Stubart Investments Ltd. v. The Queen, 81 DTC 5120, [1981] CTC 168 (FCA), rev'd 84 DTC 6305, [1984] CTC 294, [1984] 1 SCR 536

Urie, J:—This is an appeal from a judgment of the Trial Division whereby the appellant’s appeal from reassessments for income tax made by the Minister of National Revenue (hereinafter referred to as “the Minister”) for the taxation years 1966, 1967 and 1968 was dismissed.

The appellant at all material times was a wholly owned subsidiary of Finlayson Enterprises Limited, a public company. When it was incorporated, the appellant was known as W. Lloyd Wood Company Limited. In 1962, while still so named, it purchased the bulk of the assets of a company called Stuart Brothers Company Limited which was in the business of manufacturing and selling food flavourings and essential oils (hereinafter referred to as “the flavourings business”). By supplementary letters patent, in 1962, the name of the appellant was changed to Stuart Brothers Limited. It was not until 1969 that the name was changed to that shown in the style of cause herein (hereinafter, for convenience, referred to as “Stuart”).

The flavourings business was very profitable. However, another wholly owned subsidiary of Finlayson Enterprises Limited, Grover Cast Stone Company Limited (hereinafter referred to as “Grover”), the business of which was the manufacture and sale of pre-cast concrete products had, by 1965, incurred substantial losses. As a result, on the advice of its solicitors and accountant, the Canadian assets of Stuart, not including its shares in certain off-shore companies, were transferred to Grover. This transfer effectively permitted Grover to engage in the flavourings business in Canada formerly carried on by Stuart.

The transfer purportedly was accomplished by means of an agreement of purchase and sale and a nominee agreement, both dated as of January 1, 1966, which were approved by the boards of directors of both Stuart and Grover at meetings held on March 10, 1966. Those approvals were later confirmed by the shareholders of each company at meetings called for the purpose. The actual documents were not executed until July 1966.

According to the evidence, the purpose of the sale was to enable the profits of the flavourings business to be offset by the tax losses incurred by Grover. Also, according to the evidence, the purpose of the appellant in entering into the nominee agreement, which had the effect of permitting Stuart to carry on the flavourings business as Grover’s nominee, was to prevent the counter-claimant in a law suit instituted by Grover as plaintiff, from being alerted to the fact that Grover was the possessor of substantial new assets and profit-making potential and thus from proceeding more vigorously with its counterclaim.

There was also evidence, it should be pointed out at this stage, from which it could be inferred that the intention of Finlayson was to transfer the appellant’s business to Grover only temporarily and that, when Grover’s tax losses had been fully utilized, the flavourings business would be transferred back to the appellant. Notwithstanding this evidence, certain actions were taken by the parties to implement the agreement of purchase and sale:

(a) the property on St Antoine Street in Montreal, upon which Stuart conducted its manufacturing and sales operations was transferred from Stuart to Grover pursuant to a deed which was duly registered pursuant to the laws of the Province of Quebec;

(b) certain trade marks were assigned by Stuart to Grover by an assignment dated July 27, 1966 as a result of which Grover was registered as owner of the marks by the Trade Marks Office on August 24, 1966;

(c) Grover appointed Stuart as a registered user of the marks by a registered user agreement executed by each party;

(d) a debenture was given to Stuart as security by way of a floating charge on the undertaking and all the property and assets of Grover, including those transferred to it by Stuart, as security for the balance of the purchase price, in the principal sum of $184,909;

(e) after obtaining supplementary letters patent enabling it to do so, Grover executed a trust deed of hypothec, mortgage and pledge in favour of Canada Permanent Trust Company whereby it was required to issue a debenture securing Grover’s Quebec assets, including the St. Antoine Street property, which it did, following which the debenture was duly registered as required by the laws of the Province of Quebec;

(f) Grover’s directors passed a resolution authorizing Grover’s guarantee of Finalyson’s indebtedness to the Bank of Nova Scotia in the sum of $1,000,000, which indebtedness had formerly been guaranteed by Stuart by way of a debenture securing its assets;

(g) arising out of the aforesaid guarantee, Grover issued a debenture in favour of the Bank of Nova Scotia similar to that which Stuart had given and it too was registered in Quebec;

(h) while the books of account for the Canadian flavourings business continued to be kept in Montreal on the Stuart premises, they were kept separate and apart from the West Indian part of Stuart’s business and were reflected by one entry annually in Grover’s head office accounts;

and

(i) Grover reported the income from the flavourings business in its corporate income tax returns for the 1966, 1967 and 1968 taxation years and paid taxes in those years on its net taxable income.

