insufficient time to process a loan for $1,000,000.00
and that Drewlo should use his line of credit.
[29] The Appellants and Drewlo all gave
evidence which confirmed that this was the backdrop to the
transaction of March 8, 1993. When these individuals left the
Bank, they went to their solicitor's office where the deal
was struck. As Ardshell was struggling financially, Drewlo agreed
to loan $1,000,000.00 to Harry, William and Wasko. This loan was
to be used to cover Walloy's one-half share of the deposit as
well as their share of other Ardshell debts. Drewlo asked for the
Harrison property for security. The evidence confirmed that when
they agreed on the loan and the security, Drewlo wrote three
cheques of $333,333.00 each to Harry, William and Wasko. Ardshell
was the successful bidder but the vendor backed out of the deal.
Some of the loan to each of the Appellants was used to pay off
the debt load of Ardshell so they were unable to repay Drewlo.
Eventually Drewlo wanted the loan repaid and because they were
unable to do so, the balance of Harrison property was conveyed to
one of his companies in the manner set out in Hill's
memo.
[30] I turn now to the documentary evidence,
which included:
1) the November 30, 1993
Agreements;
2) the March 8, 1993
cheques;
3) the accounting
entries;
4) the interests'
adjustment; and
5) the corporate
resolutions.
To understand the November 30, 1993 Agreements, it is
essential to look at Hill's memo to the solicitor (Exhibit
A-1, Tab 30). I have reproduced the memo in its entirety:
BILL & HARRY LOYENS
_________
1. Presently Bill and
Harry Loyens along with Bill Wasko own 50% of a farm property
referred to as the Harrison Farm. They each have a 1/3rd interest
in the 50% 722973 Ontario Limited as a bare trustee corporation
holds 50% of the property in trust for these individuals
remaining 50% is held in trust for Drewlo Holdings Inc.
2. Bill and
Harry Loyens wish to transfer their interests to a partnership
called Varna Elevators. At present they are the only partners and
each has a 50% partnership interest. They would be transferring
their beneficial interest only as 722973 Ontario Limited would
continue to hold legal title.
The fair market value of the property is $500,000 each and
there is $166,667 loan outstanding ($333,333 in total). Bill and
Harry and the partnership will elect to have Section 97(2) apply
and each will elect to have the transfer apply at $166,667 for
tax purposes. Consideration for the transfer will be assumption
of the debt of $166,667 and a credit to the partner's capital
account of $333,333. Please prepare the necessary transfer
documentation.
3. Following
completion of the transfer as outlined in 2) above Harry Loyens
will transfer his partnership in Varna Elevators to Lobro Stables
(1991) Ltd. Consideration for the transfer will be the issuance
of Class A special shares having a redemption amount equal to the
fair market value of the partnership interest. The parties will
agree to have the transfer subject to the provisions of Section
85 of the Income Tax Act and agree that the elected amount shall
be equal to Harry Loyens adjusted cost base of his partnership
interest which amount is to be determined. The paid up capital of
the special shares should be limited to the election amount.
Note:
We understand that it will be necessary to have a class of
special shares created in Lobro. We would suggest the following
attributes:
1) non-voting,
redeemable, retractable
2) redemption
amount of $100 per share
3)
non-cumulative dividends of 6% of the redemption amount. Please
prepare the necessary transfer document.
4. Bill Loyens
will then transfer his partnership in Varna Elevator to Lobro
Stables (1991) Ltd. Consideration elected amounts, etc. will be
the same as set out in item 3.
5. Through
these steps beneficial title in the Harrison Farm property
formerly owned by Bill and Harry Loyens has been transferred to
Lobro Stables (1991) Ltd.
6. Lobro
Stables (1991) Ltd. and Bill Wasko will then sell their interest
in the Harrison Farm to 643288 Ontario Ltd. The selling price is
$1,500,000 with the consideration being the assumption of debt
for $500,000 and a note payable to Lobro Stables (1991) Ltd. for
$666,667 and Bill Wasko for $333,333. Closing of this sale must
be on November 30th. Please prepare the usual purchase and sale
agreement.
7. Previously
Drewlo Holdings advanced $333,333 to Bill, Harry and Bill Wasko.
We propose to treat these advances as a loan during the interim
period. After the closing of the sale in 6 all parties should
agree that all notes are cancelled by set-off.
8. We will
transfer the notes payable by Bill and Harry to Lobro by reducing
their shareholder loans in that company.
643288 Ontario Limited
1. As set out
in point 6 of the Loyens memo this company will be acquiring the
Harrison Farm (50%) for $1,500,000.
2. The set off
procedures for the notes results in a $1,000,000 payment by
Drewlo to 643288. In addition Drewlo will assume the $500,000
bank loan thereby increasing the payment to $1,500,000. This is
to be treated as a $1,500,000 repayment by Drewlo on its loan
from 643288. We will ask that you prepare an acknowledgement of
this for Drewlo Holdings Inc. and 643288 signatures.
I can be reached at Queen Elizabeth Hotel in Montreal:
514-861-3511, Room 1646.
I will check regularly for messages.
Our apology for the time pressure on this.
Regards,
W.J. Hill*mh
[31] Prior to November 30, 1993, 722973 was
the registered owner of the Harrison property, holding it as bare
trustee for the shareholders. Pursuant to Hill's memo, the
Appellants, by Agreement dated November 30, 1993, transferred
their 16.7% beneficial interest in the Harrison property to their
partnership, Varna Elevators ("Varna partnership"). The
Appellants were equal partners in the Varna partnership. This
transfer was carried out pursuant to subsection 97(2) of the
Act. The total consideration received by each Appellant
consisted of an assumption of liabilities of $166,667.00 and a
partnership interest of $333,333.00, totalling $500,000.00
consideration for each Appellant. Each Appellant reported taxable
business income of $133,333.00. Again 722973 acted as bare
trustee for the Varna partnership with respect to the
partnership's beneficial interest in the Harrison
property.
[32] Subsequently, on the same day, each
Appellant by separate document dated November 30, 1993
transferred their partnership interest from the Varna partnership
to their company, Lobro Stables (1991) Ltd. ("Lobro
Stables"). Again these transfers were in accordance with
Hill's November memo. The Appellants filed an election
pursuant to section 85 of the Act for the disposition
of the partnership interest in Varna to Lobro Stables. The T2057
elections specified a fair market value for each individual
partnership interest as at November 30, 1993 of $281,000.00.
The consideration received by each Appellant was paid by the
allotment and issuance of 2,180 Class A Special shares. Subject
to the section 85 election, the agreed transfer amount was
$1.00. Since the Varna partnership had a negative cost base, each
Appellant reported a capital gain of $24,136.00 on their 1993 T1
form.
[33] Subsequent to the disposition to Lobro
Stables and on the same date, Lobro Stables, by agreement dated
November 30, 1993, sold the interest it now owned in the Harrison
property to an affiliate of Drewlo Holdings, called
643288 Ontario Limited ("643288"). Lobro Stables,
at the time of transfer to 643288, owned two-thirds of a 50%
beneficial interest in the Harrison property, with
William Wasko owning one-third of a 50% beneficial interest.
