Robson Leather Co. Ltd. v. MNR, 74 DTC 6666, [1974] CTC 872 (FCTD), aff'd 77 DTC 5106, [1977] CTC 132 (FCA)

Collier, J:—The appellant (sometimes hereafter “Robson Leather’’) appeals the respondent’s assessments of its income tax for its 1964 and 1965 taxation years. In the notice of appeal to this Court, Robson Leather alleged errors in respect of a number of matters and issues. The parties have between themselves resolved all of these matters and issues but one. The agreement is set out in Exhibit 1 and there

will be: judgment in respect of those matters in the terms set out in paragraphs 1 to 6 of the Exhibit. I think paragraph 6 ought to be included in the pronouncement because the agreement set out in paragraph 5 is conditional on the one set out in paragraph 6.

I turn to the unresolved issue. By an agreement dated October 31, 1964 (Exhibit 2.7), Appel Process Limited (hereafter “Appel”) sold certain American patent rights owned by it to Robson Leather. The consideration was $500,000 payable in ten equal annual instalments commencing October 31, 1965. In its return for the taxation year 1965, the appellant brought into its assets, for the purposes of depreciation, the Appel American patents at the sum of $500,000. The respondent, in his assessment, did not accept that figure, but took the position that the correct figure, by virtue of subsection 20(4) of the Income Tax Act, RSC 1952, c 148 and amendments, was $244,861.

The Minister contends that that was the capital cost to the original owner, Appel; that the transaction between it and the appellant was not at arm’s length; that the capital cost to Robson Leather is therefore deemed to be $244,861 and not $500,000.

I should state at this point that there is no suggestion that Robson Leather was not acting in good faith in this matter. The valuation of $500,000, as a true valuation, has not been impugned by the Minister. The capital cost figure (to Appel) has been accepted by both sides.

The nub of the dispute remaining is whether the Appel-Robson Leather transaction was at arm’s length. The latter expression is not precisely defined, in the ordinary sense of definition, in the various sections of the statute where it appears. Counsel are in agreement that subsections 139(5a), (5b), (50) and (5d) are inapplicable, on the facts of this case, to the problem of “arm’s length”. I set out, however, subsection 139(5):

139. (5) 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.

Paragraph 139(5)(a) has no application on the facts here; paragraph (b) remains. The question here to be determined is therefore essentially one of fact, with whatever assistance can be gleaned from case law or other jurisprudence.

In order to make these reasons intelligible to the parties, and in the event of appeals, it is necessary to set out the relevant history and surrounding circumstances relating to the sale or transfer of the patents. I do not think it is necessary, however, to recount all of the corporate genealogy and financial transactions testified to at trial.

Robson Leather was incorporated in 1933. The business of that company goes back to the late nineteenth century. In the early post- Second World War years, Charles N Robson was the active member of the Robson family tn respect of that company and of other cor- porate ventures, which I shall loosely term the “Robson group”. At Some stage in 1963 Charles Robson became, for practical. purposes, the sole owner of a company called Eclipse Consultants Limited (hereafter “Eclipse”). It was essentially a management company. For a period prior to the creation of the Robson Family Trust (to be referred to later) Eclipse wholly owned Robson Leather. ,,

In 1955 Appel had been incorporated. A Dr Appel, a German citizen who came to Canada in 1951, was an inventor. He had invented or perfected a machine or process (and improvements) which, in the eyes of many, had great possibilities in the field of producing tubing for Various commercial purposes. I need not dwell on that history. The world patent rights were put into that company. At the relevant times its shares were owned 50% by Appel Consultants Ltd (in effect the Appel family) and Eclipse. Appel had hoped to exploit commercially the patents and to produce consumer products manufactured by machines using the Appel process patents. A good deal of money was spent, but the venture was perennially unprofitable. Considerable sums had been put into Appel through Eclipse or other companies in the Robson group. From a tax point of view Appel had several years of recurring losses, but as there were never any profits it could not carry these losses forward into other years.

In 1963 Robson Leather, or perhaps the Robson group, acquired two businesses which I shall refer to, for convenience, as the John A Lang and the Murray-Selby shoe businesses. This led to the birth of, among other companies, Robson-Langs Leather Co Ltd and Murray- Selby Shoes Co Limited. These two corporations were wholly owned by Robson Leather. The Murray-Selby Shoes Co Limited operation was a very successful and profitable one until 1966 or 1967.

