The Queen v. Special Risks Holdings Inc., 83 DTC 5046, [1983] CTC 36 (FCA)

Heald, J:—This is an appeal from an interlocutory judgment of the Trial Division which:

(a) granted the respondent’s motion to delete paragraph 8 from the statement of claim and to make certain amendments to paragraph 12 of the statement of claim;

(b) ordered that the words “but adds that plaintiff entered into a scheme described in said paragraphs with the hope and expectation of avoiding tax on the distribution of dividends” be struck from paragraph 3 of the appellant’s statement of defence; and

(c) ordered that the appellant’s motion that the respondent be ordered to produce* [1] documents pursuant to Rule 448 be dismissed.

While the notice of appeal purports to appeal against all three branches of the Trial Division order supra, the appellant’s memorandum of fact and law limits the appeal to subparagraphs (b) and (c) supra, and the appeal was argued on this basis.

The relevant facts are summarized in the reasons of the learned motions’ judge as follows (AB 48 and 49):

The proceedings are an appeal against assessments dated March 19, 1981, resulting from elections made by Defendant in March 1978 and December 1978 pursuant to subsection 83(1) of the Income Tax Act to pay dividends out of its tax paid undistributed surplus on hand account (TPUS) and its 1971 capital surplus on hand account (CSOH). A number of inter-corporate transactions and share subscriptions and changes were involved between Plaintiff, Hogg Robinson Group Ltd, Richards, Melling & Co Ltd, and Melling Hogg Robinson Ltd, which need not be gone into here. As a result Plaintiff paid a dividend of $185,000 on March 31, 1978, calculating that $181,604 of this was paid out of its TPUS account and $3,396 out of its CSOH account, and another dividend on December 29, 1978 of $1,346,231 out of its 1971 CSOH account. The Minister in the re-assessment calculated that. with respect to the March 13, 1978 election an amount fo $129,334.35 was deemed to be paid from the TPUS account and $51,171.65 from the CSOH account, and assessed additional tax accordingly.

Plaintiff relies on Sections 3, 83, 86, 89, 184 and 248 of the Act as applicable to the 1978 taxation year and on Section 26 of the Income Tax Application Rules. Defendant relies on the same sections.

Defendant admits a number of paragraphs of Plaintiff’s Statement of Claim including an admission in Paragraph 3 of Paragraphs 10, 11, 12, 14, 16 and 18 of it, but in the said paragraph then goes on to say “the Plaintiff entered into a scheme described in said paragraphs with the hope and expectation of avoiding tax on the distribution of dividends”.

In Paragraph 4 Defendant denies paragraphs 13, 15 and 17 adding that in assessing Plaintiff the Minister assumed that Plaintiff, in effect, controlled at all rele- vant times, Richards, Melling & Co Ltd. Paragraphs 5 and 8 supplement this contention that Plaintiff was not dealing at arm’s length with the said company after it disposed of its shares, paragraph 8 concluding that the amount referred to in paragraph 89(1 )(a)(ii) of the Act is deemed to be nil in accordance with the provisions of paragraph 89(5)(a)(ii) of the Act. The parties agree that this is the issue between them.

In respect of that portion of the order set out in subparagraph (b) supra, the reasons given by the motions’ judge read as follows (AB 49 & 50):

Plaintiff objects strongly to the allegation in paragraph 3 of the Defence that it entered into a scheme with the hope and expectation of avoiding tax on the distribution of dividends, pointing out that it is well established that a taxpayer may arrange his affairs in such a manner as to minimize or avoid taxation, and in the absence of sham is entitled to do so. There is no allegation of sham in this case and Defendant admits that the various manoeuvres with the shares were carried out. Plaintiff does not deny that the objective was to avoid taxation on the dividend distributions but contends that it had a legal right to take the steps it did, and that Defendant has no right to take the steps it did, and that Defendant has no right to go into its motives for doing so. Defendant contends that it is the substance, not the form of the transactions which must be looked into, and that for a brief period of 11 days control passed out of the hands of Plaintiff, before returning to it. Defendant has not pleaded Section 245 of the Act dealing with Artificial Transactions, section 246 respecting Tax Avoidance, or Section 247 dealing with Dividend Stripping. I therefore find that the allegation in the latter part of Paragraph 3 of the Defence relating to Plaintiff’s motives should be struck.

