Maritime Forwarding Ltd v. The Queen, 88 DTC 6114, [1988] 1 CTC 186 (FCTD)

Joyal, J.:—On June 2, 1982, Revenue Canada, Taxation, directed that under the provisions of subsection 247(2) of the Income Tax Act, the plaintiffs, Maritime Forwarding Ltd. and Jaans Leasing Limited, be deemed to be associated with each other for the 1975, 1976, 1977 and 1978 taxation years.

Subsection 247(2) of the Act reads as follows:

247(2) Associated corporations. Where, in the case of two or more corporations, the Minister is satisfied

(a) that the separate existence of those corporations in a taxation year is not solely for the purpose of carrying out the business of those corporations in the most effective manner, and

(b) that one of the main reasons for such separate existence in the year is to reduce the amount of taxes that would otherwise be payable under this Act or to increase the refundable investment tax credit under section 127.1

the two or more corporations shall, if the Minister so directs, be deemed to be associated with each other in the year.

It is admitted by the parties that the foregoing provisions are to deal with two or more corporations which do not come within the provisions of section 256 of the Act setting out the technical criteria for associated corporations. The effect in either case, however, is the same: each individual corporation cannot avail itself of the special tax treatment given to Canadian controlled private corporations under section 125 of the Act.

An appeal lies from an assessment made pursuant to subsection 247(2) of the Act. The Tax Court of Canada or the Federal Court may vacate the direction if as subsection 247(3) states, “it determines that none of the main reasons for the separate existence of the two or more corporations is to reduce the amount of tax that would otherwise be payable under this Act". [My emphasis.]

Both Maritime Forwarding Ltd. and Jaans Leasing Ltd. have appealed to this Court and under the date of May 1, 1987, it was ordered by the Associate Chief Justice that both appeals be heard together on common evidence.

Before enquiring into the grounds for the defendant's direction under subsection 247(2) and the plaintiffs’ refutation of them, a brief history of these corporations is required.

Background

Maritime Forwarding Ltd. (MFL), as its name implies, carried on the business of forwarding agent between points in Toronto and Montreal and the maritime provinces. During the 1960s, it fell into hard times. Its main business, out of Moncton, New Brunswick, was with the Canadian National Railways and it owed the railway company a lot of money.

A South African-born chartered accountant, Mr. Aubrey K. Schwartz, then entered the picture. Mr. Schwartz had settled in Canada in 1959 and after completing his C.A. studies in 1961, had joined the Canadian National Railways. Within a brief few years, he had become assistant to its president. When informed of the MFL situation, he saw an opportunity to turn it around. He bought the outstanding shares of MFL for $4,000. He left CNR and thereafter devoted his full time to the affairs of the company.

Mr. Schwartz was able to work out a deal with CNR with respect to its debt to it. The business prospered. Within seven years, the whole debt had been paid off.

In the fall of 1974, he incorporated Jaans Leasing Ltd. (Jaans) to operate a truck leasing business. In April 1975, he executed a trust deed. He named his wife, Sharon Schwartz and the Royal Trust Company as trustees and named his children as beneficiaries. He named the trust Algoa Trust.

When everything had been put in place, Algoa Trust became the owner of all outstanding shares of Jaans. Mr. Schwartz, either directly or indirectly through Aubrey Investments Ltd., continued as sole shareholder of MEL.

The purpose of creating Jaans, according to the evidence of Mr. Schwartz, was to rid MFL of any tangible assets which might become subject to seizure. Mr. Schwartz wished to protect his capital in MFL from any downturn risk which the company continually faced. He further testified that the presence of Jaans in the truck-leasing market stabilized leasing costs charged by other leasing companies and resulted in operational savings in MEL. It was further his intention to keep MFL bare of any seizable assets which might not otherwise be pledged, to strip MFL of its surplus by transferring it to his own investment company, Aubrey Investments Ltd., and, through income accruing to Algoa Trust from the profits of Jaans, assure some measure of security to his children. His conclusion was that the setting up of Jaans was not to reduce the amount of taxes which would otherwise be payable but to meet purely business exigencies. He further maintained that any tax advantages which might flow through from these arrangements were matters with which he was not familiar and which were left to his auditors.

The Evidence

The documentary evidence adduced at trial was voluminous. Some 350 documents were filed, most of them taken from the records of both MFL and Jaans. For purposes of the case, however, I need only summarize the following:

1. There was produced a "Rental Savings Schedule" for the period of 1974-1981, purportedly prepared by MFL's bookkeeper indicating some $146,000 worth of savings to the company in leasing some of its trucks from Jaans.

