LJP SALES AGENCY INC.,
HER MAJESTY THE QUEEN,
REASONS FOR JUDGMENT
 At first blush, this is a case
about the application of the technical associated corporation
rules. Upon hearing the witnesses and viewing firsthand the pain
the Passarellos have been through, and are continuing to go
through, it is clear this case is not just about a dispassionate
interpretation of technical rules; it is about a couple torn
apart, and how they have struggled to stay together. This
conflict has led them to arrange their affairs with separate
companies, not because, as the Respondent suggests, one of the
main purposes was to save tax, but solely to save a family from
 The issue is whether the
Appellant, LJP Sales Agency Inc. ("LJP"), a company
owned 100 per cent by Leonard Passarello, and Jo-Van Distributors
Inc. ("Jo-Van"), a company owned 91 per cent by Mr.
Passarello's wife, Wendy, and 9 per cent by Mr. Passarello
are associated corporations. The Respondent contends that they
are associated in accordance with subsection 256(2.1) of the
Income Tax Act (the "Act"), because one
of the main reasons for the separate existence of the two
companies is to reduce the amount of tax that would otherwise be
payable under the Act. I find that, although tax was a
consideration of the Appellant's professional advisor,
reduction of tax was not one of the main reasons for the separate
existence of the corporations, and, therefore, the corporations
are not associated in accordance with subsection 256(2.1).
 Mr. and Mrs. Passarello were
married in the mid-1960s. Mr. Passarello worked in the locksmith
business. He decided that he could fare better by going out on
his own. He established his own locksmith business from his home,
but soon moved into a store. Mrs. Passarello was very much
involved in the business and indeed she ran the store while Mr.
Passarello serviced the customers. The business was incorporated
under the name Supreme Locksmiths Limited
 In the 1970s, Mrs. Passarello made
a short-lived venture into the alarm system business under the
auspices of the corporate entity, Academy Security Systems Ltd.
("Academy"). This proved unsuccessful and the company
lay dormant for a period of time, although Mrs. Passarello bought
out the other shareholders of Academy to the extent of eventually
holding 91 per cent of Academy, while Mr. Passarello held the
remaining 9 per cent. Throughout the 1970s both Mr. and Mrs.
Passarello took steps to qualify as locksmiths.
Mr. Passarello became very involved with the American
Association of Locksmiths and eventually became the president of
 In 1980, the Passarellos decided
to build a plaza and move Supreme's business into the plaza.
The plaza was built and owned by Supreme. The Passarellos'
next business step was to establish a wholesale division for
locks and related inventory. In 1982, Academy was revived for
this purpose and began operating under a new name - Jo-Van.
Business grew steadily and Academy o/a Jo-Van moved into its own
premises on Crockford Avenue, though only briefly before moving
into larger premises on Warden Avenue in the late 1980s. The
acquisition of the property on Warden Avenue was an expensive
proposition for Academy o/a Jo-Van. It borrowed considerable
funds both from Supreme and the bank. Mrs. Passarello ran Academy
 In 1988, Supreme received an offer
from Chubb Securities ("Chubb") that it could not
refuse, and did not. It sold its business assets to Chubb though
retained the real property, the plaza. Supreme had to change its
name in accordance with the deal with Chubb. It became VMP
Properties Inc. ("VMP"), a company whose only business
at this point was the ownership of the plaza.
