Schultz v. The Queen, 93 DTC 953, [1993] 2 CTC 2409 (TCC)

Beaubier, T.C.C.J.:— These matters were heard together and on common evidence by consent of the parties in Toronto, Ontario, commencing on May 31, 1993 and concluding on June 12, 1993. They are appeals pursuant to the general procedure of this Court concerning both appellants’ 1983, 1984, 1985, 1986 and 1987 taxation years. The appellants are husband and wife.

At the opening of trial the counsel for the appellant Thomas M.G. Schultz abandoned claim 25A, leaving the following claims to be determined:

25. B. The respondent improperly increased the appellant's income tax payable herein, by way of income adjustments made by the respondent by way of reassessments;

C. The respondent improperly included onto the appellant's income, income earned and received by another taxpayer;

D. The respondent failed to exercise his statutory duty under paragraph 165(3)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act");

E. The respondent can not rely on subsection 245(1) of the Income Tax Act herein, because it is unconstitutional;

F, The respondent denied or infringed upon the appellant's rights guaranteed by sections 7 and 12 and subsection 15(1) of the Canadian Charter of Rights and Freedoms.

The appellant Lois Schultz recited the following claims to be determined:

29. A. The respondent improperly increased the appellant’s income tax payable herein, by way of income adjustments made by the respondent by way of reassessments;

B. The respondent improperly included onto another taxpayer's income, income earned and received by the appellant;

C. The respondent failed to exercise his statutory duty under paragraph 165(3)(a) of the Income Tax Act;

D. The respondent can not rely on subsection 245(1) of the Income Tax Act herein, because it is unconstitutional;

E. The respondent denied or infringed upon the appellant's rights guaranteed by sections 7 and 12 and subsection 15(1) of the Canadian Charter of Rights and Freedoms.

Thus, the two appellants’ claims are identical.

The following witnesses testified:

1. For the appellant:

(a) John K. Maguire, owner of J.K. Maguire & Associates ("JKM & A")

(b) Dr. Thomas M.G. Schultz, appellant

(c) Mrs. Lois Schultz, appellant

(d) Roderick H. Campbell

(e) Mark Davis

(f) Robert Benyi

2. For the respondent:

(a) Peter McCrodan

(b) Mark Salutin, CA

(c) Richard A. Holt

The notices of reassessment respecting Dr. and Mrs. Schultz dealt with them, in numbers as follows:

The assessments relate to securities transactions in dispute respecting investment clubs in which Dr. and Mrs. Schultz were allegedly involved in 1983 and hedging transactions they conducted in 1984, 1985, 1986 and 1987. These occurred after the Schultzes met with John K. Maguire.

Mr. Maguire testified that he first met the appellants in 1983 when they were referred to him by his client, Dr. Watts. They discussed income splitting in the initial interview.

In 1983 Mr. Maguire operated a total of 68 brokerage accounts according to testimony by Mr. Salutin, an auditor employed by Revenue Canada. Mr. Maguire described some of these as "investment clubs”. The appellants allegedly participated in two of these investment clubs, Dr. Schultz in Club 0352 and Mrs. Schultz in Club 0345. These investment clubs used Nesbitt Thomson Bongard Inc. ("Nesbitt") as their broker. The numbers are the last four digits of the Nesbitt account numbers. These two accounts dealt in Government of Canada bonds. At the outset Mrs. Schultz filed her once in a lifetime election (Form 1123) pursuant to subsection 39(4) of the Income Tax Act in order to treat her dealings in Canadian securities as capital in nature. She also elected in her 1984 income tax return (Exhibit IV 2) to have a business year which began December 30, 1983 and ended December 29, 1984.

The organization of the alleged investment clubs was described by Mr. Maguire, during his examination-in-chief, in the following words:

MR. ZALDIN: Q. Did the Schultzs join any groups of clients?

MR. MAGUIRE: A. Yes, they did. They participated in a bond hedge that was executed through Nesbitt Thomson.

Q. Tell us about that.

A. That was essentially an income splitting hedge where Dr. Schultz took a short position in a Government of Canada bond and his wife, Lois, took a long position in a similar Government of Canada bond. I believe the maturity dates were within 12 months of one another, similar coupons, so that the bonds were close enough in terms that the risk was minimized in terms of one investment losing a lot more money than another might be making. The primary purpose by having Thomas go short, he would incur all the expenses on the short sale, the interest expense, the borrowing cost, and Lois, being long, would receive the income from her bonds, so we would be accomplishing the primary goal of getting income into Lois’ name and having Thomas incur some expenses.

Q. Would the Schultzs be in the same club or different clubs?

A. They were in different clubs because the one club was shorting in Government of Canada bonds. There was a separate club that was going long, this other Government of Canada bond.

Q. Do you know how many people were in. . .

A. In the Schultzs' club I believe there were 29 members.

Q. That would be in each club?

A. I believe there were 29 in both clubs, yes. Most of the members would have been in a similar situation, low income spouses in the long club and high income spouses in the short club.