2. In its first year of operation, Jaans purchased at book value some $25,900 worth of MFL trucks and leased them right back to MFL at $72,000 per year.

3. Jaans was able to put Mrs. Sharon Schwartz on its payroll as president for which she received an average yearly salary of some $22,000 over the period of 1975-1978. There is oral evidence from the plaintiffs that Mrs. Schwartz' responsibilities consisted of co-signing company cheques.

4. Dividends were received by Algoa Trust from Jaans in the amounts of $36,000 for 1976, $36,000 for 1977 and $63,000 for 1978. Furthermore, at the end of 1978, the undistributed income of Jaans amounted to $155,657.

5. The paper work for Jaans' operation was the responsibility of Mr. Bjornson, himself a chartered accountant and an old CNR friend of Mr. Schwartz. His professional remuneration over the course of the relevant years was from $5,000 to $7,000 annually. Mr. Bjornson admitted that the time spent looking after Jaans' affairs was very limited. It only required a day or less a week with perhaps a little more at month-end.

6. There is further evidence from both Mr. Bjornson and from documents that Jaans’ operations during the relevant years were limited to leasing trucks to MFL. Jaans had no commercial office and no telephone number but it did have a postal box number. Bank statements, at least in the earlier years, were routinely forwarded to MFL. Mr. Bjornson's responsibilities were carried out from his home on Marlowe Avenue in Montreal. The auditors for both MFL and Jaans were the same and when later it was decided to change auditors, the same firm of auditors was appointed for both. Jaans did not engage into any advertising or marketing program, its primary role being to meet the needs and demands of MFL.

7. With respect to MFL, the documentary evidence discloses dividends of $60,000 and $30,000 paid out in 1972 and 1973 respectively. It also discloses directors’ remuneration of $54,000 and $56,000 in 1971 and 1972 and of $126,000 and $88,000 in 1973 and 1974. The CNR debt in 1968 was some $226,000 and had been reduced to $150,000 in 1969.

8. MFL had sufficient surplus funds in 1974 to invest some $78,000 in farming operations in the Eastern Townships and to invest into marketable securities. These securities amounted to $153,000 in 1975, $185,000 in 1976 and $116,000 in 1977.

9. Retained earnings of MFL amounted to $169,000 in 1975, $249,000 in 1976 and $336,000 in 1977. In 1978, after a dividend payout of $156,000, retained earnings amounted to $276,000.

10. In Supplementary Financial Information for the year ended December 31, 1976, there is disclosed executive salaries of $90,000. For the year 1976, the financial statements disclose an aggregate remuneration of officers of $165,500. This same item discloses remuneration of $77,326 in 1977 and $128,000 in 1978.

11. After MFL's original $78,000 investment in farming operations in 1974, the net book value of farm assets had increased to $100,000 in 1975, to $121,000 in 1976, to $142,000 in 1977, to $134,000 in 1978 and to $153,000 in 1979. At cost, the total farm investment had reached $237,000 by 1979. During that same period of time, MFL absorbed a total of $257,000 in farm losses. In 1980, after changing the accounting basis for these operations from the accrual to the cash method, an additional loss of $479,000 was absorbed by the company.

12. There is also evidence to indicate that throughout the relevant period, Mr. Schwartz was held by financing institutions and bankers as the directing head of both Jaans and MFL.

13. Finally, there is in the testimony of Mr. Schwartz and of Mr. Bjornson evidence that in many instances, financing negotiations for the purchase of trucks by Jaans and the lease documents executed by Jaans with MFL were conducted or prepared at MFL offices.

The Findings

It has often been repeated in tax matters that assertions by a taxpayer as to his intentions are only persuasive to the extent that they may be directly or indirectly confirmed by or be consistent with overt and objective fact.

The assertions of Mr. Schwartz were that the setting up of Jaans was to achieve three concurrent purposes, namely to control or reduce truck leasing costs, secondly to protect his capital investment in MFL by removing tangible assets from possible seizures and finally, to redirect beyond the reach of creditors and for the benefit of his children some of MFL's earnings.

On the evidence, it could be concluded that Mr. Schwartz' avowed intentions were realized. The incorporation of Jaans and the creation of Algoa Trust represented good financial planning. It permitted the diversion of MFL earnings to the benefit of Jaans. In turn, it permitted Jaans to pay out generous dividends to Algoa Trust for the benefit of Mr. Schwartz' children.

