Walls v. Canada, [2002] 2 S.C.R. 684,
2002 SCC 47
Her Majesty The Queen Appellant
v.
Jack Walls and Robert Buvyer Respondents
Indexed as: Walls v. Canada
Neutral citation: 2002 SCC 47.
File No.: 27724.
2001: December 12; 2002: May 23.
Present: McLachlin C.J. and L’Heureux‑Dubé,
Gonthier, Iacobucci, Major, Bastarache, Binnie, Arbour and LeBel JJ.
on appeal from the federal court of appeal
Income tax – Source of income – Test to determine
whether taxpayer has business or property source of income – Whether
“reasonable expectation of profit” test appropriate test – Income Tax Act, S.C.
1970-71-72, c. 63, s. 9.
The respondents were limited partners in a
partnership. A mini-warehouse was purchased from Fraser Storage Park Ltd.
(“FSPL”) on behalf of the partnership for $2,200,000 payable in the form of $1
in cash and the balance in the form of an agreement for sale with interest
payable at 24 percent per annum. The partnership also entered into agreements
by virtue of which the partnership obligated itself to pay, on an annual basis,
interest, service fees, and management fees, as well as 50 percent of the
net operating profit of the operation to FSPL. The partnership generated
losses on the mini-warehouse of which the respondents deducted their
proportionate share for income tax purposes in 1984 and 1985. On reassessment,
the Minister of National Revenue reduced the losses by reducing the purchase
price of the mini-warehouse to reflect a fair market value of $1,180,000 and
also reduced the allowable interest expense by disallowing interest on debt in
excess of the fair market value and by lowering the interest rate to
16 percent. The respondents filed notices of objection, but the Minister
confirmed the reassessment. The Federal Court, Trial Division dismissed the
respondents’ appeals based solely on its finding that the partnership did not
carry on business with a reasonable expectation of profit and, therefore, that
the losses from the storage park operation were not losses from a business and
thus could not be deducted by the respondents. The Federal Court of Appeal set
aside the judgment, holding that the trial judge erred in applying the
reasonable expectation of profit doctrine, and remitted the matter to the trial
judge for a determination of the outstanding issues of whether there had been
an arm’s length transaction and its fair market value. The only issue in this
appeal is whether the storage park operation constituted a source of income for
the purposes of s. 9 of the Income Tax Act.
Held: The
appeal should be dismissed.
When the two-stage approach and the principles set out
in the companion case Stewart v. Canada, [2002] 2 S.C.R. 645, 2002 SCC
46, are applied, it is clear that the respondents’ storage park operation
constituted a source of income for the purposes of s. 9 of the Income
Tax Act. It is self-evident that such an activity is commercial in nature,
and there was no evidence of any element of personal use or benefit in the
operation. Where, as here, the activities have no personal aspect, reasonable
expectation of profit does not arise for consideration. Although the
respondents were clearly motivated by tax considerations when they purchased
their interests in the partnership, this does not detract from the commercial
nature of the storage park operation or its characterization as a source of
income. A tax motivation does not affect the validity of transactions for tax
purposes. In addition, given the specific anti-avoidance provisions in the
Act, courts should not be quick to embellish its provisions in response to tax
avoidance concerns.
Cases Cited
Followed: Stewart
v. Canada, [2002] 2 S.C.R. 645, 2002 SCC 46; restricted:
Moldowan v. The Queen, [1978] 1 S.C.R. 480; distinguished: Moloney
v. The Queen, 92 D.T.C. 6570; referred to: Tonn v. Canada,
[1996] 2 F.C. 73; Mastri v. Canada (Attorney General), [1998] 1 F.C. 66;
Backman v. Canada, [2001] 1 S.C.R. 367, 2001 SCC 10; Shell Canada
Ltd. v. Canada, [1999] 3 S.C.R. 622; Canada v. Antosko, [1994] 2
S.C.R. 312; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Ludco
Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, 2001 SCC 62; Neuman v.
M.N.R., [1998] 1 S.C.R. 770.
Statutes and Regulations Cited
Income Tax Act, S.C. 1970-71-72, c. 63 [now R.S.C. 1985, c. 1 (5th Supp .)],
ss. 9, 18(1) (a), 20(1) (c), 67 , 172(2) , 251 .
APPEAL from a judgment of the Federal Court of Appeal
(1999), 250 N.R. 324, 2000 D.T.C. 6025, [2000] 1 C.T.C. 324, [1999] F.C.J.
No. 1823 (QL), reversing a decision of the Trial Division (1996), 107
F.T.R. 108, 96 D.T.C. 6142, [1996] 2 C.T.C. 14, [1996] F.C.J. No. 145
(QL). Appeal dismissed.