Q. How was the membership determined?

A. The membership was determined by essentially grouping together people with like financial needs. As I said, in the Schultzs’ cases it was largely having high income individuals on the short side of the market, the short club, and the low income spouses on the long side. It was essentially like financial situations, like tax circumstances.

In 1984, 1985, 1986 and 1987 matters proceeded on the basis of individual accounts in the names of Dr. Schultz and Mrs. Schultz. In 1984 and 1985 these accounts were with McLeod Young Weir Ltd. (” McLeod"). In 1986 and 1987 the accounts were with Merrill Lynch Canada Inc. ("Merrill"). Mr. Maguire described the operation of these accounts, during his examination-in-chief, in this way:

MR. ZALDIN: Q. Could you explain that in a little bit more detail, the conversion aspect, and what it does?

MR. MAGUIRE: A. Yes, quite simply, the investment club was more designed for income splitting and there was a much larger, obviously, tax emphasis on income splitting than investment whereas with other hedges we — to give you a simple example, let's say there is a stock at $50 and there's a warrant giving you the right to buy that stock for $50 and let's say that warrant trades for $3. If we buy the warrant and short the stock, you only have to put up the $3 of capital and there's going to be $50 sitting in your account that’s going to earn interest. That's probably going to recover all or most of the $3 over the life of the hedge.

Q. Is there a margin requirement in that case?

A. Yes, the $3. So, let's say, generally speaking, the bulk of that capital would be returned via cash flow, if not all of it, and if the market fell a great deal of money would be made because if the stock went from $50 to $40, you make $10 on the short side, but the warrant could only go from $3 to zero, so you can only lose $3 on the long side. Essentially the brokers, and to a certain extent ourselves, would be looking for investment opportunities. Hedging is basically a mathematical type of vehicle where you are looking for aberrations where you can make investments with very little capital at risk and an opportunity to make a great deal of money generally if the market falls.

Q. Mr. Maguire, you are finished with the other reference?

A. I’m finished with the U.S. dollar reference, yes. I just wanted to clear that up for the record.

To come back to the tax loss selling at year end, yes, I would have cause to look at a client's position and where there was losses that would generate tax benefits, would generally choose to realize them in the same fashion that most of the financial papers are so advising at that time.

MR. ZALDIN: Q. What advice did you give in this instance?

A. The same. The warrants were sold and — there's other reasons as well. The stock had not at this point in time fallen precipitously enough that it looked like money was going to be made, so you're reserving your capital as well by liquidating, but there was both a tax loss and there's actually profits being locked in on this particular trade so that there is a real economic benefit over and above the tax savings sought to be realized. So, this is the type of year end tax selling that was frequently done.

Dr. and Mrs. Schultz testified that they arranged to meet Mr. Maguire in about October of 1983. During examination-in-chief Dr. Schultz testified as to the purpose of their visit in the following words:

DR. SCHULTZ: A. I phoned and made an appointment with Mr. Maguire.

Q. Why did you do that? What were your concerns which led you to telephone for an appointment?

A. I'd been working for ten years up to that point as a dentist and basically had only professional income and I wasn't into any other types of income producing ventures. A dentist works with his hands, and if you’re not in the office you’re not producing. I thought it would be nice to have something that wasn't directly related to my profession of dentistry. So I wanted to make extra income not related to dentistry. I wanted some good tax planning advice. I also wanted to do some income splitting. I wanted my wife to also have an independent income as well.

Q. What do you mean by income splitting? What does that mean to you?

A. I'm in a very high tax bracket and if 1 could shift some of the taxes to my wife in a legal manner I was perfectly willing to do so.

Q. Tell the Court what you understood at that time.

A. I understood at that time that the investment club would be set up by Mr. Maguire on our behalf with other members and he would look after the paperwork.

Q. What would the investment club do? What would be its business or what would it do?

A. It was going to do the short selling of bonds.

Q. You knew it was bonds?

A. Yes.

Q. You knew it was short selling.

A. Yes.

Q. What was your understanding at that time about the concept of short selling, Mr. Schultz?

A. My understanding of the short selling concept was that if the bonds went up, you'd actually lose money. If bonds went down, you’d make a profit to a certain extent.

Q. Who would?

A. The short seller would.

Q. You indicated that you had an intention to go ahead with this investment club deal; correct?

A. Correct.

Q. What was your purpose or motivation? Why did you do that? Why did you want to?

A. Basically to income split.

At the opening of cross-examination Mrs. Schultz confirmed that in respect to both the investment club and the convertible hedges the purpose was that she would get the gains and Dr. Schultz would get the losses. She stated:

CROSS-EXAMINATION OF MRS. LOIS SCHULTZ BY MR. OLSSON:

Q. You have described how you met Mr. Maguire and had an initial consultation with him, Mrs. Schultz, and your husband has explained that as well. I gather both of you understood the basic concept of trying to take offsetting positions where you would get the gains and your husband would get the losses.