I find, however, that he did not quite succeed in reducing leasing costs. I am satisfied that the calculations in the Rental Savings Schedule showing cost savings through Jaans do not stand up to scrutiny. The allegedly comparative costs are not comparable. Distinctions between net/net leases, full service leases, short term or longer run leases as well as items relating to overhead, maintenance and labour costs are either overlooked or are simply distorted. Furthermore, I am not satisfied that in the course of the years 1974-1978, the supply of leased trucks was so tight that Jaans, with its limited participation in leasing trucks to MFL, could exercise any market pressure. In any event, whether Mr. Schwartz succeeded or not in this respect is only material to the weight to be given to his expressed intention.

Mr. Schwartz further claimed that his capital in MFL was at risk and the sale of MFL trucks to Jaans protected them from creditors. On the evidence before me, Mr. Schwartz' capital could not be considered at risk in 1975 when the first transaction between Jaans and MFL took place. Admittedly, the earlier years of Mr. Schwartz' involvement in MFL were risky. Under his strong guiding hand, however, the business prospered. By 1975, MFL could invest $78,000 in farming operations and could enjoy stock trading with an investment portfolio worth $153,000. At the end of that same year, retained earnings in MFL exceeded $170,000. Not a bad return on an original $4,000 investment. Again, repeating what I said earlier, whether or not Mr. Schwartz' capital was at risk is only material to the weight to be given to his expressed assertions in that regard.

I must now refer to the relationship between Jaans and MFL. I must find that although Algoa Trust held title to Jaans' capital stock to the exclusion of both Mr. Schwartz and MFL, the guiding hand throughout with respect to the operation of both companies was the hand of Mr. Schwartz. Algoa Trust, in accordance with the terms of its trust deed, was a passive instrument. Algoa Trust depended on Jaans' dividends to fund it. In turn, Jaans depended on the exclusive discretion of MFL to lease trucks from it from time to time. Jaans itself was a passive instrument. MFL could turn on or turn off the tap at will. The participation of Jaans in certain real estate operations as well as the determination of the number of truck leases, their terms and their rates remained the prerogative of MFL. Jaans had no bargaining power, at least in the sense that it could not readily bite the hand which was feeding it. The fact that Jaans was owned by Algoa Trust and MFL by Mr. Schwartz had absolutely no consequence. The effective control and management of Jaans remained in the hands of Mr. Schwartz. One consequence, however, was to exempt the two companies from technical definitions of associated corporations as set out in section 256 of the Income Tax Act and to enable Jaans to avail itself of the small business deductions under section 125 of the Act.

Conclusions

In Leonard Reeves Incorporated v. M.N.R., [1985] 2 C.T.C. 2054; 85 D.T.C. 419, Christie, A.C.J. provides a helpful analysis of those things which are germane on the issue of relevant intention in tax matters, among them the intentions attributed to a corporation. The Associate Chief Judge quotes the case of Metropolitan Motels Corporation v. M.N.R., [1966] C.T.C. 246; 66 D.T.C. 5208, per Jackett, P. (as he then was), at page 247 (D.T.C. 5209):

If the appellant is a corporation, the relevant intentions to be attributed to it are those which the natural person by whom it was managed and controlled had for it.

The decision of the Supreme Court of Canada in Johnston v. M.N.R., [1948] C.T.C. 195; 3 D.T.C. 1182, is authority for the general principle that the onus is on the taxpayer to demolish the basic fact on which taxation rests.

This principle was specifically applied to a subsection 247(2) issue in the case of The Queen v. Covertite Ltd., [1981] C.T.C. 464; 81 D.T.C. 5353, where Marceau, J., then of the Trial Division of this Court, said as follows at pages 466-67 (D.T.C. 5355):

. . . The taxpayer corporation, on its being reassessed pursuant to a direction under subsection 247(2), is given a right of appeal but to succeed it must sap the foundations on which the direction was based, it must refute the conclusion reached by the Minister. The appeal tribunal, the Board or the Court, is entitled to vacate the direction if, but only if, it can determine that none of the main reasons for the separate existence of the two corporations was that of reducing taxes. The onus on the taxpayer appellant is complete and the role of the Court is clear. . . .

Later on, at page 467 (D.T.C. 5355), Marceau, J. says that:

. . . To succeed, the taxpayer must: (a) disprove the facts assumed by the Minister in reaching his conclusion; or (b) convince the Court that the inferences drawn by the Minister from the facts assumed were unreasonable and unwarranted; or (c) add further facts capable of changing the whole picture and leading to different inferences pointing to the conclusion that the other reasons alleged have actually been prevalent.