In June of 1964, for estate planning purposes, the Robson Family Trust was set up. The mother of Charles N Robson was the settlor. The sum settled was $100. There were three trustees, one of whom was Charles N Robson. The beneficiaries were his wife and children. Article VII of the Trust document (Exhibit 2.1) reads in part:

If at any time during the terms of this trust Charles Robson desires the retirement of any one or more of the Trustees for any reason whatsoever, and a substitute therefor of some other person or persons as Trustee, then the said retiring Trustee or Trustees shall forthwith transfer the trust estate to the remaining Trustees, if any, and to the Trustee or Trustees designated by Charles Robson in substitution therefor.

After the creation of the trust and sometime before October 31, 1964, the trust became the owner of 21,000 or three-quarters of the issued shares of Robson Leather. It purchased them from Eclipse. Eclipse retained 7,000 shares, or the other one-quarter.

I now go back a little in time. In 1958 Dr Appel and his family company became a client of Mr Francis Lorenzen. Mr Lorenzen was a chartered accountant. His firm practised in the Windsor area. I think it fair to describe Mr Lorenzen as a financial consultant and adviser, as well as a chartered accountant. He appears to be very able and ingenious in the financial and business fields. This, of course, includes the general field of corporate taxation. Through Dr Appel he met Mr Robson. Mr Robson and the Robson group of companies became clients of Mr Lorenzen and his firm. Mr Lorenzen had, at the relevant times here, other clients including two other company groups in addition to the Robson group. The three company groups were large clients. The Appel client in comparison (I do not mean that disparagingly) was small. Mr Lorenzen was an officer of some of the Robson group companies referred to at the trial, the auditor of some and the financial adviser to a number. Up to the latter part of October 1964 he had no financial interest in any of the companies whose affairs are pertinent to this litigation. What is important, however, he had been an adviser to the Robson group for several years, as well as an adviser to Dr Appel and his family company. The Lorenzen family itself had, at the relevant times, a company which was called International Tax Services Limited.

The only witness to give viva voce evidence at the trial was Mr Lorenzen. In 1964 the following situation existed in respect of Mr Lorenzen’s clients:

First, Dr Appel, the inventor, was unhappy and had financial problems: The prosperous development and utilization of his patented processes in Appel had not materialized. Appel had been a moneyloser for some time. Mr Robson and his companies already had a large investment in Appel. They were unwilling to contribute more. It was a propitious time to try and buy out Dr Appel’s interest.

Two, Appel had a series of losses, some of which could not be brought forward because there were no profits against which to set them off. If Appel could be brought, in some manner, into a profit position, some tax relief could legitimately be obtained. I think it fair to say as well that there Could be an opportunity to recoup, to some limited extent, the tax-paid dollars previously put into Appel by Robson Leather or Eclipse or both. As Mr Lorenzen said, there was a mountain of debt hanging. over the Robson group.

Mr Lorenzen,. as a financial adviser, had always favoured the adoption in business of some kind of profit-sharing plans for senior corporate executives and: employees. He had been recommending such schemes to Mr Robson and the Robson group of companies. Mr Robson, according to Mr Lorenzen, :did not share this same philosophy. I attach no significance, either sinister or laudatory, to that. I mention profit-sharing plans, because they were, to some extent, a part of the transactions which follow.

In the middle of October 1964, Mr Lorenzen came up with a plan. It involved some negotiation and bargaining, some approvals and consents, and some reorganization of the Robson corporate family. The essence of it was as follows:

1. The interest of Dr Appel and of his family company in Appel should be purchased. I comment, at this point, that this had to be the initial step for the plan to be carried to fruition. If that interest could not be extricated, then the overall scheme, as originally designed, fell.

2. Appel should then be converted into a profitable enterprise. This could be done by inserting into it the very successful Murray-Selby Shoe business.

3. As the Appel patents had no real connection with the leather and related businesses carried on by the other companies in the Robson group, assets represented by the American patent rights could be transferred out to Robson Leather. Robson. Leather had been used for some time as a holding company for the Robson group. A fair price was to be paid for the patents.

4. The remaining world patent rights could be leased to another company. In fact, Eclipse ultimately became the lessee for a 10-year period.