It is the position of the appellant that the respondent controlled Richards, Melling & Co Ltd (RMC) immediately before it disposed of its RMC shares on December 23, 1976 and was not dealing at arm’s length with RMC immediately after that disposition. Thus, in the submission of the appellant, subparagraph 89(1 )(l)(ii) of the Income Tax Act appliest [2] and pursuant thereto, the amount referred to therein is deemed to be nil in accordance with the provisions of subparagraph 89(5)(a)(ii) of the Act^. [3] The respondent, on the other hand, pleads each and every step of the various transactions and takes the position that the deeming provisions of subparagraph 89(5)(a)(ii) do not apply to the circumstances of this case because the respondent did not control RMC immediately before its disposition of the RMC shares owned by it. Based on the transactions outlined in paragraphs 9 to 18 inclusive of the statement of claim, I perceive the respondent’s position to be that from December 20, 1976 to December 31, 1976, the respondent did not control RMC within the meaning of subsection 186(2) of the Act**. [4] Thus, put another way, the issue between the parties is the continuity of respondent’s control of RMC. Based on the statement of claim, I understand the respondent to be saying that up until December 20, 1976, the respondent controlled RMC. Then, on December 20, 1976, that control passed to Melling, Hogg, Robinson Ltd, (MHR). However, the respondent did not control MHR pursuant to subsection 188(2) because MHR’s voting shares were divided equally between another company and the respondent. Therefore, the respondent could not be said to have control of RMC. This, in respondent’s view, was the position when the respondent disposed of its RMC shares on December 23, 1976. It was not until December 31, 1976 that respondent regained control of MHR. Thus, in respondent’s view, the respondent did not control RMC from December 20, 1976 to December 31, 1976, a period of 11 days. During that 11 day period when it was not in control of RMC, that is, on December 23, 1976, the respondent disposed of its RMC shares.

The appellant submits that the impugned portion of paragraph 3 of her statement of defence should be read together with paragraph 4 of the statement of defence and, if that is done, it will be seen that the impugned portion is necessary and relevant to the issues as defined by the pleadings. It is the appellant’s position that since paragraph 3 alleges that the respondent entered into the “scheme” pleaded by the respondent “with the hope and expectation of avoiding tax on the distribution of dividends”, the Court had a duty to carefully scrutinize all aspects of that “scheme” to ascertain whether the parties in fact achieved the position that they set out to achieve or put another way, the test should be whether subject series of transactions has been effectively implemented in every way so that the legal relationships which the parties claim to have created have in fact and in law really been brought into existence. Counsel for the appellant said that the Crown intended to challenge the result of the scheme and that the impugned portion of paragraph 3 was necessary and relevant to that intention. In support of this submission, counsel relied on the Court’s decision in Amelia Rose v MNR, [1973] CTC 74; 73 DTC 5083. In that case, the former Chief Justice of this Court, said at 5085:

It does not seem to be in doubt that the reason for the scheme under which the corporations in question would be constituted a partnership to undertake management services for Central Park Estates Limited was to achieve tax advantages for the individuals owning the shares of some or all of those corporations. While this does not affect the result actually achieved by what was done, it does, in my view, warrant a very careful appraisal of the evidence when considering whether what was projected with that end in view was actually carried out.

However, a perusal of the record in that case shows that the Minister pleaded, in paragraph 7 of his reply to the amended notice of appeal that the taxpayer’s . .. alleged participation in the alleged Central Park Management Company partnership was not the carrying on of a bona fide active financial, commercial or industrial business but an artificial attempt to create the appearance of the carrying on of such a business”. It is also noted that the Minister, in paragraph 16 of his memorandum of fact and law in the Rose case submitted, inter alia, that ... the arrangement under which the partnership agreement and the management agreement were set up was a sham”. In my view, this is a very significant difference between the case at bar and the Rose case (supra). In Rose, artificiality was pleaded. Here there is no such pleading. The decision in Rose and the comments of the former Chief Justice supra in that decision must be considered in the light of the pleadings in that case. In the case of The Queen v John J. Daly [1981] CTC 270; 81 DTC 5197, in writing the judgment of the majority of the Court, I said:

In a case of this kind, where it is acknowledged that what is sought by a certain course of action is a tax advantage, it is the duty of the Court to examine all of the evidence relating to the transaction in order to satisfy itself that what was done resulted in a valid, completed transaction.

Likewise, I observe that in Daly (supra), the Crown pleaded that there was “... no business purpose” for the procedure adopted (statement of defence, paragraph 7) and pleaded further that the Crown assessed the taxpayer on the basis that “There was no valid or legitimate business purpose for the procedure . . (statement of defence, paragraph 8). Additionally, the Crown also pleaded the provisions of section 245 of the Act and the predecessor section to section 245. Those sections deal with artificial transactions.

Accordingly, it is my view that the jurisprudence of this Court as developed in the Rose case and the Daly case must be evaluated in the light of the issues made relevant by the pleadings in those cases. In Rose, the Minister pleaded artificiality. In Daly, the Crown pleaded lack of valid or legitimate business purpose. In the case at bar there is no such plea. I take it that the references by the learned motions’ judge to sections 245, 246 and 247 of the Act were meant to refer to the circumstance that in this case the Crown had not pleaded facts, which if proven at trial, would bring into play one or more of those sections so as to attract tax liability.

The state of the pleadings herein is that the appellant did not allege facts which would establish a sham, lack of valid business purpose, artificial transactions under section 245, tax avoidance under section 246 or dividend stripping under section 247.