An appeal from the foregoing was subsequently dismissed, without reasons, by the Federal Court of Appeal (A-721-81 of June 14, 1985).

Applying in a somewhat generic fashion the test suggested by Marceau, J., I should conclude:

1. The facts assumed by the Minister in his direction under subsection 247(2) cannot be seriously disproved. These facts all come out in the evidence which I have summarized earlier and on which I made a number of findings.

2. The inferences drawn by the Minister on the facts before him cannot be said to be unwarranted or unreasonable. Notwithstanding the intentions asserted at length by Mr. Schwartz before this Court that tax savings were not an issue in setting up Jaans or that any tax advantage to be derived was a matter left to his auditors, it is a warranted and reasonable inference to draw that it was not solely for the purpose of carrying out the business of the two corporations in the most effective manner.

As I have indicated in my findings, the assertions by Mr. Schwartz, although not totally discounted, have very little in the way of overt and objective fact to support them and the weight to be given to these assertions is considerably attenuated. I might add in this respect that I see nothing particularly effective from a business point of view in MFL paying to Jaans in one year three times the cost of capital equipment Originally sold to it. Nor do I find it a particularly attractive business purpose in Jaans paying Mrs. Schwartz a substantial annual salary for cosigning cheques.

3. Among the conclusions which may be drawn from the evidence to which I have referred is that the directing hand in the operation of the two companies was an articulate, astute and talented entrepreneur who picked up a senile enterprise 20 years ago and made of it a remarkable success. In so doing, he adopted good business and management techniques. His professional experience as a chartered accountant lent itself to the numbers-crunching game in which he became involved. His entrepreneurial spirit in turn lent itself to his involvement in a farming enterprise in the Eastern Townships and to real estate development in Moncton.

An analysis of the companies' operations and of their financial statements over the years under review clearly attests to an awareness of any number of tax considerations to which the collective mind of his auditors, if not his own, was applied. I need only give as examples of this that the trust deed creating Algoa Trust stipulated its situs as Prince Edward Island, with its consequent tax advantages; that Jaans triggered off a sprinkler effect out of MFL earnings to the benefit of Mrs. Schwartz by way of remuneration and to the benefit of the children by way of dividends to Algoa Trust; that MFL, notwithstanding the strictures imposed by section 31 of the Income Tax Act, made full use of its farm losses in its returns; finally, as the fact is, that the ownership of Jaans in the hands of Algoa Trust ostensibly put the company beyond the reach of section 256 of the Income Tax Act.

Admittedly, no individual fact adduced in evidence or to which I have referred in these reasons would by itself necessarily justify the inferences made by the Minister or would forcefully lead to the conclusion that one of the main reasons for the separate existence of the two companies was to reduce the amount of taxes otherwise payable. The burden on the Minister cannot be discharged so easily. Nevertheless, I should find that the cumulative effect of the objective facts is to lead to the inferences drawn by the Minister and to amply justify the conclusions he reached.

I venture to observe that it is no lack of civic virtue for a taxpayer to so arrange his affairs so as to minimize the amount of taxes payable under the Income Tax Act. It does provoke many a taxpayer, however, to go to the leading, and indeed precarious, edge of taxing provisions to attempt this. I have conceded that Mr. Schwartz did arrange his corporate affairs to achieve many purposes, not the least of which was to sprinkle MFL earnings into the lap of family members who were not shareholders. It cannot be conceded that he did not have other purposes as well.

It is clear that the Minister’s authority under subsection 247(2) is for the particular purpose of closing any gap which might otherwise exist between appearance and form on the one hand and reality and substance on the other. The evidence before me and the finding that Mr. Schwartz, through MFL, exercised real and substantial control over Jaans are certainly of a nature to invite ministerial scrutiny and ministerial direction.

The plaintiffs having failed to establish that none of the main reasons for their separate existence was to reduce the amount of taxes payable, the Minister’s direction as well as any consequent reassessments must be confirmed.

The two actions, namely that of Maritime Forwarding Ltd. and Her Majesty the Queen (T-712-84) and that of Jaans Leasing Ltd. and Her Majesty the Queen, (T-421-84) are dismissed. The defendant is entitled to party and party costs and disbursements in each action up to the date of trial. There should, however, be only one set of counsel fees at trial.

Actions dismissed.