5. Appel, with the patent assets effectively out of it through sale or lease, and expected to become profitable through the acquisition of the Murray-Selby business, could be used to carry out some profit-sharing plan for the benefit of senior executives and employees. At this point, the name of another company becomes relevant: Garsam Limited. It was ultimately to be the vehicle by which to accomplish the profit-sharing ideas.

6. The losses of Appel in previous years could be brought forward (subject to the limitations in the Income Tax Act) and applied against profits. This could result in reduced taxation, quite permissible by the statute.

I now go to the evidence as to how this plan was executed or carried out.

Mr Lorenzen dealt with Dr Appel. He says there was bargaining between the Appel interests and himself, representing all other interests. He did not necessarily go back to Mr Robson with the round-by-round details of these negotiations. He conducted the auction, he says, pretty well on his own. I accept that evidence. I cannot overlook the fact, however, that any money or financing required to carry out this purchase, or any of the other facets of the overall plan, had to come from the Robson group, either directly or by loans obtained or guaranteed in some manner, by the cornerstone of this whole corporate monolith, Robson Leather. Charles Robson and the Robson Family Trust were therefore involved and vitally interested. No matter what price seemed reasonable to Dr Appel or Mr Lorenzen for the Appel family’s interest, the concurrence, in a practical and business sense, of the Robson group was vital. In any event, the 500 shares of Appel (not held by Eclipse) were purchased for an. agreed price of $120,000. The terms are set out in Exhibit 2.2, dated October 28, 1964. The shares were purchased in the name of Mr Lorenzen. The evidence is quite clear, setting aside any legal niceties, that 475 shares were ultimately to go to a company in which the senior executives and employees previously referred to would have an interest. Because of the time factor, as October 31 had been selected as the effective date for the implementation of the overall plan, a dormant “paper” company had been obtained from a firm of solicitors. The evidence is clear the practical and commercial reality of the operation of this part of the plan through Garsam did not occur until some time after the October 31 date.

Mr Lorenzen held the remaining 25% of the shares for himself and his family company. The only reasonable inference to be drawn from the evidence is that that facet of the scheme obviously had to have the express approval of Robson Leather and Mr Robson.

On October 31, the agreement in question (the sale of the American patent rights) was executed. The appellant says that at the “particular time” (paragraph 139(5)(b)) of this transaction, Appel and Robson Leather were dealing with each other at arm’s length. The onus, in this case, is on the appellant to prove this.

The first submission on behalf of the appellant is premised on the theory of share control of Robson Leather. It is urged that the company was not controlled by Charles N Robson but by the Robson Family Trust; even assuming (for the purposes of this submission) that the mind that directed the bargaining on behalf of Appel was Mr Robson, through Mr Lorenzen, the mind that directed the bargaining on behalf of Robson Leather was not that of Mr Robson, or a mind acting on his dictates; that Mr Robson could not, as a co-trustee or otherwise, order the manner in which the other two trustees must vote in respect of the affairs, decisions or transactions of Robson Leather; that there had to be unanimity of vote; the mere right in Mr Robson to demand and obtain the retirement of his co-trustees and the appointment of substitutes is something legally distinct and apart from the right to direct the votes of the trustees.

I am unable to accept this first submission. I can accept the legal distinction made by Mr McDougall between a right in Mr Robson to remove (in effect) recalcitrant trustees and a right to direct in what manner the trustees must vote. The trust document is silent as to the manner of voting among trustees. There is no provision that Mr Robson’s vote is to be the deciding one. I can well understand the absence of any provision giving precisely voting. control to Charles N Robson. That would destroy the apparent aloofness of the trust from the Robson group and its business affairs. I can also understand the absence of a majority vote provision; at a particular instant of time the wishes of Charles N Robson could be vetoed, and perhaps the wishes of the Robson family itself frustrated. In my opinion, however, in deciding the larger issue before me, I must look:at the practical and business reality of the operation of the trust. By demanding retirement of trustees, or even the threat of such a demand, or the knowledge in the co-trustees that the ultimate power was always in Mr Robson, I have no doubt that Mr Robson, for practical and legal purposes, controlled the trust and, therefore, controlled Robson Leather. I add the caveat here, that share control alone (or absence of it) is not necessarily conclusive; it is a factor to be considered in determining questions of “arm’s length”.