It was appellant’s contention that all of the foregoing actions demonstrated that there was a real transfer of all of Stuart’s flavourings business to Grover. As a result, the reassessment of the Minister adding back to Stuart’s taxable income for the taxation years in issue were wrong and thus the judgment of the Trial Division upholding the reassessments was also wrong and that, therefore, the reassessments should be vacated.

Specifically, the objections to the judgment appealed from as set out in appellant’s memorandum of fact and law, were as follows:

(a) the learned trial judge erred in treating the hearing before him as an appeal and not as a trial de novo;

(b) he erred in agreeing with the Tax Review Board that the ability of the directors of Stuart and Grover to reverse the transactions justified the conclusion that the original agreement was in effect a “sham”; and

(c) he erred in not considering section 23 of the Income Tax Act, 1952

At the hearing of the appeal, counsel for the appellant abandoned his objection based on section 23 of the Act so that there were only two bases for his attack on the impugned judgment.

I shall deal first with objection (a) supra.

Stuart first appealed the reassessments to the Tax Review Board. His Honour Judge K.A. Flanigan, at that time Chairman of the Board, upheld the Minister’s reassessments on the basis that he was not persuaded by the evidence that the purchase and sale agreement, supra, was a valid and genuine agreement for the reasons which he stated in the following passage from his judgment:

The reason I cannot come to that conclusion, with respect to the agreement, is that in the Finlayson group of companies there were sufficient common directors and officers in Stuart Brothers Limited and in Grover to reverse those overt acts at any time that it suited them. They ran no risks whatsoever in conveying the property from one company to another, because they could simply have reversed the whole proceeding by another agreement, and so I must find, on my interpretation of the definition of Lord Justice Diplock (in Snook v London & West Riding Investments Ltd.) and in view of what took place in this case, that the agreement was never intended to be implemented in the manner in which it reads, but that it was always intended that Stuart would continue to operate the business and merely put money into Grover until the loss was used up and then the property could be put back where it belonged and where, I feel, it had never, in law, left.

In the Trial Division, the learned trial judge dismissed the appeal by Stuart from the decision of the Tax Review Board, giving reasons which, because of their brevity, I set out in full hereunder:

It is my conclusion that the decision of Chairman Flanigan of the Tax Review Board herein is correct. Besides the matters referred to in his judgment, the following evidence lends weight to his decision. Exhibit 6 is a memorandum made by Harry Sutherland, solicitor for the companies involved, on January 10, 1966, following the meeting of the boards of such companies on January 6, 1966. It was made to record the decisions arrived at by such boards in regard to the transfer from Stuart to Grover. At paragraph 3 of such memorandum is found the following explanation:

“When the tax loss on Grover has been fully utilized the business carried on by Stuart Brothers will be sold by Grover to Stuart Brothers.”

Mr Sutherland, in his examination-in-chief, said that is what was proposed to be done at that particular time. later (sic) in his evidence he said that the boards decided that the trade marks could be retransferred “as soon as the present arrangement has served its purpose”.

To my mind, such an obligation on the part of Grover to reconvey the assets to Stuart when the Grover loss had been absorbed in reducing the Stuart income tax, when coupled with the facts set out in the judgment appealed from, is convincing evidence that the directors of both companies never contemplated the transaction as a transfer of the Stuart assets nor a genuine sale.

The appeal should therefore be dismissed with costs.

It was submitted by counsel for the appellant that his reasons for judgment indicate that the learned trial judge did not decide the appeal on the basis of the evidence adduced before him but merely gave brief reasons for agreeing with the judgment of the Tax Review Board and in so doing, failed to recognize that, while the proceeding in the Trial Division is entitled an appeal from the Tax Review Board, it has been held to be and is, in fact, a trial de novo. That this is so is beyond question. See: Campbell v MNR, [1953] 1 SCR 3; [1952] CTC 334; 52 DTC 1187; Smith v MNR, [1965] SCR 582; [1965] CTC 257; 65 DTC 5149.

Moreover, the proceeding in the Trial Division was held as a trial de novo. While appellant called only one witness before the Tax Review Board, it called four to testify at trial. That being so, it is clear that neither the parties nor the learned trial judge were under any illusion as to the nature of the proceedings in the Trial Division and did not feel themselves to be restricted to the record of what transpired before the Board in presenting the appeal.

It is true that the trial judge did appear to affirm the correctness of the judgment of the Tax Review Board but it is equally true that, in his brief reasons, and in particular in the penultimate paragraph thereof, he directed his mind to that portion of the evidence adduced before him indicating that “the directors of both companies never contemplated the transaction as a transfer of the Stuart assets nor a genuine sale”. The fact that he resorted to the convenient expedient of referring to the facts as found by the Tax Review Board rather than himself detailing his findings of fact, other than those to which he made specific reference, does not indicate, in my view, that he did not understand that he must decide the appeal on the evidence before him. On the contrary, I think that his reasons indicate that he based his decision on the evidence adduced before him. In my opinion, therefore, the appellant’s first ground of appeal must fail.