 In the early 1990s Mr. Passarello
helped Mrs. Passarello in the Academy o/a Jo-Van business to some
extent, but I find it was Mrs. Passarello who really ran the
business. During this time Mr. Passarello looked after the plaza
and worked extensively with the American Association of
Locksmiths. His contribution to Academy o/a Jo-Van was to assist
 Academy o/a Jo-Van had a
financial problem with the bank. The Warden Avenue property was
heavily financed with a 12 per cent mortgage, and by the early
1990s, rates had dropped to 7 or 8 per cent. The property value
had also dropped by half. The Passarellos tried to renegotiate
with the bank. According to Mr. David Fine, their accountant, had
the operating business been housed in a separate company from the
property they would most likely have simply handed the property
over to the bank. They were eventually able to find new financing
and, on the advice of Mr. Fine, on November 1, 1994, Academy
o/a Jo-Van rolled its business, other than the property, into a
newly formed company, Jo-Van Distributors Inc. Jo-Van was
owned on the identical basis as Academy, that is, 91 per cent by
Mrs. Passarello and 9 per cent by Mr. Passarello. Jo-Van
owed Academy $400,000 as a result of the transaction. Mr. Fine
described this transaction as a creditor proofing arrangement,
separating the business from the real property.
 To recap, from a business
perspective just before May 1994, Mr. Passarello held all of
the shares of VMP, which owned the plaza. Its income before taxes
in 1994 was $116,000, $68,000 of which was interest and the
balance rent. Mrs. Passarello owned 91 per cent of Academy,
carrying on as Jo-Van, which later in the year reorganized
so that Jo-Van carried on the wholesale business, while Academy
held the Warden Avenue property. Mr. Fine testified that he would
advise the Passarellos on an annual basis to bonus down the
corporate income to below the $200,000 small business limit. The
signs in the mid-1990s were clearly that fortunes of Jo-Van were
on the rise, especially as the financial concerns with the bank
were coming under control. Mr. Passarello was out of the Supreme
locksmith business, was winding down his extensive American
Association of Locksmiths' involvement and was helping on the
sale side of Academy o/a Jo-Van. It was evident to Mr. Passarello
that Mrs. Passarello was in a favourable position to see her
equity grow considerably more quickly than his. Why this is
significant is clear when we review the sorry tale of the family
 In 1994, the Passarellos' son and
daughter were 28 and 17 years old respectively. The problems the
Passarellos had with their children went well beyond normal
concerns of parents for their young adult children. It is
unnecessary to go into detail other than to note Mr. Passarello
was deeply affected by their behaviour. Mr. Passarello stated, in
his emotional testimony, that his children embarrassed him. They
had no respect for their parents or the family name. He felt they
hoodwinked Mrs. Passarello into getting their way. He was
humiliated and disappointed to the point that he wished to
disinherit them. Mrs. Passarello acknowledged the problems with
the children but claimed they were still her children and she
simply could not abandon them. This drove a wedge between the
Passarellos. They sought counselling. They went to psychologists
and psychiatrists. They considered divorce. As Mr. Passarello put
it, his world was collapsing.
 Mr. Passarello approached Mr. Fine for
help as to how he and Mrs. Passarello could each accomplish
what they wanted vis-à-vis the children. Mr. Fine knew the
family and could see the torment the Passarellos were going
through. He also indicated that he believed Mrs. Passarello would
not be prepared to give up any ownership of Academy o/a Jo-Van.
He therefore made a recommendation to Mr. Passarello in a memo of
May 5, 1994, which reads as follows:
To: Len Passarello
From: David M. Fine
Date: May 5, 1994
I am sitting down and writing some of the points we discussed
last month while you were signing your personal tax returns, your
major concerns were as follows:
1. Jo-van is
becoming very profitable and profits will probably continue to
increase in accordance with an anticipated increase in volume.
You're concerned that Wendy is becoming far wealthier than
you. Wendy owns 91% of Jo-Van, which is the largest producer of
cash, and 91% of Academy which owns the building at 929 Warden.
You own 9% of each and 100% of VMP which owns the plaza on
Lawrence. You felt that this doesn't make any sense.
2. You were
also concerned because your children are alienated from you and
you do not want them to inherit from your estate while Wendy is
prepared to let them inherit from hers.
You seemed to be very upset because you are certain that they
will soon dissipate any wealth they inherit.
3. Since she
has substantial control of Jo-Van, if she wanted to she could
sell the company to a third party and receive a substantial
amount of cash.
We discussed several options to attempt to solve this
shares from Wendy - she refused.