A. Yes.

Q. That is what was referred to as income splitting and the advantage was that your tax rates were lower, so that if you could end up more or less with gains and losses that substantially offset each other there would be a tax advantage because your husband has a high income and you have a relatively low income.

A. Yes.

Q. That concept applied both to the investment club strategy and to the later convertible hedge strategy.

A. Yes.

Q. You understood that, too.

A. Yes.

The Schultzes stated that they agreed to go into separate investment clubs to deal in Government of Canada bonds during a meeting with Mr. Maguire in his office in 1983. All of the investment activities in these clubs were conducted by Mr. Maguire. Mrs. Schultz testified that the Schultzes did not know of any of the activities of the clubs until April of 1984 when they received the reports attached to their income tax returns. Moreover, the Court saw and heard evidence from Dr. and Mrs. Schultz and it is clear that neither of them ever understood any of the stock or bond transactions done by Mr. Maguire at any time. Mrs. Schultz testified that when they met with Mr. Maguire and he explained these things to them it was clear to her at the time, but when they left, they lost any comprehension of what was going on. She also said that while Dr. Schultz was sometimes apprehensive, she was not. Mr. Salutin testified that Dr. & Mrs. Schultz's names were discovered at the end of Revenue Canada's investigation of these investment clubs. Some statements filed by other taxpayers showed a Mr. and Mrs. Harvey named instead of Dr. and Mrs. Schultz.

Dr. and Mrs. Schultz and Mr. Maguire testified that the Schultzes signed a Nesbitt form investment club account” or something similar for the purposes of the 1983 clubs. Mrs. Schultz recalled the form she signed was completed in some part at the top. She testified that she mailed the signed forms to JKM & A sometime between October and Christmas 1983. A sample (Exhibit A-1) of the Nesbitt form was filed. However Mr. McCrodan testified that no signed "investment club account” form was ever received by Nesbitt on account of any of the alleged clubs. The Schultzes state that they never kept a copy. Mr. Maguire implied that the 1983 forms were sent by JKM & A to Revenue Canada and never returned; there is no evidence of that.

Mr. McCrodan testified that each of the Nesbitt accounts was in Mr. Maguire's name with a different account number referenced back to his original opening account. He stated that he had an idea that these accounts were conducted by Mr. Maguire for clients. The form of Exhibit A-1 refers to a partnership, whereas the appellants’ positions are that each club was a joint venture. The members of the clubs the appellants are alleged to have been in never met, and the Schultzes never knew who was in their clubs until they got their statements in 1984. These statements are identical to the "Harvey" statements (Exhibits R-3 and R-4), except that the Schultzes names are situated where the Harvey names were.

Mr. Maguire testified that in his mind he planned to put Dr. Schultz in a different club in 1983 than the one in which Dr. Schultz was eventually placed. He stated that the placement of Dr. Schultz in Investment Club 0352 was actually done in 1984. Moreover, the cheque that paid the losses on Dr. Schultz’s 1983 club was taken from another club account which was not Mrs. Schultz’s club. Nothing ever authorized this procedure. The only evidence of payment of Dr. Schultz's losses is the endorsement by Mr. Maguire on the back of the other club’s cheque. The cheques did not clear. Rather the cheque was issued by Nesbitt with signatures deleted and then cancelled by Nesbitt. Thus, the evidence is that Dr. Schultz did not pay the shortfall in his account in 1983 and Mrs. Schultz did not receive the profit in her account. In addition to the shortfall, there was a" rental fee” on a short transaction of $432.44 that was paid by JKM & A. Mr. Maguire's allegation is that Dr. Schultz was one of 29 members of the club and therefore Dr. Schultz was billed /29th of the total fees attributable to that club. The broker fees and JKM & A's fees were the only money that Dr. Schultz paid.

Mr. Salutin, Revenue Canada's auditor of the "investment clubs”, stated that as far as he was concerned respecting the investment clubs, nothing ever happened. Revenue Canada found a total of 68 accounts. Most were in Mr. Maguire's name and some were in Mr. Benyi's name; there was no documentation respecting these accounts with anyone else's name and signatures on them in respect to any of the alleged investment clubs or clients. To this date none has been discovered except the reports issued by JKM & A and filed with its clients’ income tax returns. The brokerage houses treated each of Mr. Maguire's and Mr. Benyi's accounts as personal to that individual. The Schultz- es' investment club "trades" were conducted within the brokerage house itself.

The result was that Revenue Canada saw Mr. Maguire dealing with himself in respect to the alleged gains or losses in those 1983 accounts. In these circumstances he had no gains or losses. He merely incurred some fees and charges by the brokerage houses. Because he was merely dealing with himself, there was no prospect of gaining income and thus the brokerage fees and charges were not incurred for the purpose of gaining income and were not deductible. Furthermore, in these circumstances, the Schultzes had no legal interest or entitlement in or to the alleged transactions which were entirely Mr. Maguire's.