Again 722973 acted as bare trustee holding the beneficial
interest in the property now for 643288. The total consideration
paid by 643288 to Lobro and Wasko was the sum of $1,500,000.00,
with the consideration being the assumption of a mortgage of
$500,000.00 and a note payable to Lobro Stables for $666,667.00
and to Wasko for $333,333.00. On disposition of the property
Lobro Stables reported a profit for its fiscal year, ending March
31, 1994 on disposition of the property. Since it had losses in
prior years, the corporate tax payable was reduced to $6.00.
[34] Pursuant to Hill's memo, the
Harrison property was now transferred to 643288, an affiliate of
Drewlo Holdings.
[35] I do not believe that these
transactions were artificial or manufactured. The legal
relationships and their commercial reality are legitimate. The
documents reflect the nature of these relationships. There is no
evidence that they were backdated. The form they took on November
30, 1993 reflected the legal and accounting advice they sought.
For me to reach any other conclusion would necessitate rejecting
the evidence of both Appellants, William Drewlo and
Bill Hill, all of whom presented consistent and
uncontradicted evidence. The evidence of both Appellants,
corroborated by Drewlo, established a consistent, plausible
explanation of the background to the events of March 8, 1993 and
November 30, 1993. After reviewing the evidence of Harry, William
and Drewlo, I am simply not prepared to reject the evidence of
all three individuals plus the evidence of their accountant.
[36] In respect to the cheque notations of
March 8, 1993, the evidence of each Appellant and Drewlo was
consistent. The March 8, 1993 cheques resulted from the mutual
desire of these three individuals plus Wasko to quickly come up
with money to tender on a development property. The three cheques
were written at their solicitor's office after Drewlo agreed
to loan money to the Appellants and Wasko.
[37] Both Appellants and Drewlo were adamant
that the memo "Re: Sale 722973 Ont. Ltd." on the bottom
left hand corner was not present when the cheques were signed at
the solicitor's office or at the time of deposit. Harry's
response concerning this notation was: "Those words were not
on that cheque on March 8, all the time I had it in my
possession". The evidence of both Appellants and Drewlo was
that this memo was not on the cheques at the time of completion.
Harry's evidence was that the cheques did not contain the
memo when he deposited them. The bank's microfiche copies
contained the same memo. I can speculate on the nature of the
memo, for example, it may have been added to refer to the
eventual sale of 722973 to Drewlo, and as the collateral to the
loan in the event it was not repaid. If that were the case, the
memo would refer to a future event and not the actual nature of
the March 8, 1993 transactions. However the memo got on the
cheques, I cannot agree that the acceptance and negotiation of
these cheques, even with the notation, constitutes a valid and
binding contract for the sale of land. I do not accept the
Respondent's submissions that the sale occurred on
March 8, 1993. It takes far more than mere passing of
cheques with no further supporting documentation to transfer an
interest in real property. The primary attributes of beneficial
ownership are possession, use and risk (Johnson). The
transaction date should be determined on objective evidence
(Elias v. R., 2001 DTC 5674 (Fr.), 2002 FCA 319). There is
no evidence that possession, use and risk associated with the
property changed on March 8, 1993. It was the November 30, 1993
Agreements that changed these three items. The evidence of the
Appellants and Drewlo is uncontradicted. They presented a
plausible explanation of the events leading up to and surrounding
the March 8, 1993 cheques. All three individuals denied that the
notation was on any of the three cheques while in their
possession. I accept their evidence, as there were no
inconsistencies in their testimony. They were hard-nosed,
successful businessmen who had long standing business
relationships. Drewlo's evidence was that they often did
things on a handshake. There was no need to involve tax advisors
or lawyers at this point, as it was strictly a loan. If they had
been successful in the tender bid, they felt they would have been
able to repay the loan quickly. When we look at the November 30,
1993 Agreements, these individuals were quick to contact
solicitors and accountants when the Appellants were forced to
sell the Harrison property to Drewlo. There was nothing in their
evidence to suggest that there was any type of commitment to sell
the property on March 8, 1993. It was collateral to a loan only.
In fact the evidence of the Appellants suggests that they really
did not want to sell the property. They had owned it since the
1970s. They had never subdivided it and used it to grow hay most
of the time.
[38] The cheques alone cannot be used to
verify certainty of terms with respect to parties, property and
price. According to the evidence of the Appellants and Drewlo,
there was no oral agreement among these individuals to sell the
property in March 1993. Upon examination of the events of March
8, 1993 and November 30, 1993, I can see no evidence of any
change in the Appellants' beneficial interests in this
property until November 30, 1993. No change in possession, risk
and use occurred until November 30, 1993 and it only occurred on
this date because the Appellants could not repay Drewlo. Drewlo
is an impartial witness here who has nothing to win or lose in
respect to the outcome. He obtained the property, which has
apparently become quite valuable, because the Appellants could
not repay him. I believe the documents and agreements reflect
exactly what occurred here.
[39] In The Queen v. Friedberg, 92
DTC 6031, Justice Linden stated at page 6032:
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.
[40] I conclude that the Appellants intended
to do, on November 30, 1993, what the documents unequivocally
state they were doing. Not only does the documentation support
the transfer date of November 30, 1993 but so does the evidence.
There is no cogent evidence to contradict these documents or to
show that the parties intended to transfer on any other date.
[41] In addition to the cheques, the
Respondent relied upon the accounting treatment and entries in
respect to Drewlo Holdings (Exhibit A-1, Tab 25). These records
prepared on February 1, 1994 show a recharacterization of the
$1,000,000.00 payment to Harry, William and Wasko from an
investment to an account receivable. The Respondent pointed out
that the non-consolidated balance sheet of Drewlo Holdings stated
that "as at October 31, 1993", the $1,000,000.00 was
listed as an account receivable. Given the preparation date of
1994, it was argued that it had been re-characterized from
an investment to an account receivable.
[42] Associate Chief Judge Bowman in Jabs
Construction Limited v. The Queen, 99 DTC 729 at
paragraph 33 states:
... I am not prepared to treat these accounting entries as
reflecting the true legal relationship between the appellant and
Felsen. Accounting entries are supposed to reflect reality, not
create it...
[43] The accountant testified that the
change was a correction and not a recharacterization. On
cross-examination when questioned why, in paragraph 7 of his
memorandum (Exhibit A-1, Tab 30) to solicitor Donovan, he used
the phrase "we propose to treat these advances as a loan
during the interim period", he replied as follows:
And I'm going to suggest to you, sir, that you don't
know what you're talking about. I did not re-characterize
anything. I would not have re-characterize anything. I understood
from Mr. Loyens and also from discussions with Mr. Drewlo, that
the million dollars in March of 1993 was a loan. Had anyone told
me that it wasn't and that the sale had occurred in March of
1993, I would not have done this in November. And I know that to
be a fact.
[44] Mr. Hill was adamant that he made an
adjusting journal entry to correct the initial recording of
$1,000,000.00. I accept his testimony that he did not
re-characterize the events of March 8, 1993. He acted on his
discussions with the Appellants and Drewlo which gave birth to
the November 30, 1993 memo. I have no reason to disbelieve
him.
[45] The Respondent also relied on an
adjusting debit note for Drewlo Holdings, contained in a Bank of
Nova Scotia document dated March 2, 1994. The
"particulars" box on this document contained the
following wording:
Reversal of interest charges to Ardshell Limited on
722973 Ontario Limited from March 8th, '93 to
Feb. 21, '94. See attached. Should be Drewlo Holdings
Inc.