Brent Paris and Richard
Gobeil, for the appellant.
Craig C. Sturrock
and Thomas M. Boddez, for the respondents.
The judgment of the Court was delivered by
Iacobucci and
Bastarache JJ.--
I. Introduction
1
This appeal raises substantially similar issues to those considered by
the Court in Stewart v. Canada, [2002] 2 S.C.R. 645, 2002 SCC 46, the
decision and reasons in which are being released herewith. Consequently, the
reasoning set out by the Court in that case is applicable to this appeal. As
in Stewart, we conclude here that the taxpayers’ activities constituted
a source of income for the purposes of s. 9 of the Income Tax Act, S.C.
1970-71-72, c. 63 (the “Act”). Accordingly, we agree with the disposition of
the Federal Court of Appeal and would therefore dismiss the appeal.
II. Facts
2
In July 1983 Fraser Storage Park Ltd. (“FSPL”) was incorporated under
the laws of British Columbia. One third of its issued shares were owned by
Victor Bolton through a holding company. One quarter of its issued shares were
owned by Raymond Matty, also through holding companies.
3
In the fall of 1983, FSPL, represented by Raymond Matty and Victor
Bolton, arranged to purchase a mini-warehouse from Twin Builders Ltd. for
$1,180,000. In October, Fraser Storage Park Partnership (the “Partnership”)
was founded, with Brem Management Ltd. as the general partner and Matty
Developments Ltd. as the founding partner. Raymond Matty and Victor Bolton
each owned 50 percent of the shares of Brem Management Ltd., and Raymond Matty
owned all of Matty Developments Ltd. In October, FSPL entered into an interim
agreement to sell the mini-warehouse to Brem Management Ltd. on behalf of the
Partnership for $2,200,000, payable in the form of $1 in cash and the balance
in the form of an agreement for sale with interest payable to FSPL at 24 percent
per annum. Raymond Matty and Victor Bolton negotiated the purchase and sale of
the mini-warehouse on behalf of both FSPL and the Partnership. The transfer of
the mini-warehouse from Twin Builders Ltd. to FSPL and the agreement for sale
between FSPL and Brem Management Ltd. on behalf of the Partnership were all
registered on December 30, 1983.
4
In addition to entering into the agreement for sale, the Partnership
also entered into a management agreement and a services agreement with FSPL.
By virtue of these agreements and the agreement for sale, the Partnership
obligated itself to pay, on an annual basis, $528,000 in interest, $140,000 in
service fees, and $50,000 in management fees, as well as 50 percent of the net
operating profit of the operation.
5
The respondents, Jack Walls and Robert Buvyer, were limited partners in
the Partnership. The Partnership generated losses on the mini-warehouse,
which were allocated to the respondents and the other partners on a prorated
basis. The respondents deducted their proportionate share of the losses for
income tax purposes. The respondents were reassessed by the Minister of
National Revenue for their 1984 and 1985 taxation years on the losses claimed
by virtue of their being partners in the Partnership. The Minister reduced the
losses by reducing the purchase price of the mini-warehouse to reflect a fair
market value of $1,180,000, rather than the $2,200,000 paid by the
Partnership. The Minister also reduced the allowable interest expense by disallowing
interest on debt in excess of $1,180,000, and by lowering the interest rate
from 24 percent to 16 percent on the basis that 24 percent was excessive. The
respondents filed notices of objection, but the Minister confirmed the notices
of reassessment. The respondents appealed, and the two appeals by each of the
two respondents were heard together.
6
The respondents claimed that, owing to the depressed real estate market
at the time, it was impossible to obtain conventional financing with respect to
such projects without providing substantial equity in the project and full
recourse financing. They argued that, given the terms of the agreement, and
since FSPL and the Partnership were at arm’s length, the interest expense was
reasonable as required under s. 20(1)(c) and s. 67 of the Act. The
respondents also argued that $2,200,000 was the fair market value of the
property at the material time.
7
The Minister argued that the Partnership did not carry on business with
a reasonable expectation of profit such that the losses from the storage park
operation were not losses from a business and thus could not be deducted under
s. 18(1)(a) of the Act by the partners. In the alternative, the
Minister asserted that the amount of interest claimed by the Partnership was
unreasonable pursuant to s. 20(1)(c) and s. 67 of the Act, that the fair
market value of the mini-warehouse had been $1,180,000, and that Brem
Management Ltd. and the Partnership were not dealing at arm’s length with FSPL
pursuant to s. 251 of the Act.
8
The Federal Court, Trial Division, dismissed the appeals based solely on
its finding that the Partnership did not carry on business with a reasonable
expectation of profit and, therefore, that the losses from the storage park
operation were not losses from a business and thus could not be deducted by the
respondents. The Federal Court of Appeal allowed the appeals, set aside the
lower court judgments, and remitted the matter to the trial judge for a
determination of the two outstanding issues of whether there had been an arm’s
length transaction and its fair market value.