This resulted in an argument with her - you did not wish to
pursue this as you were afraid it would affect your marriage and
besides this would not be a solution if you had to pay her
your relationship with Jo-Van. Again you were concerned it may
affect your marriage.
your own company to takeover the marketing and sales functions of
Jo-Van for a fixed % of Jo-Van sales. This has the effect of
syphoning off that % of profits from Jo-Van which will then
accrue to your company. This, as the volume of sales in
Jo-Van increases, your company will increase in profits and
value as well. Also, if Wendy decides to sell her shares in
Jo-Van, and if she agrees, you may participate in the increase in
the value of the company, by having the sale of your shares in
the new company included in the sale of the Jo-Van shares.
For examples, since Jo-Van is projecting annual volumes in excess
of 7 million dollars - the profits in your company assuming a
rate of 5% of sales - would be $350,000 - which would be more
You will, of course, make sure that your will is done in
accordance with your wishes.
I am available to discuss this memo at your convenience.
 Mr. Passarello executed a will in April
1994 in which he left the remainder of his estate equally to his
grandson and charity. It is interesting to note the proviso in
the bequest to the grandson:
... If at that time, or if he shall be thirty five (35) years
of age or older at the time of my death, he still has the legal
name LEONARD MICHAEL JOHN PASSARELLO and is commonly known by
that name and as well has not been convicted of any serious
criminal offense, he will be entitled to receive for his own use
absolutely the assets remaining in this trust at that time.
It is clear how deeply Mr. Passarello had been traumatized by
the deteriorating relationship with his son.
 Mrs. Passarello's will dated June
1994 left her estate equally to her two children.
 The Passarellos followed Mr. Fine's
advice and Mr. Passarello incorporated LJP. On June 1, 1994, LJP
entered a Sales Agency Agreement with Academy o/a Jo-Van, which
on November 1, was assigned to Jo-Van as part of the
reorganization of Academy o/a Jo-Van. The Sales Agency Agreement
provided for a commission of 5 per cent of the net revenues
received by Academy o/a Jo-Van in respect of orders solicited by
 When each asked independently of the
tax considerations in establishing the separate companies, Mr.
Passarello answered that tax was the furthest thing on his mind,
and Mrs. Passarello answered that she had no idea there was tax
savings. The Passarellos clearly left the tax planning to their
 The relationship between the
Passarellos was strained, and remains so, though Mr.
Passarello's initial reluctance to begrudgingly contribute to
the sales effort has developed into a more cooperative
contribution. He fulfills a role that Academy o/a Jo-Van had
previously engaged a third party sales representative to handle.
Mr. Passarello remains the figurehead of Jo-Van, for, as Mrs.
Passarello stated, Mr. Passarello is the locksmith well known in
the community. Also, regretfully, she acknowledged that the
locksmith community appeared to prefer dealing with a man. She
would seek Mr. Passarello's recommendations on inventory
though made it abundantly clear that it was her call as to
ultimately what quantity of what stock was bought. My impression
of the way the business operated was that it was indeed Mrs.
Passarello's business, with Mr. Passarello as the front man,
 LJP shared space with Jo-Van, though
Mr. Passarello's sales agency was in a separate part of the
building. Both LJP personnel and Jo-Van personnel manned the
sales counter. There were two separate payrolls, bank accounts,
and phones. LJP paid rent to Jo-Van. Most expenses were
reimbursed to LJP, other than rent and Mr. Passarello's
 Mr. Fine corroborated the
Passarellos' explanation of their troubles and their needs in
1994. He believed that by severing off the major marketing arm of
the business, Mr. Passarello could share in the increased
goodwill of the business should it be sold in the future. He
suggested other options were limited as Mrs. Passarello was
reluctant to divest herself of any percentage ownership interest
in Jo-Van. Mr. Fine testified that he provided no further advice
on the separate companies other than achieving the objective of
equalizing future wealth accrual, so that in the future their
wishes on distribution to the children could be met. He said that
tax was not an issue, though acknowledged that he organized the
Passarellos' business affairs generally in a tax effective
way. He described this arrangement as the least tax damaging.