[46] The Respondent submits that this
document proves that the sale of the property occurred March 8,
1993 because Drewlo Holdings paid interest on the mortgage from
that date.
[47] Drewlo testified that he did not recall
if a reversal in interest payments was in the negotiations when
the transaction closed. The "particulars" box does
refer to 722923 so I do believe this document refers to the
Harrison property. It is also apparent from this banking document
that Drewlo retroactively assumed the mortgage on the property
effective March 8, 1993. Since Drewlo's evidence was
consistent on all other points with that of the Appellants, I
accept his testimony here that the interest adjustments were
simply as he said, a "subsequent deal or a possible
amendment to the deal". This would explain the retroactive
nature of the interest adjustments. Drewlo did state that
interest was never part of the negotiations between the parties
on March 8, 1993. He stated: "... the thinking was at the
time ... if we ... would have gotten the land we would have to
make arrangements anyhow". I think it is clear that if they
got the tender, they would quickly have to involve lawyers and
accountants. His evidence was that they often went back and made
adjustments on big land deals. I do not believe this type of
negotiations would have been out of the ordinary for these
businessmen.
[48] It was obvious from his testimony that
Drewlo was clearly interested in obtaining the remaining 50%
interest in the Harrison property. He indicated that the benefit
of obtaining the Harrison property outweighed any interest
payments. He was involved in business transactions worth millions
of dollars with the Appellants. The Appellants were struggling
financially at this time and Drewlo stated that they had many big
deals where they would go back at a later date and readjust. I
also believe that if one buys into the argument that Drewlo
should have been concerned about six months interest, then one
certainly has to answer why he would purchase in March and yet
not bother to get the property legally transferred until almost
nine months later.
[49] The Respondent referred to the lack of
appropriate corporate resolutions on November 30, 1993,
respecting the two interim transfers, that is the transfer to the
Varna partnership and the transfer to Lobro Stables. The
resolution of the Board of Director of 722973, which confirmed
the share transfer, identifies the transfer as being from the
Appellants to 643266. The resolution omits any reference to Varna
or Lobro Stables. The Respondent suggested that form does matter
and here the forms were inadequate. This supported a sale date of
March 8, 1993, according to the Respondent. I do not agree.
722973 has no beneficial interest in the property. Its sole
purpose is to act as bare trustee. Black's Law Dictionary
(Seventh Edition) defines "bare trustee" as:
A trustee of a passive trust. • A bare trustee has no
duty other than to transfer the property to the beneficiary.
The structure of the transaction does not require Varna or
Lobro Stables to be included in these resolutions and share
transfers. Mr. Hill's memo outlining the November 30, 1993
transactions had no reference to the inclusion of Varna and Lobro
Stables in the resolutions of 722973. They certainly could have
been included but their absence is not fatal. The shareholdings
of 722973 were calculated on the percentage of beneficial
interest in the property, but the beneficial interest in the
property itself is independent of the shares. 722973's job as
trustee was simply to track who owned the beneficial interests
from time to time.
[50] The Respondent referred to several
discrepancies surrounding the March 8, 1993 events. Firstly, why
did the Appellants borrow more money than the $1,000,000.00
required for the tender bid? In reality the money required to
inject into Ardshell by the Appellants and Wasko as their share
of the bid on behalf of Walloy (remembering Walloy was a 50%
shareholder of Ardshell along with Drewlo Holdings) was
$500,000.00. The money to be loaned to Walloy was originally to
be only $500,000.00 to cover their 50% share of the bid.
According to Drewlo's evidence, he loaned the money to the
Appellants and Wasko so they could inject some money into
Ardshell to pay their share of the debt in that company.
Remember, at this point Ardshell had some successful developments
but had lost a great deal of money on the Hunt Club development
and was struggling financially.
[51] Secondly, why did Walloy inject more
money into Ardshell than necessary? Walloy deposited $700,000.00
into Ardshell; $200,000.00 over and above Walloy's 50% share
of the $1,000,000.00 bid. The evidence supports that the excess
amount went to pay Walloy's share of Ardshell's
debts.
[52] Thirdly, why did the Appellants and
Wasko receive $333,333.00 each from Drewlo? Wasko had a 50% share
of Walloy with the Appellants retaining 25% each. Why then would
the money be loaned to each of them equally? I think this can be
answered easily. The loan was not to Walloy. It was a personal
loan to these individuals, each of whom owned one-half of the
Harrison property in equal shares. It is important to remember
that all of these parties had a long-standing business
relationship. According to the evidence of Drewlo and the
Appellants, the loans were personal; partially to cover their
share of the bid with the balance to allocate as they personally
chose.
[53] Fourthly, was it mere coincidence that
on the same day the Appellants and Wasko obtained a loan from
Drewlo in the amount of $1,000,000.00, the value of the property
was $1,500,000.00, which is exactly the amount to cover the
$500,000.00 mortgage against the property plus the loan. The
Appellants owned the Harrison property since the 1970s. Drewlo
had purchased property adjacent to the Harrison property plus he
had purchased a 50% share of the Harrison property from the
Appellants. They were all shrewd businessmen involved for years
in some aspect of land developing. To speculate that they may not
have known the value of the property they were dealing with is
just not plausible. In fact, on cross-examination, Drewlo himself
agreed that he would not be disappointed if he got the remaining
50% of the Harrison property: "Like I said, I was always
interested in the other 50% too".
[54] In summary, I accept the explanation
for the events of March 8, 1993 and November 30, 1993 provided by
the Appellants and Drewlo as plausible and credible. Their
testimony is consistent and Hill's evidence supports their
explanations that the sale occurred on November 30, 1993. The
documentary evidence is insufficient to support a sale on March
8, 1993. I find no deception in completing the November 30, 1993
transactions and therefore there is no sham here. The disposition
of the Harrison property occurred, as the Appellants claim, on
November 30, 1993.
[55] The Respondent relied upon 227287
Alberta Ltd. v. The Queen, 97 DTC 1106 (T.C.C.), for the
proposition that the March 8, 1993 transactions performed
everything but the mere formal act of sealing the engrossed
deeds, such that the completion relates back to March 8, the
contract date. The application of the "Relation-Back"
theory is subject to a test that was neither met nor pursued by
the Respondent's counsel. As such, no further comments are
necessary on this argument.
[56] Finally, I want to briefly address two
items which came up during the hearing: the admissibility of the
microfiche documents (Exhibit A-1, Tab 31) and the applicability
of the Statute of Frauds. For the purposes of this appeal
the Bank's microfiche copies of the three cheques have been
admitted into evidence through the Book of Documents, although
under protest by Appellants' counsel. Counsel argued that the
microfiche copies were unreliable and might not be complete as
there was no evidence pertaining to the creation and preparation
of these documents.
[57] As I understand from the evidence on
banking procedures, the original cheques are microfilmed before
they leave the bank en route to a central clearing house.
Apparently cheques are sent by midnight on the day of a
deposit.
[58] The admissibility of business records
is legislated through the Canada Evidence Act, R.S.C. 1985
c. C-5 ("CEA").