Two further submissions were advanced on behalf of the appellant. Mr McDougall argued them together. It is said that Charles Robson or Robson Leather did not control, by shares or other means, Appel; that on the evidence here the mind that directed the bargaining on behalf of Robson Leather did not direct the bargaining on behalf of Appel. It is convenient, before dealing with these arguments, to set out extracts from the authorities relied on by both counsel. I refer first to MNR v T R Merritt Estate, [1969] 2 Ex CR 51; [1969] CTC 207; 69 DTC 5159. Cattanach, J said at pages 45-7 [216-18, 5165-6]:

In M.N.R. v. Sheldon's Engineering Limited, [1955] S.C.R. 637; [1955] C.T.C. 174,, Locke, J, delivering the judgment of the Supreme Court of “Canada, had occasion to comment upon the expression “dealing at arm’s length” as it appeared in a provision in the Income Tax Act. He said at page 643 (p. 179]:

“The expression is one which is usually employed in cases in which transactions between trustees and cestuis que trust, guardians and wards, principals and agents or solicitors and clients are' called into question. The reasons why transactions between persons standing in these relations to each other may be impeached are pointed out in the judgments of the Lord Chancellor and of Lord Blackburn in McPherson v Watts (1877), 3 App. Cas. 254.”

He went on to say, however, that “These considerations”—i.e., the reasons why transactions between persons standing in such relations as ‘trustee and cestuis que trust may be impeached—“have no application in considering the meaning to be assigned to the expression in Section 20(2)”.

Having. thus put aside the principles that had been developed concerning ;: transactions between persons standing in the relationship of trustee and

cestuis que trust and other relationships giving rise to an implication of undue influence, Locke J. went on to reject the argument that the provision in the: Income Tax Act at that time whereby certain defined classes of persons were deemed not to deal with each other at arm’s length was exhaustive of the classes of persons who could be regarded as not dealing with each other at arm’s length for the purposes of that Act. He said:

“I think the language of Section 127(5) [now 139(5)], though in some respects obscure, is intended to indicate that, in dealings between corporations, the meaning to be assigned to the expression elsewhere in the statute is not confined to that expressed in that section.”

While, therefore, the facts in the Sheldon’s Engineering (supra) case did not fall within any of the specially enumerated classes of cases where persons were deemed not to deal with each other at arm’s length, Locke, J. concluded that it was still necessary to consider whether, as a matter of fact, the circumstances of the case fell within the meaning of the expression “not dealing at arm’s length” within whatever meaning those words have apart from any special deeming provision.

In this appeal, the question is whether the circumstances are such as to fall within the words “persons dealing with each other at arm’s length” in Section 29(1) of the Estate Tax Act. In my view, these words in the Estate Tax Act have the same meaning as they had in the income tax provision with which Locke, J. was dealing in Sheldon’s Engineering when those words were considered, as Locke, J. had to do, apart from any special “deeming” provision.

It becomes important, therefore, to consider what help can be obtained from the judgment in Sheldon’s Engineering as to the meaning of the words “persons dealing at arm’s length” when taken by themselves. The passage in that judgment from which, in my view, such help can be obtained, is that reading as follows:

“Where corporations are controlled directly or indirectly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm’s length. Apart altogether from the provisions of that section, it could hot, in my opinion, be fairly contended that, where depreciable assets were sold by a taxpayer to an entity wholly controlled by him or by a corporation controlled by the taxpayer to another corporation controlled by him, the taxpayer as the controlling shareholder dictating the terms of the bargain, the parties were dealing with each other at arm’s length and that Section 20(2) was inapplicable.”

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party ‘t a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties are dealing at arm’s length. In other words where the evidence reveals that the same person was “dictating” the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.

He goes on:

In my view, it is immaterial that the whole arrangement was the “brain child” of the professional advisers. It would have been of no effect if the deceased had not accepted their advice, made the scheme his own, and given instructions that it be carried out. It is also immaterial whether he ever completely absorbed the details of the plan.

In Swiss Bank Corporation et al v MNR, [1971] CTC 427; 71 DTC 5235, Thurlow, J quoted substantially all of the above passages from the Merritt case and added this at pages 437-8 [5241), and I quote:

To this I would add that where several parties—whether natural persons or corporations, or a combination of the two—act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the “mind” that directs may be that of the combination as a whole acting in concert or that of any one of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to be made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest from the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqualify the transaction as one between parties dealing at arm’s length. The Sheldon’s Engineering case, . . . as I see it, is an instance of this.