In 1984 JKM & A forwarded a report and T-5 slips under Nesbitt's name, without any authority from Nesbitt, to each of the Schultzes and to other “club” members respecting their investment clubs’ 1983 activities. These documents which were falsely prepared by JKM & A under Nesbitt's name after December 31, 1983 are the only documents evidencing any" investment club” or any interest whatsoever by the appellants in an“ investment club” in 1983.

JKM & A is in the tax advising business. Dr. Schultz had been in practice for approximately ten years when these events occurred. Nesbitt is a nationally known brokerage house. Yet no copy of what the Schultzes purported to sign respecting the alleged clubs has been presented to the Court. The Court is prepared to believe that the appellants each signed something and that Mrs. Schultz mailed those two signed documents. But the Court does not believe that they signed documents relating to the two investment clubs in which they are alleged to have been members in 1983. Nor does the Court believe that such clubs ever in fact existed in any form.

The fact that some of the issued reports in question have the Harvey names rather than the Schultzes’ names, the fact that such documents as exist were prepared after the calendar year end, the fact that they were prepared under the Nesbitt name, and the fact that Mr. Maguire admits that he had a different club in mind for Dr. Schultz all create serious credibility problems. Mrs. Schultz never received any of her "profits". Dr. Schultz never paid any part of his" losses" in 1983 except the fees billed by JKM & A and Mrs. Schultz's alleged profits were not used to pay his alleged losses.

It is the Court's view that both form and substance are missing. Dr. and Mrs. Schultz were not in business in any so-called “investment clubs” in 1983. Furthermore, on the evidence before the Court, there were no investment clubs in 1983. There was just Mr. Maguire trading with himself and making up lists in 1984.

Dr. Schultz’s 1983 notice of reassessment (Exhibit AR-III-6) dated July 28, 1987 States:

Disallowed Business Loss,

Re: Investment Club 0288352 $36,954.31

The proposed letter (Exhibit ARV-48) dated June 16,1987 corrects the numeric name of the club and states:

It is our view that you were not engaged in a bona fide business nor was there any expectation of profit therefrom.

The notice of confirmation dated October 16, 1991 (Exhibit AR-111-16) confirms the reassessment and also refers to paragraph 18(1)(a) and subsection 245(1). Mrs. Schultz's taxation year 1983 is affected by revision of her child tax credit. She purports to have interest income and a capital gain from her alleged dealings in "investment club 02-770345" in respect to which her business year ended in calendar 1984.

Both appellants’ appeals respecting their 1983 taxation years are dismissed. Any consequence or the so-called "investment clubs” that Mrs. Schultz reported in her 1984 income tax return and in respect of which she appealed is a nullity and is also disallowed. Mrs. Schultz's 1984 assessment is referred to the Minister of National Revenue for reconsideration and reassessment in accordance with the reasons contained herein.

Mr. Maguire described the Schultzes' 1984, 1985, 1986 and 1987 hedging transactions during examination-in-chief in the following words:

MR. ZALDIN: Q. Mr. Maguire, regarding the transaction of Thomas Schultz which are detailed in the four-page Schedule A to the notice of appeal, were you personally involved in the why of those transactions being done when they were done?

MR. MAGUIRE: A. Yes, I was. Some of the hedging ideas were my own, some of them were the broker's. Even if they were the broker’s, I would normally be apprised of the investment merits of the particular hedge. I did indicate that we also got duplicates of all these transactions so that we would always be fully cognizant of any hedge that was being executed. Moreover, I would certainly be consulted for the tax end of the hedges. There is a tax side to — or there can be a tax side to hedges as well as the investment side and I would be consulted in that Capacity as well.

Q. Consulted when?

A. When the hedge is entered into. Often towards year-end a client, specifically in this case Dr. Schultz, would want someone like myself to review their investments and to extract any appropriate tax advantage that might be extracted. There was a plethora of tax loss selling articles in the paper around this time of year normally in the Post and the Times and the Globe. It normally advises people to look at their portfolios, take a look at what might be available in it for tax purposes. So normally towards year-end someone would be in to specifically look at what tax advantage, if any, might be able to be extracted for a particular investment.

Q. Was that the situation with Dr. Schultz?

A. Yes, it was.

Q. Was that the situation with Lois Schultz?

A. Yes, it was.

Q. Can I ask you, Mr. Maguire, when you are referring to the monthly statements to firstly state, for example, the McLeod Young Weir November 1984 statement at page 4. . . .

A. Yes.

MR. ZALDIN: Lois Schultz is Volume II, Your Honour, and Thomas Schultz is Volume I, and each of the monthly statements appear in those volumes at tabs 3 and 4.

BY MR. ZALDIN: Q. Let's start with 1984 for Dr. Schultz and that will be in tab 3 of Volume I.