[59] The microfiche cheques were admitted
into evidence (Exhibit A-1, Tabs 22-24). The weight to be
given to the microfiche copies can be made with reference to J.
Sopinka et al., The Law of Evidence in Canada, (Toronto,
Butterworths 1999) which at page 18 states:
§ 2.14 Real evidence (also referred to as
demonstrative evidence) cannot be produced before a court without
prior testimonial evidence, or at least an admission, in order to
establish the identity of the thing. The level of authentication
required for admitting real evidence is relatively low. Once the
evidence has been admitted, it is for the trier of fact to
determine what weight to give it.
[60] The microfiche copies of the cheques,
in addition to the photocopies of the cheques, were utilized by
the Respondent's counsel to buttress the fact that the cheque
notation was on the cheques at the time of deposit. Even if I
gave little weight to the microfiche copies, it would not be
detrimental to either party.
[61] The Appellants submitted that the
Statute of Frauds states that an agreement concerning an
interest in land is unenforceable by action unless evidenced in
writing and signed. The Respondent submitted that the Income
Tax Act works independently of the Statute of Frauds
and is applicable only if there is a breach of contract and one
party wants to enforce his or her rights. The Income Tax
Act works in conjunction with the Statute of Frauds,
not independently of it. However, the circumstances of this case
do not require application of any of the provisions to the
Statute of Frauds.
Issue Two: If the sale date is November 30, 1993,
is the rollover of the Varna partnership interest to Lobro
Stables valid pursuant to the application of subsections 85(1)
and 85(1.1) of the Act?
Appellants' Position:
[62] Canada Tax Service, Stikeman's
analysis of section 85 of the Income Tax Act, states that
the transfer of a partnership interest is not a transfer of real
property inventory. Therefore such a transfer does not violate
paragraph 85(1.1)(f) of the Act.
Respondent's Position:
[63] The rollover of the partnership
interest to Lobro Stables was technically flawed and invalid. The
Varna partnership dissolved on November 30, 1993 because the
transfer of both partners' interest to Lobro Stables as
individuals violates partnership law. Lobro could not be the
partner of Varna because there must be at least two partners to
comprise a partnership. What was transferred to Lobro Stables was
the Harrison property and not partnership interests.
Analysis:
[64] Section 85 allows a rollover of certain
types of property to a Canadian corporation at cost, which
results in a deferral of tax on disposition of a property.
However only eligible property may be part of a rollover.
Eligible property includes inventory but not real estate or real
property that is inventory. It is defined in paragraph
85(1.1)(f) as:
"Eligible property". For the purposes of
subsection (1), "eligible property" means
...
(f) an
inventory (other than real property, an interest in real property
or an option in respect of real property);
[65] The Appellants were land developers,
particularly in respect to large subdivisions. These appeals
focus on the Harrison property. This property was classified as
inventory. Generally the gain derived from the sale of inventory
gives rise to income and not capital gain. The Appellants'
accountant knew that the Appellants could not directly roll the
Harrison property into Lobro Stables because of the limitation in
paragraph 85(1.1)(f). It was desirable however that
the property go to Lobro Stables because that corporation had
non-capital losses which could be utilized.
[66] To circumvent the limitation contained
in subsection 85(1), the Appellants looked to subsection 97(2).
Subsection 97(2), unlike subsection 85(1), contains no similar
limitation in respect to real property inventory. The Appellants
were partners in the Varna Elevators partnership. The Harrison
property was rolled into this partnership pursuant to subsection
97(2). Subsequent to this rollover, the partnership interest was
then rolled into Lobro Stables.
[67] The Respondent stated that his research
had revealed no case law on this particular point. Commentary by
Vern Krishna, The Fundamentals of Canadian Income Tax,
Sixth Edition (Toronto: Carswell, 2000) at 910, states:
11. Indirect Transfer of Land Inventory
Subsection 85(1) allows a taxpayer to transfer property to a
taxable Canadian corporation on a tax-deferred basis. An
important exception to this rule is that a taxpayer is not
permitted to transfer land inventory on a tax-deferred basis to a
corporation. There is, however, no explicit prohibition against
transferring land inventory on a tax-deferred basis to a Canadian
partnership. Hence, where a taxpayer wants to transfer land
inventory to a corporation on a tax-deferred basis, the taxpayer
can proceed in two stages. First, the taxpayer can form a
partnership with the prospective purchaser of the property and
transfer the land to the partnership, electing under subsection
97(2) to defer the gain on the transfer. The purchaser can
contribute a nominal amount of cash for the partnership interest.
Second, the vendor can transfer his or her partnership interest
to the purchaser corporation in consideration for shares with a
fair market value equal to the value of the partnership interest,
and the parties may then elect under subsection 85(1) in respect
of the transfer. On the acquisition by the purchaser corporation
of the taxpayer's partnership interest, the partnership
ceases to exist and subsection 98(5) applies to deem the
purchaser to have acquired the land at an amount equal to the
taxpayer's cost amount for the land.
As a consequence of this two-step arrangement, the purchaser
corporation acquires the land inventory and the taxpayer avoids
the recognition of any gain on the transfer of the property.
[68] The Respondent's argument has some
merit but I believe it may apply only to a situation where the
subsection 85(1) rollover of the partnership interest to the
company is occurring at the same moment in time. Section 2 of
The Ontario Partnership Act requires that a valid
partnership have a minimum of two partners. The evidence in this
appeal supports the view that the transfer of the Appellants'
partnership interests did not occur simultaneously. The transfers
of the Appellants' respective interests in Varna to Lobro
Stables are contained in two separate and distinct documents
(Exhibit A-1, Tabs 20 and 20.1). This is noticeably different
from the agreement in which each of the Appellants' interest
in the Harrison property was rolled into the Varna partnership
(Exhibit A-1, Tab 19). This was accomplished using only one
document. This clearly supports my conclusion that the subsection
85(1) rollovers of the partnership interests of each Appellant
occurred one at a time and not simultaneously. I consider this
clear and unequivocal evidence that, although the documents were
dated the same day, the transfers occurred one at a time even
though moments apart. For example, I assume William transferred
his interest in Varna to Lobro first. The result is that Harry
and Lobro Stables become the partners in Varna. Subsequently, by
separate agreement, although only moments after, Harry executes a
transfer document rolling his interest to Lobro Stables, which
has now acquired the entire partnership interest. Subsection
98(5) contemplates this type of situation where one partner
continues to carry on the business of the former partnership when
the other partner has left. Pursuant to subsection 98(5) the
partner carrying on the business of the former partnership
acquires the assets of the former partnership at cost base. In
drafting two separate documents, I believe it is easily inferred
that this was clearly part of the overall design that this tax
plan was intended to reflect. Otherwise everything would have
been included in the one agreement as occurred with the
subsequent transfer to Lobro Stables. Thus, the rollovers are
technically valid.
[69] In the circumstances of this case, the
subsection 85(1) rollovers are therefore technically valid.
Issue Three: Does the general anti-avoidance
rule, section 245 of the Act, apply?
[70] This issue was argued by the Respondent
in the alternative.
Appellants' Position:
[71] It is conceded that in accessing losses
in Lobro Stables there was a tax benefit to the Appellants, a
condition precedent to the application of section 245. It is also
conceded that there was quite clearly a series of transactions,
being the November 30, 1993 Agreements, but that there was no
misuse of the relevant provisions of the Act or an abuse
of the provisions of the Act as a whole.