 The sole issue in this case is whether
subsection 256(2.1) of the Act applies to deem LJP and
Jo-Van to be associated corporations. Subsection 256(2.1) reads
256(1) For the purposes of this Act, one
corporation is associated with another in a taxation year if, at
any time in the year,
(2.1) For the purposes of this
Act, where, in the case of two or more corporations, it
may reasonably be considered that one of the main reasons for the
separate existence of those corporations in a taxation year is to
reduce the amount of taxes that would otherwise be payable under
this Act or to increase the amount of refundable
investment tax credit under section 127.1, the two or more
corporations shall be deemed to be associated with each other in
 I find that the main reason for the
separate existence of the companies was to accommodate the
Passarellos' desire to equally split their future accrual of
wealth, so they could leave their respective estates as they
intended; that is, Mrs. Passarello's to the children and
Mr. Passarello's to a grandchild and charity, in effect
disinheriting his children. This is supported by the
Passarellos' most credible testimony, the documents (wills,
agency agreement, assignments) and Mr. Fine's corroborating
evidence. As far as Mr. and Mrs. Passarello were concerned there
was only one reason for the separate companies and that was to
resolve a family issue that was tearing them apart. The separate
companies allowed the Passarellos to reach a detente, albeit a
somewhat uneasy one, and at least be able to get on with their
 Was there, however, a second
main reason for the separate companies, the reason of
reducing tax? Appellant's counsel, Mr. McRae, was adamant
that there was only the one main reason, and the Passarellos
compelling testimony was to be believed. I accept both
counsel's assertions that credibility is critical. And I do
believe the Passarellos testimony, but I also find it is
necessary to look at the surrounding circumstances and to those
who actually devised the arrangement, especially, as here, where
the evidence is that the Passarellos relied entirely on their
professional advisor for tax planning advice.
 Respondent's counsel gleaned from
the many cases dealing with this issue a number of circumstances
that I should consider in ascertaining whether it "may
reasonably be considered that one of the main reasons" is
the reduction of tax. I review these factors in the context
however of my finding that the Passarellos themselves only had
one reason in mind for the separate existence of the companies.
But as Ms. Boris for the Respondent pointed out, the reason may
be an unconscious one. In support of this contention, she relies
on the following passage from Justice Urie in Levitt-Safety
(Eastern) Ltd. and Levitt-Safety Limited v. M.N.R.:
... In his narration of the problems he was, in my opinion, a
credible witness and I believe, therefore, that the actions that
he took were for valid business and personal reasons. However, I
do not believe that these were the only reasons that changes were
made in the corporate structure of his business since I believe
that the evidence also indicates that it must have been in the
minds of Mr. Levitt and his advisers that substantial tax savings
were available in adopting the solutions to the problems which he
did, namely in dividing Safety's business into three separate
entities, none of which were associated within the meaning of
Section 39 of the Income Tax Act as it then stood. As
Jackett, P., as he then was, said in Holt Metal Sales of
Manitoba Limited et at. v. The Minister of National Revenue
 Ex. CR 612 at page 622, 70 DTC 6108 at 6111-12:
If the evidence were such as to convince me that some or all
of these and other reasons that have been advanced were
sufficiently compelling in the minds of William Holt and his
advisers to constrain them to select the creation of the
Appellants in preference to all other possible methods of
achieving the same results, I should have thought that it might
be open to me to conclude that the probable reduction in income
taxes through having three companies instead of one to enjoy the
18% tax rate was not one of the main reasons for deciding to have
three companies instead of one. An example of a case where the
other considerations dictated the creation of several
corporations and the income tax benefit arising therefrom was
only an incidental benefit, is Jordans Rugs Limited et at. v.
Minister of National Revenue  CTC 445 [69 DTC 5290].