I turn now to the second attack of the appellant on the judgment under appeal. In effect, while he did not use the word, in the passage from his reasons for judgment quoted earlier herein, the learned Chairman of the Tax Review Board did find later in his reasons that the transaction between Stuart and Grover was a “sham” as that term was defined by Lord Justice Diplock, as he then was, in the well-known judgment in Snook v London <& West Riding Investments Ltd, [1967] 1 All ER 518. The learned trial judge was of a similar view, as the penultimate paragraph in his reasons for judgment, supra, discloses. Lord Diplock in the Snook case (supra) at page 528 of the report, in an oft-quoted passage, said:

As regards the contention of the plaintiff that the transactions between himself, Auto-Finance, Ltd and the defendants were a “sham”, it is, I think, necessary to consider that, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co v Maclure, [1882] 21 Ch.D. 309; Stoneleigh Finance, Ltd v Phillips, [1965] 1 All ER 513; [1965] 2 Q.B. 537), that for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a “shammer” affect the rights of a party whom he deceived.

It was appellant’s counsel’s submission that the directors of Stuart and Grover did not have a common intention that the various acts and documents to which they were a party should not create legal rights and obligations. The sworn testimony of all of Stuart’s witnesses, each of whom was a credible witness as their respective backgrounds would indicate, was to the contrary, counsel said, and this evidence was ignored by the trial judge.

Counsel for the respondent on the other hand argued that the various transactions purporting to transfer the business or assets from Stuart to Grover were a sham because they did not change or affect the commercial reality and were taken solely to support and lend credence to the fiction that Stuart was carrying on the business not on its own account but as a nominee of Grover. In support of this contention, he directed the Court’s attention to a large number of matters which ought to have been undertaken to complete the transaction if it had been a genuine one but which had not been done. I will refer to these matters in greater detail later herein. Suffice it to say, for this aspect of the discussion, that I do not believe that it is necessary on the above facts fo find that the transaction was or was not a sham.

It was admitted that the transactions were entered into for the purpose of utilizing the tax losses accumulated by Grover. That in itself is not a reprehensible, let alone an illegal, act since every person is entitled to organize his affairs in such a manner as to minimize or eliminate taxes so long as he does so within the limitations imposed by the law. To attach to those transactions the pejorative term “sham”, in the circumstances of this case, it seems to me may be unnecessary, unfair and perhaps unwarranted, although it must be said that the evidence certainly points in that direction. However, even if they did not comprise a sham, that conclusion does not necessarily permit the appellant to claim that the Minister’s reassessments were invalid. As I see it, it must, in any event, satisfy the Court that what it purported to do, namely to transfer its assets and undertakings to Grover, was in fact accomplished. Since the acknowledged purpose of the transactions was to reduce the tax consequences arising out of the profits of the flavourings business by applying Grover’s tax losses thereto, the Court is entitled, indeed obliged, to examine all of the evidence relating to the transactions to ensure that what was done for the purpose of achieving the desired result in fact was sufficient to enable the Court to conclude that there had been a valid, completed transaction.

Chief Justice Jackett (as he then was), in Rose v MNR, [1973] FC 65; CTC 74; 73 DTC 5083, factually a case quite different from this one, observed that, when it is acknowledged that by a course of action what is sought is a tax advantage, a Court should make

. . . a very careful appraisal of the evidence when considering whether what was projected with that end in view was actually carried out.

A careful appraisal of all that was done here to achieve the desired result is thus, it seems to me, warranted. Having so done, it should first be observed that at the time the various transactions were entered into the admitted purpose therefor was to utilize Grover’s tax losses following the full utilization of which the flavourings business would be sold back to Stuart. Documentary and viva voce evidence both disclose this intention. In the event, the sale back never took place because in 1968 the flavourings business was sold, in an arm’s length transaction, to Givaudan Stuart Brothers Limited for over $2,000,000.

It should next be observed that while the formalities of assigning Stuart’s trademarks and registered user agreements were complied with, they were undertaken with a view to re-assigning them to Stuart “as soon as this present arrangement has served its purpose” (Memorandum of Finlayson dated July 13, 1966, Appeal Book, Vol. Il, p. 191).

It is not without significance that the consideration for the sale of the flavourings business was the book value thereof and was paid for by the assumption by Grover of Stuart’s liabilities in the approximate amount of $500,000 and the balance of $184,909 was payable, without interest, on demand. No part of the consideration was a payment for goodwill. By way of contrast, three years later, Givaudan Stuart Brothers Limited paid $750,000 for goodwill. Incidentally, the balance of the purchase price as then shown on Stuart’s books was not paid until 1971.