[72] OSFC Holdings Ltd. v. R., 2001
DTC 5471 can be distinguished from the present case because in
OSFC Holdings Ltd. arm's length persons purchased
losses incurred by the Appellants. The transactions were
specifically designed to sell losses. The overall purpose of the
November 30, 1993 transactions however was to sell the Harrison
property in the most tax efficient manner. Counsel also submitted
that it is the whole transaction that must be viewed and that it
was incorrect to artificially split off or isolate various
components of the overall transaction in order to create an
avoidance transaction.
[73] If these transactions are not preserved
from the application of GAAR by subsection 245(3), then the
relevant policy behind the provisions and the Act must be
clear and unambiguous to allege misuse and abuse. Justice
Rothstein's comments in OSFC Holdings Ltd. make it
clear that it is up to the Respondent to explain the clear and
unambiguous policy behind the provisions of the Act. They
simply have not done so.
Respondent's Position:
[74] Section 245 is not meant to interfere
with legitimate commercial transactions. It applies when the
purpose of the transactions is an avoidance of tax. In this case,
the Appellants should have sold the Harrison property directly to
Eugene Drewlo or his designate without going through the numerous
steps of the November 30, 1993 transactions.
[75] Contrary to the Appellants'
position, the proper approach in determining whether the
transactions were undertaken for a purpose other than a tax
benefit is to look at the individual transactions that make up
the series.
[76] With respect to the misuse of the
provisions or abuse of the Act as a whole, the Respondent
submitted that when the policy is clear there is no need to refer
to extrinsic evidence to establish the object and spirit of the
provisions, per Justice Noel's remarks in Water's
Edge Village Estate (Phase II) Ltd. v. The Queen, 2002 DTC
7172 (leave to appeal to Supreme Court of Canada denied on March
20, 2003). The policy behind paragraph 85(1.1)(f) is that
the rollover of real property inventory is prohibited.
[77] To avoid the prohibition against the
transfer of real property inventory to a corporation pursuant to
paragraph 85(1.1)(f), the Appellants utilized
subsections 97(2) and 85(1) in a manner which amounted to
misuse of these provisions. Section 245 should be applied to deny
the rollovers and the profit realized on the Harrison property
should be included in the income of the Appellants.
[78] OSFC Holdings Ltd. says loss
trading is prohibited. This case is a mirror of OSFC Holdings
Ltd., that is, loss trading is interchangeable with profit
trading. The Appellants transferred the profit on the sale of the
Harrison property to their corporation to use the
corporation's losses. That is an abuse of the Act as a
whole.
Analysis:
[79] Several Federal Court of Appeal
decisions have established the analytical framework within which
GAAR is to be applied; in particular the decisions of cites
OSFC Holdings Ltd. and Water's Edge Village Estate
(Phase II) Ltd. and most recently NovopharmLimited
v. The Queen, 2003 FCA 112. The decision in
Novopharm, although it was in respect to the former
subsection 245(1), has firmly established that the approach taken
in Canada v. Fording Coal Ltd., [1996] 1 F.C. 518 is the
correct one and that it is the preferred approach over that taken
in Canada v. Mara Properties Ltd., [1995] 2 F.C. 433.
For section 245 to apply the following questions must
be addressed:
(1) Was there a series of
transactions within the meaning of section 245, and if so, which
transactions were parts of that series?
(2) Did the November 30, 1993
transactions result in a tax benefit to the Appellants?
(3) If so, can the transactions
reasonably be considered to have been undertaken primarily for a
purpose other than to obtain the tax benefit?
(4) If not, did the transactions
result in a misuse of the provision of the Act or an abuse
having regard to the provisions of the Act, other than
section 245, read as a whole?
[80] The Appellants' counsel concedes
the first two factors. First, the series of transactions
occurring on November 30, 1993 were: the transfer of the Harrison
property by the Appellants to the Varna partnership, the transfer
of this same property from Varna to Lobro Stables and the
transfer of the property from Lobro Stables to 643288. Second the
November 30, 1993 transactions allowed the Appellants to access
losses in Lobro Stables, resulting in the tax benefit.
Primary Purpose:
[81] There is a tax benefit here so there
must be a determination of the primary purpose of the transaction
or any of the transactions in the series. If the primary purpose
is to obtain a tax benefit, then it is an avoidance
transaction.
[82] The Respondent's counsel argues
that each transaction within the series must be analyzed and if
the primary purpose of any one of the transactions within the
series is to obtain the tax benefit, then it is considered an
avoidance transaction within subsection 245(3). The Respondent
relies on OSFC Holdings Ltd. where at paragraph 45 it
states:
Once it is determined that a series of transactions results in a
tax benefit, any transaction that is part of the series may be
found to be an avoidance transaction. The question is the primary
purpose of each of the transactions in the series. If the primary
purpose of any transaction is to obtain the tax benefit, it is an
avoidance transaction.
[83] The Appellants' counsel contends
that the series of transactions as a whole or in their entirety
should be looked at to determine the purpose behind those
transactions. The Appellants cite The Queen v. Canadian
Pacific Limited, 2001 F.C.A. 398 (F.C.A.) for the
proposition that the series of transactions on November 30, 1993
must be examined as a whole. Paragraph 27 of this decision quotes
from the Tax Court of Canada decision as follows:
The transactions which the Respondent says constitute the
series were, when viewed objectively, inextricably linked as
elements of a process primarily intended to produce the borrowed
capital which the Appellant required for business purposes. The
capital was produced and it was so used. No transaction forming
part of the series can be viewed as having been arranged for a
purpose which differs from the overall purpose of the series. The
evidence simply does not support the Respondent's position.
Accordingly none of the transactions on which the Respondent
relies was an avoidance transaction within the meaning of s.
245(3).
[84] The quote from Canadian Pacific
Limited is a determination based on the facts of that case
and not a general proposition. My reading of that case is that
one transaction within a series of transactions cannot be further
divided into separate components for the purpose of finding one
of those components an avoidance transaction.
[85] It is clear from the Fording
approach utilized in the case of Novopharm that the
entire series of related transactions must be considered and not
just the one transaction that gave rise to the benefit.
[86] There are three transactions occurring
on November 30, 1993. According to OSFC Holdings Ltd. it
is necessary to analyze the primary purpose of all of the
relevant transactions in the series. The primary purpose of each
transaction must be determined on the facts at the time the
transaction occurred. Justice Rothstein in OSFC Holdings
Ltd. stated at paragraph 46:
The words "may reasonably be considered to have been
undertaken or arranged" in subsection 245(3) indicate that
the primary purpose test is an objective one. Therefore the focus
will be on the relevant facts and circumstances and not on
statements of intention. It is also apparent that the primary
purpose is to be determined at the time the transactions in
question were undertaken. It is not a hindsight assessment,
taking into account facts and circumstances that took place after
the transactions were undertaken.
[87] The most direct route for the transfer
of the Harrison property would have been from the Appellants to
Drewlo. After these individuals struck the deal they contacted
their tax advisor. He devised the necessary steps to accomplish
transfer of the property so that the accumulated losses in Lobro
Stables could be accessed. According to both Appellants they
simply referred this matter to Hill for tax advice as they had
probably done innumerable times in the past as land developers.