Here, however, no attempt was made to show that, in the minds of
William Holt and his advisers, to achieve any one or more
compelling objectives (such as conferring property benefits on
members of the family) the only practicable method was the
creation of multiple companies (and other methods of achieving
such objectives certainly existed); one is left with the
conclusion that the very substantial prospective annual reduction
in income tax must have been, consciously or
unconsciously, one of the main factors that operated on
the thinking of William Holt and his advisers to bring them to
elect for this particular method of reorganization and
re-arrangement of William Holt's affairs in preference to all
 It is unusual that a court might rely
on an unconscious reason of an individual especially where an
individual's testimony is so adamantly to the contrary. The
inferences must be overwhelming to support such a case. The
circumstances in Levitt, supra, were not those of a
family in turmoil, but businessmen with some knowledge of tax
advantages making calculated business decisions. The Court also
simply did not accept Mr. Levitt's contentions and relied on
surrounding circumstances to find that tax was a main reason. I
am faced with a significantly different situation. I will address
the several factors that Ms. Boris suggests are so persuasive as
to draw an inference that can override Mr. Passarello's
contention that tax was not a main reason.
Did the business change? Ms. Boris refers to Debruth
Investments Ltd. v. M.N.R. where Justice Collier indicated that nothing had
really changed in the operation of the business, and that such
fact confirmed the view that tax reduction was the main purpose.
However, in that case there was some testimony to the effect that
tax had been expressly considered, giving rise to the possibility
that tax reduction was a main purpose. Justice Collier was
looking to the objective facts to confirm that purpose. In the
situation of the Passarellos, there is no evidence of any express
attention to tax. Given that, the fact that the business of
Jo-Van carried on much the same way after LJP was incorporated as
before incorporation, does not confirm any pre-existing tax
motivation. I do note that the two entities did have separate
accounts, bank accounts, payrolls and telephones although they
certainly did work from the same premises. To the public they
appeared as one business, the business of Jo-Van. Though
Mr. Passarello's salary from LJP and the rent paid by
LJP were not reimbursed by Jo-Van, most of the other expenses
were. So, indeed, there were indications of the business not
significantly changing, but I do not find this is a sufficient
basis for a determination that a main reason was the reduction of
Did Mr. and Mrs. Passarello's role change? Mr.
Passarello's role changed only to the extent that, as he
became less involved with the American Association of Locksmiths,
and more comfortable with the new cease-fire arrangement, he
devoted more time to the sales effort. He remained a figurehead
for Jo-Van notwithstanding the separate corporate structure. Mrs.
Passarello carried on much as before.
 (iii) How
close was Academy o/a Jo-Van to its maximum small business limit
prior to the establishment of LJP? For the year end October
31, 1993, income before taxes in Academy o/a Jo-Van was $143,000
and for the following year was $185,000. The inference which Ms.
Boris wishes me to draw from this is clear.
 (iv) What
other tax planning did LJP and Jo-Van engage in? The
Passarellos acknowledged that their accountant would bonus down
to the small business limit each year. Tax advice was sought in
the creditor proof reorganization of Academy. Ms. Boris stressed
that the tax tail so wagged the dog that in two years bonuses of
$20,000 and $25,000 were paid to the disinherited daughter.
Further, Mr. Fine understood tax implications and regularly
provided tax advice. It is reasonable, Ms. Boris suggests, that
he would continue to do so in the creation of LJP, and it would
also be reasonable to think the Passarellos would expect him to
do so. I am not swayed that such inferences, given the firsthand
testimony from Mr. Fine and the Passarellos, lead to a finding
that tax was a main reason. It does satisfy me that the
Passarellos could and did expect their advisor to meet their main
purpose in a tax effective manner. That is certainly not
unreasonable in light of previous professional advice. Yet, there
is a quantum leap required to take an expectation of tax
effectiveness in a new structure where the main reason for such
new structure is so clear, to a finding that tax reduction is one
of the main reasons for that structure. Mr. Fine did not
cite tax as a reason, let alone a main reason. His concern was
for the family, and his objective was to accommodate their needs.