A. We had two investment hedges executed in 1984. They were both initially constructed in the same fashion as the 1983 investment club. The income side of the hedge was in Lois Schultz’s name and the expense side of the hedge was in Dr. Thomas Schultz’s name, specifically the two hedges because there are numbers relating to both of them. There was a short sale of. . . .

HIS HONOUR: What page are we on now?

THE WITNESS: Sorry, Your Honour. We are at page 2, tab 3, Volume I. This is the November McLeod Young Weir statement for Dr. Thomas Schultz. He has a short sale of 5,000 shares of Allied Stores for $267,525, while concurrently Lois purchased— this is in Volume II, tab 3, page 2 — on the same date, November 9, Lois purchased $200,000 face value of Allied Stores convertible debentures for a total debit of $274,140 U.S. These are all U.S. funds.

So, you had a net difference between the proceeds generated to Dr. Schultz of $267,000 and the cost to Lois of $274,000. You had investment of approximately $6,500 of capital requirement in that the brokers allow you to use the debit to cover the credit or the credit to cover the debit or vice versa. The funds required for such an investment would only be the difference, so you would have an investment of roughly $6,500 U.S. This would have had projected cash flow. The $200,000 face value debentures, as indicated on Lois’ November statement, had a coupon rate of 9.5 per cent, so that she could have expected a $19,000 per annum interest return from these debentures and they didn't mature until the year 2007. So there's a long term expected cash flow which met with the Schultzs’ desire for income splitting.

She would generate, let's say, $19,000 U.S. annual interest income from the Allied Stores debentures. Whereas the expenses that Dr. Thomas Schultz would incur, if we look at Schedule A, if I may simplify things a bit, we will see that there was a dividend on December 21 of $2,500 that has been disallowed and we would have expected the two expenses for four dividends a year. So four times $2,500 is $10,000, and we would have had rentals of approximately a little over $400 a month, so another you can call it $5,000 a year. So he would have had expenses of $15,000 U.S. a year while she would have an income of $19,000 a year. So there was some effective income splitting where she would receive $19,000 of income, he would incur $15,000 of expenses, so there was a very high cash flow at the outset to this particular trade.

Similar with the other hedge . . . .

Mark Davis is a broker employed by McLeod, now known as Scotia McLeod. He and Mr. Maguire first worked together at Eaton Bay Financial. He commenced working for McLeod in 1981. Mr. Davis acted as broker for the Schultzes and other JKM & A clients when they dealt with McLeod in 1984 and 1985.

Mr. Davis testified that a hedge transaction requires a short and long position. The short position sells short the common stock that the second security is convertible into. The long position buys the convertible security (e.g., a warrant, a convertible debenture or another convertible security). With cross guarantees, the only capital necessary is the amount of the difference between the two positions, which are matched or paired as closely as possible as to the amount of conversion shares. For the person in the long position it offers good income flow and a possible capital appreciation. In a dramatically falling market, the short position may obtain large gains at very little risk. Mr. Davis testified that he did not advise on the tax aspects of a hedge. Mr. Maguire did. Mr. Davis said that Mr. Maguire thought it advantageous if the short hedge account was an income account and the long account was a capital account.

The Schultzes conducted hedging transactions with Mr. Davis. Dr. Schultz sold short and Mrs. Schultz purchased long. The Schultzes each signed a guarantee on the other's account, each opened a margin account and each gave the other a trading authorization to deal on the other's account. Mr. Davis testified that Mr. Maguire would indicate to Mr. Davis where a hedging transaction would produce a positive cash flow and ask Mr. Davis if McLeod could borrow enough stock to do the hedge. If McLeod could acquire the stock and the hedge could be done at a specified amount, Mr. Davis would get the Schultzes’ authorization and execute the hedge.

Roderick H. Campbell is a stock broker who was employed by Merrill during 1986 and 1987. JKM & A referred a number of clients, including the Schultzes, to him and he and other employees of Merrill were a team who conducted hedging transactions for them in 1986 and 1987. The Schultzes each opened a margin account with Merrill and each signed a guarantee on the other's account. He stated that all the instructions were received from Mr. Maguire and that Dr. and Mrs. Schultz merely confirmed those instructions. Mr. Campbell testified that Merrill had a deal with JKM & A whereby JKM & A would protect Merrill for any fees or losses on transactions already begun by Merrill on Mr. Maguire's instructions, if JKM & A clients did not confirm Mr. Maguire's instructions.

In each of the years under appeal, Dr. Schultz filed a claim for a business loss. The essence of the testimony of Mr. Maguire, and each of the brokers acting for the Schultzes in the years in question, is that Mr. Maguire instructed them in the hedging transactions and that Mrs. Schultz was on the long, income producing side and Dr. Schultz was on the short, loss producing side where there was said to be some possibility of a “capital gain". Most the transactions were done at the end of Dr. Schultz's tax year. The evidence is that the only hedges they didn't do were those that they didn't have the money for.