Drewlo wanted the property and was prepared to go along with
whatever steps Hill recommended, as long as it did not affect him
adversely.
[88] According to both Hill's testimony
and his memo (Exhibit A-1, Tab 30), which outlined the steps to
effect transfer of the property on November 30, 1993, it was
clear that it would be beneficial if the Appellants could access
losses in Lobro Stables. These losses had been legitimately
accumulated. Accessing these losses could not be accomplished
directly because of the prohibition in
paragraph 85(1.1)(f) against the rollover of real
property inventory to a corporation. However if the Varna
partnership could be used, then under subsection 97(2) the
Appellants could transfer their interest in the property to their
partnership. The Appellants would then be free to transfer the
partnership interests (which included the Harrison's
property) to Lobro, as there is no similar prohibition against
rolling partnership interests. The existing Varna partnership and
Lobro Stables were introduced into the November 30, 1993
transactions to facilitate obtaining the tax benefit under the
relevant sections of the Act. The memo content clearly
supports this, as does Hill's evidence.
[89] I conclude that the primary purpose of
each of these transactions and the transactions as a whole on
November 30, 1993 was to obtain the tax benefit.
Misuse/Abuse:
[90] Subsection 245(4) excludes from the
operation of subsection 245(2) those transactions that do not
result "directly or indirectly in a misuse of the provisions
of this Act or an abuse having regard to the provisions of
this Act, other than this section, read as a whole".
Since the test here is an objective one, it is the relevant facts
that are to be considered and not the taxpayer's
intention.
[91] Which provisions are being misused? The
provisions in question are subsections 97(2) and 85(1). Section
85 allows a rollover of certain types of property to a
corporation at cost. Utilization of the provision results in a
deferral of tax on a disposition of property. However the section
is strictly controlled. Only eligible property qualifies for
election under subsection 85(1). Eligible property is listed in
paragraph 85(1.1)(f). Subsection 97(2) differs most
materially from subsection 85(1) in that there is no similar
prohibition and real property that is inventory is eligible for
rollover under subsection 97(2) but not under subsection
85(1).
[92] The Appellants' accountant was able
to indirectly roll the real property inventory, the Harrison
property, to Lobro Stables, when the Appellants could not do so
directly. By introducing the Varna partnership and utilizing
subsection 97(2), the Appellants were able to utilize the
losses in Lobro Stables to offset the gain on the Harrison
property sale.
[93] To determine the existence of misuse,
the first step is to determine the policy behind the provision.
Misuse depends upon the object and spirit of the particular
provisions, sections 97 and 85. In this case, the Appellants and
the Respondent have different views as to what the policy is
behind paragraph 85(1.1)(f).
[94] The Respondent argues that subsection
97(2) is the mechanism used by the Appellants to circumvent the
definition of eligible property found in
paragraph 85(1.1)(f). This results in misuse of these
sections by allowing the Appellants to avoid a gain that should
otherwise have been included in their income.
[95] The Appellants submit that there is no
misuse as there is no violation of the policy behind the real
property inventory restriction, which is to prevent a trader in
real property from converting income into capital gains by
rolling property into a corporation and then selling shares of
the corporation.
[96] The Respondent has summarized the
effect of the provisions without attempting to clarify the policy
behind the sections. It is merely a reiteration of the sections,
with no guidance on what the underlying policy is behind the
provisions.
[97] The Respondent's counsel argues
that the relevant provisions here are so clear that outside aids
or extrinsic evidence of policy are not required. Counsel
contends that the object and spirit is sufficiently reflected in
paragraph 85(1.1)(f), where it states clearly that real
property inventory cannot be part of the rollover.
[98] Justice Rothstein in OSFC Holdings
Ltd. clearly set out that the Court's role is to identify
a relevant, clear and unambiguous policy. He goes on to state
that a Court cannot make a finding of misuse or abuse where
Parliament has not been clear and unambiguous as to its intended
policy. At paragraph 68 of his Reasons for Judgment he
states:
Ascertaining the relevant policy is a question of
interpretation. As such it is ultimately the duty of the Court to
make this determination. There is no onus to be satisfied by
either party at this stage of the analysis. However, from a
practical perspective, the Minister should do more than simply
recite the words of subsection 245(4), and allege that there has
been misuse or abuse. The Minister should set out the policy with
reference to the provisions of the Act or extrinsic aids upon
which he relies. Otherwise he places the taxpayer and the Court
in the difficult position of trying to guess the relevant policy
at issue. Trying to ascertain the policy of a specific provision
or of an Act as a whole, in the case of an Act as complex as the
Income Tax Act, is a difficult exercise, particularly when
the transaction in question conforms to the letter of the Act.
Therefore, the Court requires the assistance of the parties to
enable it to reach a correct conclusion. Nonetheless, with or
without that assistance, the Court must attempt to determine the
relevant policy. Of course, at the next stage, once the policy is
determined, the onus remains on the taxpayer to prove the
necessary facts to refute the Minister's assumptions of fact
that the avoidance transaction in question results in a misuse or
an abuse.
[99] The Respondent cites Water's
Edge Village Estates (Phase II) Ltd. to support his
contention that if the policy is clear from the provisions, no
extrinsic evidence is required. The Respondent relied on comments
by Justice Noël at paragraph 48 which reads:
Indeed, the object and spirit of the relevant provisions is so
clear that I questioned during the hearing whether the Tax Court
Judge properly concluded, and the Minister properly conceded,
that the Act when construed without regard to section 245,
allowed Klink to deduct the terminal loss. There exists a number
of cases where the words of the Act were given a distinct meaning
derived from the object and spirit of the Act in a context that
bears some resemblance to the present case (Lea-Don, supra;
Allied Farm Equipment Ltd. v. M.N.R., [1972] F.C. 263 (F.C.A.);
Oceanspan Carriers Ltd. v. Canada [1987] 2 F.C. 171 (F.C.A.);
Holiday Luggage Mfg. Co. v. Canada, [1987] 2 F.C. 249 (Trial
Division)). In all of these cases, the Court relying on the
scheme of the Act or its object and spirit, refused to extend its
application to persons while not subject to tax thereunder.
[100] Although these remarks seem to support the
Respondent's argument that extrinsic evidence is not
necessary in certain situations, Justice Noël did rely upon
factors outside the provision in making that statement. He looked
to the objectives of the CCRA system as a whole before
determining the policy. I do not accept that these remarks were
meant to be a blanket statement that might override the approach
of Justice Rothstein in OSFC Holdings Ltd. In this case, I
do not believe the policy is as clear as Respondent contends, and
where that is so, then Respondent's counsel has an obligation
to refer to materials that might have assisted me in formulating
a policy behind these provisions.
[101] With nothing more from the Respondent than a
reformulation of what the provisions state, I could simply
conclude that there is no misuse. However, Appellants'
counsel referred me to outside material to help ascertain the
policy.
[102] I was referred to commentary by Krishna and
Stikeman to support the proposition that the policy behind
paragraph 85(1.1)(f) is to prevent a real property trader
from converting income into capital gains. V. Krishna,
Krishna's The Fundamentals of Canadian Income Tax,
Sixth Edition at p. 940, states:
(a) Inventory
The exclusion of real property inventory from eligible
property is intended to prevent a real estate trader from
converting business income into a capital gain by selling
inventory to a corporation and then selling the shares of the
corporation for a capital gain. Such a transformation of business
income into a capital gain would in any event probably fail.