III. Relevant
Statutory Provisions
9
Income Tax Act, S.C. 1970-71-72, c. 63 (now R.S.C. 1985, c. 1
(5th Supp .))
9. (1) Subject to this Part, a taxpayer’s
income for a taxation year from a business or property is his profit therefrom
for the year.
18. (1) In computing the income of a
taxpayer from a business or property no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made
or incurred by the taxpayer for the purpose of gaining or producing income from
the business or property;
20. (1) Notwithstanding paragraphs 18(1)(a),
(b) and (h), in computing a taxpayer’s income for a taxation year
from a business or property, there may be deducted such of the following
amounts as are wholly applicable to that source or such part of the following
amounts as may reasonably be regarded as applicable thereto:
.
. .
(c) an amount paid in the year or payable in respect of the
year (depending upon the method regularly followed by the taxpayer in computing
his income), pursuant to a legal obligation to pay interest on
(i) borrowed money used for the purpose of earning income from a
business or property . . .
or a reasonable amount in respect thereof, whichever is the lesser;
67. In computing income, no deduction shall
be made in respect of an outlay or expense in respect of which any amount is
otherwise deductible under this Act, except to the extent that the outlay or
expense was reasonable in the circumstances.
251. (1) For the purposes of this Act,
(a) related persons shall be deemed not to deal with each other
at arm’s length; and
(b) it is a question of fact whether persons not related to
each other were at a particular time dealing with each other at arm’s length.
IV. Judgments
Below
A. Federal
Court, Trial Division (1996), 107 F.T.R. 108
10
Each of the two respondents brought appeals before the Federal Court,
Trial Division, pursuant to s. 172(2) of the Income Tax Act with respect
to the Minister’s reassessments for the 1984 and 1985 taxation years. Pursuant
to the order of Pinard J. dated August 17, 1995, all four appeals were heard
together on the same evidence.
11
Pinard J. began his assessment of the reasonable expectation of profit
of the Partnership by referring to the following passage from the pivotal case
of Moldowan v. The Queen, [1978] 1 S.C.R. 480, at pp. 485-86:
There is a vast case literature on what reasonable
expectation of profit means and it is by no means entirely consistent. In my
view, whether a taxpayer has a reasonable expectation of profit is an objective
determination to be made from all of the facts. The following criteria should
be considered: the profit and loss experience in past years, the taxpayer’s training,
the taxpayer’s intended course of action, the capability of the venture as
capitalized to show a profit after charging capital cost allowance. The list
is not intended to be exhaustive. The factors will differ with the nature and
extent of the undertaking: The Queen v. Matthews [(1974), 74 D.T.C.
6193]. One would not expect a farmer who purchased a productive going
operation to suffer the same start-up losses as the man who begins a tree farm
on raw land.
12
In applying the criteria laid out in Moldowan to the facts before
him, Pinard J. found that the profit and loss experience was not particularly
helpful in this case, given the enormous increase in the expenses of the
storage park resulting from the agreement for sale, service agreement and
management agreement, none of which existed prior to 1983. He considered the
key factor to be the capability of the venture as capitalized to show a profit
after charging capital cost allowance. Examining the financial state of the
operation in considerable detail, Pinard J. concluded at para. 15 that:
As things stood, the Partnership was unable to make
a profit because it was effectively under capitalized. No plan existed to
raise additional capital to reduce the debts of the Partnership. The inability
of the venture as capitalized to show a profit, even before taking capital cost
allowance, is a clear indication that the Partnership did not have a reasonable
expectation of profit.
13
With respect to the other Moldowan factors, Pinard J. noted that
none of the partners had any previous experience running a storage park. As
well, no details had been provided on how to achieve the stated intended course
of action of increasing the occupancy of the storage park and increasing the
income in order to realize its inherent value. Finally, he found no basis for
claiming that the losses related to a start-up period, since the storage park
was purchased as a “going operation”.
14
Pinard J. concluded that on the facts before him, the Partnership did
not carry on business with a reasonable expectation of profit. In his view, at
paras. 17 and 19:
. . . [the Partnership] was set up as a tax shelter, with the intention
that the operation of the storage park would give rise to large initial losses
in order to provide the limited partners with tax claims. . . .
.
. .
The evidence in this case indicates that the only
financial advantage that could reasonably have been expected by a purchaser of
a limited partnership unit in this arrangement would have been by way of tax
refunds as a result of claiming the inevitable losses from the arrangement. . .
.