The Swiss Bank decision was affirmed by the Supreme Court. of Canada ([1972] CTC 614; 72 DTC 6470).

Mr McDougall, as a preliminary to his main submission, made these points. Firstly, the relevant transactions in October 1964 among these companies and persons were real transactions and not “paper” or sham transactions. I had used the expression “paper” transactions at one point in Mr Lorenzen’s testimony, and I can appreciate my remark may have been construed as derogatory. I accept, and am satisfied, the transactions here were real ones; the payments to be made by companies to other companies were substantially made, even though the method might have been, in part, by offsetting real debits and credits through journal entries, (“contra’d”, to use Mr Lorenzen’s phrase). Secondly, that no adverse or sinister inferences should be drawn because Mr Lorenzen, in the relevant transactions, wore several hats and represented different and perhaps conflicting interests, or because all transactions were, in the practical sense, financed by the Robson group. I draw no such adverse or sinister inferences. Those facts are, however, in my view, facts to be considered along with all the other circumstances.

I have already indicated that Mr Robson was in the position effectively and practically to direct any bargaining carried on by or on behalf of Robson Leather vis-a-vis Appel. Mr Lorenzen was never specifically questioned by anyone on this point (and I can understand that), but I think the conclusion is irresistible that the ultimate and real direction of the destinies of the appellant was in Mr Robson, and that was the situation in respect to the events and bargaining in the laiter part of October 1964.

The crux of the matter, as I see it, is, from what source did the decisions made by Appel in respect of the sale of the American patents really emanate. As l' earlier pointed out, the first essential step in the whole process was the removal of the Dr Appel shares from the overall design. This was accomplished by Mr Lorenzen purchasing (as trustee for others) the 500 shares held by Appel Consultants Ltd; 475 were to go to Garsam Limited.

It is admitted Dr Appel was probably never told what was proposed regarding the patent assets of Appel, or how the business of the company was to be reorganized. Even if he was told, he admittedly had no part in the transactions between Appel, Robson Leather, the Murray-Selby Shoe business, and Garsam Limited. Who then, after the disappearance of the Appel family interest, was directing the bargaining or decisions in respect of the schemes for an Appel company with a new look, new assets, and new paths of endeavour? The conclusion must be that it was. the same business “mind” or interest that effectively controlled the destinies of the Robson Group, and I say that, in effect, was Mr Robson.

Mr Lorenzen, as purchaser of the shares, was said to be a trustee, with all the obligations, legal and moral, of that position, to exercise independence and free will on behalf of Appel to the extent of the 50% overall interest taken in his name. There is no satisfactory evidence, to my mind, that those employees who were then given or were ultimately to be given an interest in Garsam Limited had anything to say as to what was to be done with the Appel patents: None of those executives or employees gave evidence. I do not think Mr Lorenzen was in a position to testify on their behalf. The decision to inject the Murray-Selby Shoe business into Appel was basically. a Robson Leather decision. Neither Mr Lorenzen, in his personal capacity or as adviser, nor any one of the persons selected to share in Garsam Limited, could affect or control, or bargain a whit, in respect of that transaction. There is, in any event, no satisfactory evidence they did.

Mr Lorenzen, as I have earlier stated, was the only person to give evidence. He was the architect and the designer of the whole scheme. He was the honest broker in the carrying out of parts of it where discussions with different groups or individuals had to be carried out. He however was not, to my mind, the decision-maker for anyone. That was the appellant, so far as Appel was concerned, and as corporations can only act (generally speaking) through officers, agents or servants, the directing mind was that of Mr Robson.

In those just stated remarks I do not intend any disparagement or criticism either of Mr Lorenzen or Mr Robson. The question before me is simply whether “arm’s length’, as used in the statute and, as Locke, J said in MNR v Sheldon Engineering Ltd, [1955] SCR 637; [1955] CTC 174; 55 DTC 1110, “within the commonly accepted meaning of that expression”, was present here.

I find that the parties to this transaction were not, within the relevant statutory provisions, at “arm’s length”. The appellant, in my view, comes with the letter of the law. The appeal of Robson Leather, in respect of that issue, is dismissed.

Counsel for the parties have agreed that the costs of the unsuccessful party in this issue be fixed at $700, exclusive of disbursements, and I so direct.