Subsection 85(1), however, adds certainty through its outright
prohibition of the use of the rollover for real property
inventory.
The distinction between capital property and business inventory
depends on the intention of the taxpayer who disposes of the
property. Therefore, it may be difficult to determine with
certainty whether real estate does or does not qualify for the
rollover under subsection 85(1). Since the characterization of
real estate gains and losses depends on the factual circumstances
surrounding its ownership, it is not possible to obtain an
advance ruling on its status from the CCRA. In cases of doubt, it
may be prudent not to transfer real property that may later be
determined to constitute inventory.
Canada Tax Service - Stikeman Analysis in referring to
paragraph 85(1.1)(f) of the Act states:
The real property exclusion presumably was considered to be
required partly in order to prevent the transfer by a real estate
trader of inventory to a corporation under subsection 85(1) and
the subsequent sale of the shares of that corporation. This could
effectively accomplish a transformation of income into a capital
gain. However, there is case law to the effect that in such
circumstances the sale of shares would give rise to income and
not a capital gain and, moreover, could well trigger a recapture
of capital cost allowance claimed in respect of the real property
concerned. See Fraser v. Minister of National Revenue,
[1964] C.T.C. 372; Belle-Isle v. Minister of National
Revenue, [1966] C.T.C. 85; Gibson Brothers Industries Ltd.
v. Minister of National Revenue, [1972] C.T.C. 221 (FTCD);
Burgess et al v MNR, [1973] C.T.C. 59; and Dumas v.
Minister of National Revenue, [1989] 1 C.T.C. 52 (FCA): (see
also the commentary to section 9, "Real Estate Profits Realized
through the Sale of Shares"). Some of these cases may suggest
that the transfer of shares in such circumstances may in
substance be a transfer of real property that is inventory and
therefore not permissible under subsection 85(1). See also the
commentary to section 54.2. (Emphasis added.)
[103] Both of these commentaries concur that the purpose
behind the real property inventory restriction in subsection
85(1) is to prevent the conversion of income into capital gains
by a real property trader. In the facts before me does the tax
planning convert business income to capital gains? Clearly that
did not occur here. The transfer to the Varna partnership
resulted in reporting of taxable business income as did the
transfer of the partnership interest to Lobro Stables. And
ultimately, in the disposition by Lobro Stables to 643288, the
gain was reported as business income. Proof of this is reflected
in the tax returns and in the evidence of Mr. Hill. There is no
conversion of business income to capital gains here. It seems to
me that this view is much more consistent with the policy
objectives behind the provisions.
[104] Quite apart from the absence of any extrinsic
evidence or materials offered by the Respondent, I accept these
commentaries as the policy behind these provisions. If the policy
was crystal clear it would not have garnered commentaries from
both Stikeman and Krishna. The most telling tale is this: If the
policy was so clear, the same prohibition could very easily have
been included in subsection 97(2). That was not done.
[105] Has the above policy been violated? The policy
behind paragraph 85(1.1)(f) is to prevent a real
property trader from converting income into capital gains. Do the
facts suggest that the Appellants violated this policy? No, they
do not. All moneys related to the Harrison property were reported
as income at every stage. There is no misuse of the provisions
because the policy of converting income to capital gains is not
violated.
[106] When I look to the particular facts of this case,
they suggest no misuse of the provisions of the Act. The
purpose behind the exclusion of land inventory from the
definition of "eligible property" in subsection 85(1.1)
is to prevent a taxpayer from converting what would otherwise be
income into capital gains by using subsection 85(1). Here, the
gain on the sale of the Harrison property was reported as income
and not as capital gain. Therefore, the policy behind the
provisions has not been violated and as a corollary, there is no
misuse.
[107] The final matter in the GARR analysis which is
whether there has been an abuse of the provisions of the
Act as a whole.
[108] The Respondent's position is that the Canadian
tax system is based on calculating tax separately for each
taxpayer. The policy of the Act prohibits the sharing of
income (per Mersey Docks & Harbour Board v. Lucas,
(1882-83) 8 A.C. 891 (H.L.) and Woodward's Pension
Society v. M.N.R., 59 DTC 1253 at 1261 and affirmed at
62 DTC 1002). Counsel then relied on Justice Rothstein's
remarks in OSFC Holdings Ltd. that the general policy of
the Act is against loss trading by corporations, subject
to certain exceptions. The Respondent argued that whether it is
loss or profit, there is no difference between the two. Counsel
then combined these propositions to argue that the term
"loss" is interchangeable with the term
"profit" and deducted that profit trading is therefore
prohibited under the Act.
[109] The Appellants' counsel argues that the
decision OSFC Holdings Ltd. is distinguishable because the
Appellants were not involved in selling of losses.
[110] As part of his argument Respondent's counsel
referred to the cases of Woodward's Pension Society
and Mersey Docks & Harbour Board (upon which
Woodward's Pension Society relied) as authorities for
the proposition that the sharing of income is prohibited under
the Act. Woodward's Pension Society dealt with
the issue whether a predestined purpose for future income can
change the taxability of that income. Both cases involved
non-profit corporations that were producing profit to distribute
the income in a manner consistent with its objectives. The Courts
held that despite the virtuous fate of the profit, it was still
profit to the non-profit corporation and therefore tax was
payable on the income. From my reading, I do not see how the
Respondent can glean any remarks that support the proposition
that profit sharing is prohibited. I also believe that his
interpretation of OSFC Holdings Ltd. is flawed. Clearly
OSFC Holdings Ltd. prohibits loss trading. However, I
would not extend the principles enunciated in OSFC Holdings
Ltd. with respect to loss trading to conclude that profit
trading is interchangeable with loss trading. There is nothing in
OSFC Holdings Ltd. that even hints at such
substitution. The factual situation in OSFC Holdings Ltd.
was entirely different. It involved strangers acquiring tax
entities built on losses incurred by others. The Federal Court of
Appeal in OSFC Holdings Ltd., in concluding that loss
trading between corporations is against the general policy of the
Act, states that the present policy is to allow refunds or
transfer of losses on a strictly controlled basis. Specifically
paragraph 94 of the decision states:
...Refundability treats annual losses and profits
symmetrically. It improves neutrality in the tax system. It
eliminates discrimination against more risky businesses that have
more volatility in earnings than less risky businesses. It may
improve competitiveness and market efficiency by allowing firms
to enter and exit industries more readily.
(Emphasis added.)
[111] Gain trading is allowed to some degree. There is
further evidence that profit trading is not interchangeable with
loss trading as they currently receive fundamentally different
treatment within the Act.
[112] There are additional sources to support this
conclusion. Krishna has relevant commentary. According to
Krishna, a section 85 rollover of property from an
individual to a related corporation is generally acceptable.
Specifically Krishna states:
7. - Section 85 Rollover to Related Corporations
Suppose an individual has property with an unrealized capital
gain that the individual wishes to sell to a third party. The
individual also has a related corporation with net capital loss.