Richard Holt was the auditor in charge of the hedging investigation of the Schultzes in 1984, 1985, 1986 and 1987. He testified that Revenue Canada reassessed the hedging transactions on the basis that Mrs. Schultz was the agent of Dr. Schultz. He pointed out that each set of hedging transactions in the years in question began with Dr. Schultz taking a short position. The funds from this short trade coupled with Dr. Schultz's guarantee of his wife's account, enabled the hedge transactions to proceed thereafter. He stated that if the hedging transactions are regarded as joint ventures or a partnership between the Schultzes, Revenue Canada would regard that joint venture or partnership as trading with itself.

Mr. Holt was cross-examined extensively concerning the possibility of any settlement between the Schultzes and Revenue Canada in which it was implied that offers were made to taxpayers who were not JKM 8: A clients that were not made to JKM 8: A clients. It is the Court's view of this testimony that certain settlements were made by Revenue Canada with taxpayers reassessed respecting hedging transactions where those taxpayers engaged in discussions with Revenue Canada to attempt a settlement. The evidence is that JKM 8: A did not enter into any discussions to attempt a settlement with Revenue Canada on behalf of its clients.

Robert Benyi, an employee of JKM 8: A testified on behalf of the appellants respecting the allegation that the respondent had unduly delayed its assessment procedure, and other matters. Mr. Benyi stated that JKM 8: A had over 200 clients who were assessed respecting investment club or hedging transactions conducted in a manner similar to the transactions of the Schultzes.

The Schultzes authorized JKM 8: A to deal with Revenue Canada respecting the assessments before the Court. The evidence and exhibits reviewed by the Court in this matter indicate that Revenue Canada requested clients of JKM & A, including the Schultzes, or JKM & A to supply information, documents, replies to proposals, waivers, or counter proposals respecting the assessments in question. Almost without exception JKM & A did not do so and advised its clients not to do so. On occasion some JKM 8: A clients did respond to Revenue Canada, apparently independently of the advice of JKM 8: A.

An example reviewed extensively was Revenue Canada's letter of proposal to Mrs. Lois Schultz dated May 8, 1987 (Exhibit AR-V-47) respecting her 1983, 1984 and 1985 taxation years. Mr. Benyi, who has approximately 3 /2 years experience as an employee of Revenue Canada, stated the letter was confusing. The Court finds that the letter was clear to anyone with the knowledge of the Schultzes’ transactions and the experience of Mr. Benyi and the lawyer employed by JKM & A. He also alleged confusion in respect to a similar letter to Dr. Schultz dated June 16, 1987 (Exhibit AR-V-48) respecting his 1983, 1984 and 1985 taxation years. (In Exhibit AR-V-48 Revenue Canada stated that it did not consider Dr. Schultz was in a bona fide business in 1983 and that there is no expectation of profit therefrom.) Mr. Benyi made like statements concerning the taxpayers' 1986 and 1987 taxation years. Mr. Benyi complained that JKM 8: A was "barraged" by Revenue Canada with paper in respect to its many clients.

Given the complicated transactions in which some of the brokers themselves had never before participated prior to receiving instructions from JKM 8: A or its clients, and the lack of responses, Revenue Canada obviously had great difficulty in preparing its reassessments and in deciding on its position in respect to these reassessments. In the 1983 “investment clubs”, payments of accounts were made from other alleged accounts with no apparent authority whatsoever. Given this conduct by Mr. Maguire, and allegedly Nesbitt, it is only reasonable for Revenue Canada to have proceeded slowly and cautiously first respecting 1983 and thereafter in the later years among the myriad of JKM & A clients and clients’ brokerage accounts which in the instant case involved different tax years for Dr. and Mrs. Schultz and different and varying capital and income positions.

In the Schultz cases before the Court, the appellants did not file statements of documents, and relied entirely on documents filed by the respondent. They complained about alleged missing 1983 Schultz documents which they implied were delivered to Revenue Canada. Both Mr. Benyi and Mr. Salutin testified to conduct identical to that already described by both Revenue Canada and JKM & A in respect to all of JKM & A's clients for all the years in question. Mr. Salutin stated that, in addition to the "investment clubs”, there are more than 1,000 hedging account investigations. Mr. Salutin testified that the Schultz name only turned up towards the end of the investment club investigation. He stated that at least one other taxpayer filing in one of the alleged Schultz investment clubs had filed the annual report with a last name "Harvey" listed and not “Schultz”. Thus the Schultz name was missing from the investment club lists during most of the investment club investigation, which concluded in 1986.

Revenue Canada wrote JKM & A on December 7, 1988 (Exhibit R-5) proposing test cases. No reply was ever made by JKM & A. Mr. Benyi stated that from September 1988 until March 1989 it had no house counsel to enable JKM & A to reply. In approximately November 1989 Revenue Canada confirmed assessments respecting six of JKM & A's clients. In a letter to the Tax Court, Revenue Canada stated that it viewed these cases as representative. At no time did house counsel for JKM & A, Mr. Zaldin, the counsel on the six files and in the Schultz matters respond to the view of Revenue Canada so far as is known to the Court.