I have been persuaded, however, that with his background and
history with the Passarellos, tax was a consideration, a reason
if you will for Mr. Fine to suggest the arrangement, but it was
an incidental, not a main reason.
 (v) Could
the Passarellos objective had been achieved by other means?
This is a factor referred to in other cases, for example,
Baycast Products Ltd. and Bay Bronze (1962) Ltd. v. M.N.R. Under
less stressed circumstances, perhaps some other plan not
involving a separate company may have worked. But the family was
in crisis; they wanted a resolution. Ms. Boris explored the
possibility of an internal corporate reorganization, a form of
partial freeze with Mr. Fine. He was adamant that Mrs. Passarello
would not see any change in her shareholdings in Jo-Van.
 Ms. Boris questioned the effectiveness
of the plan contending Mr. Passarello could have received
the 5 per cent commission personally. She also maintained that
there was no guarantee a purchaser would buy both Jo-Van and LJP,
thus not meeting the Passarellos goal of both benefitting from
the increase in the value of the goodwill. I disagree. The
Passarellos had control over what they sold. Any sale of the
business could be structured to require a purchase of the two
companies, with the price appropriately allocated. Also, simply
having Mr. Passarello accept the commission personally would
not achieve the Passarellos' objective in this regard. The
possibility of the sale of the built up goodwill was critical to
the recommendation Mr. Fine made in his memo of May 1994.
 Mr. Fine testified there may have been
more tax effective strategies, though he did not identify any.
Given the desperation of the Passarellos to resolve their family
issues, I am not surprised that Mr. Fine did not undertake a
lengthy review of every possible suitable arrangement. He came up
with a plan that made sense to the Passarellos, retained Mrs.
Passarello's same ownership interest in Jo-Van, allowed for a
division of the growth in goodwill and took more drastic measures
such as divorce off the table. I do not infer from these
circumstances that tax must have been a main reason.
 (vi) If
there had been no tax advantages would the plan have been adopted
in any event? This succinct test set forth in Jordans Rugs
Ltd. et al. v. M.N.R. was adopted by Justice Mogan in Rosner
Management Inc. v. M.N.R. It calls for some speculation, but I have no
hesitation in concluding, based on the facts, that yes,
absolutely, the Passarellos would have gone ahead with the
separate companies had there been no tax advantage. Their main,
and in their mind their only reason, would still have been met.
There is no evidence to suggest the Passarellos would have
insisted on an arrangement that had to produce a reduction in
taxes. Simply because their business affairs were handled in a
tax effective manner in the past is not sufficient reason to
infer that tax, in this highly emotionally charged context, was
critical to this arrangement. It was not, and it was not a main
 This issue is a question of fact and of
assessing credibility. I believe the Passarellos did not have the
reduction of tax in mind in splitting the business between two
companies. Tax was not a reason for them, let alone a main
reason, though there was an expectation that Mr. Fine would, as
he had in the past, arrange matters tax effectively. Mr. Fine
would not have been doing his job for the Passarellos if he did
not consider tax. But the consideration of tax was clearly
incidental to his desire to help this family resolve a dilemma
that was tearing them apart. I am satisfied tax reduction was not
a main reason for Mr. Fine's recommendations. The Crown wants
me to infer from the surrounding circumstances, which I have
enumerated, that there was, in effect, an "unconscious"
main reason to reduce tax. Inferences from the fact that the
business was carried on similarly after the incorporation of LJP,
with Mr. Passarello continuing to play a sales role,
combined with a history of effective tax planning are not
sufficient to overcome the reality that there was only one main
reason for the separate existence of the companies.
 The appeals are allowed and the matter
is referred back to the Minister of National Revenue for
reconsideration and reassessment on the basis that LJP and Jo-Van
are not associated corporations. Costs to the Appellant.
Signed at Ottawa, Canada, this 1st day of December, 2003.