If he or she sold the property directly to a third party, a
capital gain would be realized. To avoid the gain, the property
is transferred to the individual's related corporation on a
tax-deferred basis under subsection 85(1). The related
corporation then sells the property to the third party and
offsets the resulting taxable capital gain against its net
capital loss.
It is clear that such a transaction is tax motivated and,
without more, would be an avoidance transaction. The CCRA does
not, however, consider a transfer of property to a related
corporation on a tax-deferred basis to contravene the object and
spirit of the Act. Since subsection 69(11) does not permit a
person to transfer property to an unrelated corporation on a
tax-deferred basis where it is intended that the unrelated
corporation will sell the property and reduce the amount of the
gain by amounts of losses or similar deductions which it may
claim, the Agency reasons that "... by implication, the
subsection does permit a transfer to a related corporation on a
tax-deferred basis."*
The Agency does not address the broader question of whether
the grouping of income and losses of a related corporate group is
within the general scheme of the Act with respect to consolidated
income reporting for tax purposes. This may suggest that in
applying GAAR, the CCRA is less likely to be concerned with the
general scheme of the Act read as a whole and more concerned with
the misuse of specific statutory provisions.
* IT-9, "Loss Consolidation within a Corporate Group"
(February 10, 1997).[1]
(Emphasis added.)
[113] The above remarks can be cross referenced to an
example in Information Circular 88-2, General Anti-Avoidance Rule
- section 245 of the Income Tax Act to which the
Appellants referred. This circular deals with the example of an
individual rolling property to a related corporation so that
gains from the sale could be offset by losses in the
corporation:
9. - Facts
A person has property with an unrealized capital
gain that it wishes to sell to a third party. A related
corporation has a net capital loss. Instead of selling the
property directly to the third party and realizing a capital
gain, the person transfers the property to the related
corporation and elects under subsection 85(1) to defer the
recognition of the gain. The related corporation sells the
property to the third party and reduces the resulting taxable
capital gain by the amount of its net capital loss.
Interpretation
Subsection 69(11) does not permit a person to transfer
property to an unrelated corporation on a tax-deferred basis
where it is intended that the unrelated corporation will sell the
property and reduce the amount of the gain by amounts of losses
or similar deductions which it may claim. By implication, the
subsection does permit a transfer to a related corporation on a
tax-deferred basis. In these circumstances such a transfer would
be acceptable as it is within the object and spirit of the
Act.
(Emphasis added.)
[114] I conclude that the general rule against loss
trading has no equivalent rule when it comes to profit
trading.
[115] In Jabs Construction Limited v. The Queen,
99 DTC 729, Associate Chief Judge Bowman referred to section 245
as "an extreme sanction". At paragraph 48 he
states:
... It should not be used routinely every time the Minister
gets upset just because a taxpayer structures a transaction in a
tax effective way, or does not structure it in a manner that
maximizes the tax.
[116] And in Geranskyv. The Queen, 2001
DTC 243, Associate Chief Judge Bowman stated at paragraph
42:
Simply put, using the specific provisions of the Income Tax
Act in the course of a commercial transaction, and applying
them in accordance with their terms is not a misuse or an
abuse.
[117] Those remarks are equally applicable to these
appeals. Taxpayers are free to structure their transactions in a
tax effective manner, thereby reducing the tax otherwise payable,
and they have done so here.
[118] The Appellants struck a deal with a long-standing
business partner. The first place they contacted was their tax
advisor's office. He used the provisions of the Act in
conjunction with a pre-existing partnership and corporations to
structure the Appellants' agreement with Drewlo in the most
tax efficient manner. The transactions were in accordance with
normal business practice and were entered into for bona
fide purposes (part of Fording approval applied in
Novopharm). This does not amount to a misuse or
abuse of the provisions of the Act. It is simply utilizing
them for the very purpose for which they were designed.
[119] Interference with legitimate legal relationships
through the application of section 245 must of necessity be one
of last resort. This is not one of those cases.
Issue Four: Is the waiver received by
the CCRA on behalf of Harry a valid and effective waiver?
[120] Pursuant to subsection 152(4) of the Act,
the three year limitation period was to terminate on September 1,
1997 with respect to reassessment of Harry's 1993 taxation
year. On August 12, 1997 the auditor wrote to Harry requesting a
waiver. It was copied to his accountant. On August 20, 1997
the auditor's original letter to Harry together with a signed
waiver dated August 16, 1997 was returned to the auditor. He
did not verify the signature on the waiver. The signature is not
Harry's but it was agreed at the hearing that it is the
signature of his brother, Frank. Harry was not in the Province
during this period. Frank had worked for Walloy years before and
had occasionally signed employee pay cheques for Harry during
that time. The accountant recalled receiving a copy of the letter
requesting the waiver but he did not recall and had no notes of
any discussions with Harry concerning the waiver.
[121] The Appellant's position is that the waiver is
invalid because Harry did not sign the form, was out of the
Province at the time, never received it personally and there is
no evidence that he was aware of or had any knowledge of the
waiver. His brother, Frank, signed for Harry but Frank had no
authority to do so. Any signing authority Frank had, ended years
ago. James Atkinson, auditor for the CCRA, should have checked
the signature on the waiver as he had other documents in his
possession to use for comparison. In Mitchell v. The
Queen, 2002 FCA 407, the Federal Court of Appeal discusses
waivers. The decision supports the view that in order to have an
effective waiver, there must be knowledge on the part of the
taxpayer. Harry had no such knowledge.
[122] The Respondent's position is that estoppel
prevents Harry from arguing this is an invalid waiver because he
is bound by Frank's signature on the waiver. Therefore the
CCRA has a valid waiver and could reassess outside the period.
The auditor acted appropriately in proving the waiver and it was
reasonable for CCRA to place reliance on it. The requested waiver
was returned several days after it was sent and there is no duty
on the CCRA official to check every signature. He complied with
any due diligence requirements.
[123] Based on my disposition of the first three issues,
there is no requirement for an analysis and decision in respect
to the waiver issue. However, I would like to provide a few short
comments in respect to the arguments of the Appellants' and
Respondent's counsel. The Mitchell case referred to by
both counsel while providing a review of waivers generally,
concentrates on the information contained in the waiver and
whether certain letters amounted to an effective waiver. The
issue in this case focuses on the signature on the waiver and not
the information contained in the form. Consequently, I did not
find the Mitchell case particularly helpful.
[124] A waiver is a consensual arrangement between the
taxpayer and the Crown to delay the process of assessment and
enable the parties to negotiate a determination of potential
liability. The form itself (Tab 32 of Exhibit A-1) contains
a paragraph which states:
This waiver must be signed by the taxpayer or legal
representative...
[125] The facts disclosed that Harry did not sign the
waiver and that, not only was his brother Frank not his
representative, he was certainly not his representative, legal or
otherwise.
[126] Atkinson's actions were reasonable in the
circumstances when he accepted the signed waiver without any
further investigation. As I see it however, this does not make a
waiver valid when the form specifically calls for a taxpayer or a
legal representative to sign the waiver.
Conclusion
[127] The appeals are allowed, with costs, and the
assessments are referred back to the Minister for reconsideration
and reassessment on the basis that the first and second
Reassessments for the 1993 taxation year be vacated.
Signed at Ottawa, Canada, this 4th day of April 2003.
J.T.C.C.
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