The foregoing matters were heard as it was obvious that the appellants felt that they related to the last three issues raised by them in their pleadings.

The question of the Minister of National Revenue's duty pursuant to subsection 165(3) was raised as an issue. Subsection 165(3) reads:

165(3). Upon receipt of a notice of objection under this section, the Minister shall,

(a) with all due dispatch reconsider the assessment and vacate, confirm or vary the assessment or reassess, or

(b) where the taxpayer indicates in the notice of objection that the taxpayer wishes to appeal immediately to the Tax Court of Canada and that the taxpayer waives reconsideration of the assessment and the Minister consents, file a copy of the notice of objection with the Registrar of that Court,

and he shall thereupon notify the taxpayer of his action by registered mail.

The respondent is of the view that it acted with due dispatch. If it did not, the respondent states that the appellant could have appealed pursuant to subsection 169(1) after the 90 days had expired. The evidence is that Mr. Maguire and Dr. Schultz discussed appealing pursuant to subsection 169(1) and decided not to.

It is the Court's view that, in the circumstances of this case, the actions of the respondent were conducted with due dispatch given the conduct of JKM & A and the multitude of cases and matters for review respecting the transactions which are the subject matter of this case. The appellants had a right to appeal pursuant to section 169 once they had filed their notices of objection and the appropriate time had lapsed. This right of appeal was reviewed extensively by Associate Chief Judge Christie of this Court in Apfelbaum v. M.N.R., [1991] 1 C.T.C. 2599, 91 D.T.C. 800 (T.C.C.), where he stated that the right to appeal pursuant to subsection 169(1) is the appellant's remedy for any alleged delay by the respondent. This Court agrees with that determination.

The appellants raised sections 7 and 12 and subsection 15(1) of the Canadian Charter of Rights and Freedoms. The facts relating to this proceeding have been outlined. There is no evidence that either of the appellants suffered any violations of their rights as contained in sections 7 and 12 or as contained in subsection 15(1) of the Charter.

The appellants also pleaded that subsection 245(1) of the Income Tax Act as it read at the time of the assessments in question was void for vagueness. In particular paragraph 48 of the notice of appeal of Dr. Schultz and paragraph 46 of the notice of appeal of Mrs. Schultz describes a reliance "on a finding of undue or artificial reduction of income as too vague to be capable of clear understanding". The concept of vagueness was reviewed by Gonthier, J. in R. v. Nova Scotia Pharmaceutical Society, [1992] 2 S.C.R. 606, 93 D.L.R. (4th) 36. He stated at page 638 (D.L.R. 56):

This leads me to synthesize these remarks about vagueness. The substantive notice and limitation of enforcement discretion rationales point in the same direction: an unintelligible provision gives insufficient guidance for legal debate and is therefore unconstitutionally vague.

He stated further at page 643 (D.L.R. 59-60):

The doctrine of vagueness can therefore be summed up in this proposition: a law will be found unconstitutionally vague if it so lacks in precision as not to give sufficient guidance for legal debate. This statement of the doctrine best conforms to the dictates of the rule of law in the modern state, and it reflects the prevailing argumentative, adversarial framework for the administration of justice.

Subsection 245(1) is not void for vagueness. If necessary, it is for the Court to determine its application.

The Crown argued that the essence of the convertible hedging transactions was that Mrs. Schultz was an agent or partner of Dr. Schultz. The law is that partnership or agency can be determined from the activities of the parties. The relationship of husband and wife is such that in the purchase of necessities the law grants a wife authority, by virtue of the relationship, to pledge her husband's credit for necessities. The Income Tax Act itself causes attribution to spouses in many situations.

The agency reasoning by the Crown is set out clearly in paragraphs 69, 70, 71 and 72 of the reply to Dr. Schultz's appeal. In essence the Crown argues and the evidence is that Dr. Schultz sold short as the first step in every set of hedging transactions before the Court. As a result of the short sale by Dr. Schultz, there were substantial funds in his brokerage account which, coupled with his guarantee of Mrs. Schultz, enabled her to buy long.

The Court saw Dr. and Mrs. Schultz give evidence. Mrs. Schultz was strongly of the view that she wanted money and property of her own. The couple married while Dr. Schultz was in university and started off with little or no income. By 1983 Dr. Schultz was earning a substantial income. In that year he was paying Mrs. Schultz approximately $2,000 per month to work in his dental practice. It is clear from what she said and her attitude in Court that Mrs. Schultz wanted more income for herself and in the later years under appeal, Dr. Schultz increased her salary substantially. Mrs. Schultz was certainly a more enthusiastic participant in the transactions in question than was Dr. Schultz and she was more impressed by Mr. Maguire and more persuaded by him than was Dr. Schultz. There are times in a marriage when one party goes along with the wishes of the other. It is the Court's view of the evidence that Dr. Schultz went along with the wishes of his wife in respect to the transactions in question. Mrs. Schultz was not the agent of her husband. However, neither of the Schultzes exercised the control of a principal over the other. What they did, they did together.