15
As a result, Pinard J. found that the losses sustained were not losses
from business and could not be deducted by the respondents to the extent of their
proportionate interests. The appeals were therefore dismissed.
B. Federal
Court of Appeal, [2000] 1 C.T.C. 324
16
Robertson J.A., for the court, stated that, based on the facts of the
case and the Federal Court of Appeal’s previous decisions in Tonn v. Canada,
[1996] 2 F.C. 73, and Mastri v. Canada (Attorney General), [1998] 1 F.C.
66, the trial judge had erred in applying the reasonable expectation of profit
doctrine set out by the Supreme Court of Canada in Moldowan, supra.
He continued at para. 1:
For example, there is no “personal element” involved in the series of
transactions under review. The [respondents] were limited partners who
purchased an ongoing commercial business. The fact that the purchase was
driven, in part, by favourable tax considerations does not detract from the
ongoing commercial nature of the endeavour.
17
Robertson J.A. therefore allowed the appeals, set aside the lower court
judgments, and remitted the matter to the trial judge for a determination of
the two outstanding issues of whether there was an arm’s length transaction and
its fair market value.
V. Issue
18
Did the storage park operation constitute a source of income for the
purposes of s. 9 of the Act?
VI. Analysis
19
The test to determine whether a taxpayer’s activities constitute a
source of business or property income for the purposes of s. 9 of the Act is
set out in Stewart, supra, at para. 50 as follows:
(i) Is the activity of the taxpayer undertaken
in pursuit of profit, or is it a personal endeavour?
(ii) If it is not a personal endeavour, is the
source of the income a business or property?
In addition,
at para. 53 of that case, we emphasized that the first stage of this test will only
be relevant when there is some personal or hobby element to the activity in
question. Where an activity is clearly commercial, the taxpayer is necessarily
engaged in the pursuit of profit, and therefore a source of income exists.
20
Applying these principles to this case, we find that it is clear that
the storage park operation constituted a source of income for the purposes of
s. 9 of the Act. It is self-evident that such an activity is commercial in
nature, and there was no evidence of any element of personal use or benefit in
the operation. Although we state in Stewart, supra, at para. 55,
that reasonable expectation of profit may be used as one factor in making the
overall determination as to whether or not the taxpayer’s activities are
personal or commercial, where, as here, the activities have no personal aspect,
reasonable expectation of profit does not arise for consideration.
21
The trial judge referred to the storage park operation as a “tax
shelter” and concluded that the reduction of tax was the sole motivation for
its existence, citing Moloney v. The Queen, 92 D.T.C. 6570 (F.C.A.).
However, in that case, a circular scheme was set up for the sole purpose of
obtaining tax refunds with no intention on the part of the taxpayer to carry on
the business of marketing a speed reading course which was the ostensible
purpose of the transactions. It was in this context that Hugessen J.A. stated,
at p. 6570:
While it is trite law that a taxpayer may so
arrange his business as to attract the least possible tax, it is equally clear
in our view that the reduction of his own tax cannot by itself be a
taxpayer’s business for the purpose of the Income Tax Act.
[Emphasis added.]
With respect,
the case at bar is distinguishable from Moloney. There, the taxpayer was
not engaged in a commercial activity, but instead was involved in a sham set up
to appear as though it was commercial in nature where in fact the only activity
actually engaged in was that of obtaining tax refunds. Here, in contrast, the
Partnership purchased and maintained an ongoing commercial operation.
22
Although the respondents in this case were clearly motivated by tax
considerations when they purchased their interests in the Partnership, this
does not detract from the commercial nature of the storage park operation or
its characterization as a source of income for the purposes of s. 9 of the
Act. It is a well-established proposition that a tax motivation does not
affect the validity of transactions for tax purposes: Backman v. Canada,
[2001] 1 S.C.R. 367, 2001 SCC 10, at para. 22; Shell Canada Ltd. v. Canada,
[1999] 3 S.C.R. 622; Canada v. Antosko, [1994] 2 S.C.R. 312; Stubart
Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, at p. 540. In
addition, we reiterate the caution stated in Stewart, at para. 65 that,
given the specific anti-avoidance provisions in the Act, courts should not be
quick to embellish its provisions in response to tax avoidance concerns: see
also Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, 2001
SCC 62, at para. 39; Neuman v. M.N.R., [1998] 1 S.C.R. 770, at para. 63.
VII. Conclusion
23
For these reasons, we conclude that the storage park operation carried
on by the Partnership, in which the respondents were limited partners,
constituted a source of income for the purposes of s. 9 of the Act. As a
result, we would dismiss the appeal with costs.
Appeal dismissed with costs.
Solicitor for the appellant: The Deputy Attorney General
of Canada, Vancouver.
Solicitors for the respondents: Thorsteinssons,
Vancouver.
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