The evidence also discloses that the following licences held by Stuart were never transferred to Grover:

(a) Federal sales tax licence under the Excise Tax Act;

(b) Chemical Still licence under the Excise Act; applications for renewals thereof continued to be made by Stuart for the years 1966, 1967 and 1968 and were granted as requested; and

(c) Bonded manufacturers licence under the Excise Act; applications for renewals thereof continued to be made by Stuart in the years 1966,1967 and 1968 and were granted as requested.

Information returns filed by Grover pursuant to the Corporation Information Act of Ontario for the years 1966, 1967 and 1968 described its business as “the manufacture and sales of precast concrete products”. No mention was made in any of them of the flavourings business. Neither was any reference made to the two debentures issued by Grover to which I earlier made reference.

On the other hand, the information returns filed by Stuart for the same years continued to describe its business as “the manufacture and sale of essential flavourings and oil”. The returns in each year showed its debenture issue to be $1,000,000 although that had apparently been discharged by the Bank of Nova Scotia and replaced by Grover’s debenture.

There is further disclosed in the evidence a number of instances from which it might be concluded that not only did Stuart carry on the flavourings business in fact but represented that it was so doing. Just a few examples of many support this view. The St Antoine Street building in Montreal bore only the appellant’s name. Water service and business taxes continued to be billed to and to be paid by it. The appellant was shown as the employer of the employees in the flavourings business in the “Return of Remuneration Paid” filed with the Department of National Revenue and in the T-4 slips issued to employees. Bank accounts continued to be operated in the name of Stuart and Grover had no authority with respect thereto. Persons having dealings with Stuart, such as lessors, trade creditors and debtors, parties to long term contracts, employees, customers and suppliers and the bonding company do not appear to have been informed of the change in ownership of the flavourings business.

In response to the litany of deficiencies in completing the paperwork necessary to be done to effectively complete a transaction of sale, appellant, in its memorandum of fact and law, had this to say:

34. Counsel concedes that in the transfer of the flavouring business from Stuart to Grover not all matters were attended to. Excise tax licences and sales tax licences remained untransferred. Grover’s Ontario Corporate Information Return, following the transfer, did not disclose the acquisition of the flavouring business. There were other matters.

These deficiencies can be explained either by inadvertence or by the continuing desire of the officers of Stuart and Grover not to advertise the transfer in light of their apprehension of the Conniston litigation. However that may be, it is submitted that these deficiencies pale in comparison with the overt acts, the registration of the debenture etc., and to not deprive the sale by Stuart of its flavouring business to Grover of its essential character, viz., a conveyance from Stuart to Grover by which legal title passed.

In my opinion, these explanations are insufficient to lead to the conclusion that the purported transaction completely and effectively determined the rights and obligations of the parties to the transaction of sale for the purposes sought by the appellant. The closing documentation required in the agreement by the purchaser in the sale of the flavourings business in 1968 to Givaudan Stuart Brothers Limited, which is part of the record, graphically illustrates what must be done to fully and effectively transfer an undertaking to a purchaser in an arm’s length transaction. The contrast with the purported Grover purchase, in what was admittedly a non-arm’s length deal, leads me to conclude that, while the elements for a successful transfer of the undertaking of Stuart to Grover were present, the failure to do those things necessary to effectuate the complete transaction deprives it of the reality necessary to conclude that the Minister erred in reassessing the appellant as he did for the taxation years in issue. Support for this conclusion is, of course, derived from the admitted purpose for entering the transaction and the projected re-sale back to Stuart after utilization of Grover’s tax losses as well as the fact that such re-sale could readily be accomplished because the directors and, to a large extent I think, the shareholders of each company, were the same.

In so concluding, I think it might be useful to repeat what was said in another context by this Court in Atinco Paper Products Ltd v The Queen, [1978] CTC 566; 78 DTC 6387:

I do not think that I should leave this appeal without expressing my views on the general question of transactions undertaken purportedly for the purpose of estate planning and tax avoidance. It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is, correct in form, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carrying out its judicial duties, but in its duty to the public at large. It is for this reason that I cannot accede to the suggestion, sometimes expressed, that there can be a strict or liberal view taken of a transaction, or series of transactions which it is hoped by the taxpayer will result in minimization of tax. The only course for the Court to take is to apply the law as the Court sees it to the facts as found in the particular transaction. If the transaction can withstand that scrutiny, then it will, of course, be supported. If it cannot, it will fall. That is what happened here.

Those words are, in my opinion, wholly apposite here since the appellant has, on the evidence, failed to show that the transaction was in all respects a complete, real transaction.

Accordingly, for all of the foregoing reasons, I would dismiss the appeal with costs.

Heald, J:—I concur.

Kelly, DJ:—I concur.