The Court finds that Dr. Schultz did not enter into any of the security transactions in question in 1984, 1985, 1986 and 1987 with an intention to make a personal profit. From his conduct and the evidence respecting his transactions it is clear that he had no reasonable expectation of profit from his own transactions. In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 at page 485 (C.T.C. 313, D.T.C. 5215) Chief Justice Dickson stated the following:

Although originally disputed, it is now accepted that in order to have a "source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business. . .

The principal purpose of these transactions by both the Schultzes was income splitting, i.e., to reduce Dr. Schultz's high income and to increase Mrs. Schultz's low income. The evidence is that they hedged in a highly coordinated fashion. Dr. and Mrs. Schultz also had the joint intention to make a profit for their family by their coordinated transactions. They believed this was possible from the information given to them by Mr. Maguire. The Schultzes also believed that they could make this profit before taxes, not after taxes. Mr. Maguire neglected to include his advisory fees in his example which consisted of a relatively small flat fee coupled with a substantial percentage of“ "the taxes saved". Nonetheless, using Mr. Maguire's hedging example with a profit of $4,000 and including his fees, the Court finds that it was reasonably possible for the Schultzes to earn a profit both before and after taxes.

It remains to be seen if Dr. and Mrs. Schultz were engaged in a partnership. A partnership is a relationship between persons carrying on a business in common with a view to profit. Lindley on the Law of Partnership, 15th edition, beginning at page 79, lists eight tests of a partnership. Applied to the Schultzes, the tests are determined as follows:

1. A partnership is the result of an agreement. The Schultzes agreed to consult Mr. Maguire on income splitting. They agreed to enter into the transactions in question to split their incomes and, together, to profit from the transactions.

2. Partnership involves community of profit or loss. Dr. and Mrs. Schultz would like to show separate profits or losses. However, in fact they dealt out of a joint account in all their funding and they used each other's accounts to guarantee their transactions. Mrs. Schultz did not withdraw her profits. They were used to pay Dr. Schultz's losses. In fact they engaged in community of profit and loss. Moreover Mrs. Schultz testified that they never accounted to each other or anyone else for the transfers of profit or loss. They were, in her words, not like that.

3. A partner is restricted in transferring his equitable interest in the partnership. In the years in question the Schultzes did not transfer their equitable interests in the hedging enterprise. The only property they transferred was that of their various short and long positions. These were paired in all of the hedging years in question before the Court, and the guarantees to the brokerage houses tied their equity together.

4. A partner is an agent of the partnership so far as concerns activities falling within the scope of the partnership. In 1984 and 1985 they appointed each other agent in their accounts. In 1986 and 1987 they did not. However they obviously appointed each other as agent to write cheques on their joint account to pay any charges arising from the hedge transactions or to receive any profits which would be deposited into the joint account.

5. À partner has a lien on the thing owned in common for outlays or expenses. In fact Mrs. Schultz's profits in her hedging accounts were used to pay Dr. Schultz's outlays or expenses. If this was not enough, the proceeds of the joint account were used. Their guarantees of each other's account were also available for outlays or expenses. In fact liens existed on what they owned in common for outlays or expenses.

6. A partner has no right to partition in specie or to sell partnership property but does have, on dissolution, the right to have the partnership property sold and the proceeds divided. This in fact is what the Schultzes did in their brokerage accounts when they used Mrs. Schultz's account to pay Dr. Schultz’s losses or paid any additional indebtedness out of their joint account.

7. The partner's equitable interest in his or her share of the partnership property is treated as personal estate.

8. Partnership exists only for the purpose of gain. The Schultzes entered into their agreement and the hedging transactions through JKM & A to obtain a gain in their assets both before and after taxes.

Thus, the Court finds that for the 1984, 1985, 1986 and 1987 taxation years Dr. and Mrs. Schultz were equal business partners in the hedging transactions and that they shared equally in, and were legally entitled to share their profits and their losses in equal shares. The Court finds that the Minister of National Revenue's calculations on the basis that the appellants’ transactions concluded when both positions were closed are valid and correct and the calculations for the years in question are to proceed on that basis. The election by Mrs. Schultz contained in Form 1123 is to be applied to her only and is not to apply to Dr. Schultz, since that election was a personal election by Mrs. Schultz. The appeals are referred to the Minister of National Revenue for reconsideration and reassessment accordingly in respect to Dr. Schultz's 1984, 1985, 1986 and 1987 taxation years and in respect to the remaining items in Mrs. Schultz's 1984 taxation year and all of her 1985,1986 and 1987 taxation years.

The respondent is awarded its costs throughout on a party-and-party basis. Because the appeals were combined on the consent of the parties, the respondent is awarded only one set of costs in respect to the two appeals.

Appeals allowed in part.