On the contrary, the appellant admits most of the paragraphs of the statement of claim which establish the so-called “scheme”. The only paragraphs which it denies are paragraphs 13, 15 and 17. Paragraph 13 relates to control of RMC I do not read paragraphs 15 and 17 as being relevant to the question of control. They are included in the narrative of the entire series of transactions. Thus, the only matter put in issue by the appellant is the matter of control of RMC. The motions’ judge said that the respondent did not deny that the objective was to avoid taxation on the dividend distribution. Likewise, before us, respondent’s counsel did not deny this objective. However, there is here no allegation by the appellant that subject scheme is contrary to law or invalidated by a particular enactment*. [5]

Had the appellant pleaded facts sufficient to constitute sham, lack of a valid and bona fide purpose or any of the statutory prescriptions alluded to by the motions’ judge, the situation might have been different. As it is however, I fail to see how, on the pleadings as presently constituted, the respondent’s reasons for instituting subject “scheme” can be material to any fairly arguable defence open to the appellant. Accordingly, I think that the impugned portion of paragraph 3 is immaterial and that the motions’ judge was right in Striking it from the statement of defence.

I turn now to the appeal from that part of the order detailed in subparagraph (c) (Supra). The reasons of the motions’ judge for refusing this portion of the appellant’s motion read as follows:

Turning now to Defendant’s Motion under Rule 448, a letter annexed to the accompanying affidavit indicates the documents sought.

Paragraph (a) seeks documents relating to negotiations between Hogg Robinson and Plaintiff as to acquisition of Richards, Melling & Co. Ltd., and Paragraph

(b) seeks documents as to the capital reorganization of that company. Details of the reorganization have already been produced, and any writings or memoranda of any discussions go to motive and are irrelevant. With respect to Paragraphs (c) and (d) concerning the incorporation of Melling Hogg Robinson Ltd. and the distribution of its shares between the Hogg Robinson Group and Plaintiff, and the purchase of shares of Richards, Melling & Co. by Melling Hogg Robinson, here again it appears that these documents have already been produced by Plaintiff in its list filed pursuant to Rule 447, or have been admitted by Defendant in the paragraphs of Plaintiff’s Statement of Claim admitted by it. If the documentation is incomplete additional company records (as distinct from correspondence) can no doubt be obtained on discovery. Paragraph (e) asks for documents and agreements between the Hogg Robinson Group and Plaintiff respecting control of Melling Hogg Robinson Ltd. Here again this appears to go to motive, and in the absence of allegations of sham this information need to be provided. For these reasons Defendant’s motion fails.

With respect, I am unable to agree with the decision by the motions’ judge to dismiss the appellant’s motion for an order compelling the respondent to make and file and serve the list of documents contemplated by Rule 448(1). As noted earlier herein, the appellant has denied paragraph 13 of the statement of claim, thereby putting in issue the question of control of RMC. Paragraph (a) of the letter which is referred to in the reasons of the motions’ judge (supra) asks for “documents relating to negotiations between Hogg Robinson and plaintiff as to acquisition of Richards, Melling & Co. Ltd.” Such documents might well be relevant to the question of control of RMC. The request for documents relative to the acquisition of control of RMC connotes wider parameters than “writings or memoranda of any discussions” going to motive. I therefore conclude that the appellant is entitled to have a Rule 448(1) list in respect of any and all such documents. Likewise I think that paragraph (e) of the letter, in asking for all documents and agreements between the Hogg Robinson Group and the respondent respecting control of MHR, is asking for documents which might well relate to the issue of control of RMC because of the transactions between the respondent, the Hogg Robinson Group and MHR concerning RMC shares. Accordingly I think the appellant is also entitled to have a Rule 448(1) list in respect of any and all documents which are within the purview of paragraph (e) of subject letter.

I have dealt specifically with the matters described in the letter of April 1st, 1982 in respect of which, in my view, the appellant is entitled to Rule 448 discovery. However, Rule 448(1) provides for: “.. . a list of the documents . . . relating to any matter in question in the cause .. .”. The matters in question or in issue on these pleadings are the allegations of fact contained in paragraphs 13, 15 and 17 of the statement of claim. I think, therefore, that the appellant is entitled to compliance with the provisions of Rule 448(1) in respect of each and every allegation of fact contained in paragraphs 13, 15 and 17 of the statement of claim.

To summarize then the disposition I would propose to make in this appeal: I would dismiss the appeal from subparagraph (b) of the judgment of the Trial Division; I would allow the appeal from subparagraph (c) of the judgment of the Trial Division and order the respondent, pursuant to the provisions of Rule 448(1), within 20 days from the date of judgment in this Court, to make and file and serve on the appellant a list of the documents that are or have been in its possession, custody or power relating to each and every allegation of fact contained in paragraphs 13, 15 and 17 of the statement of claim herein and contemporaneously therewith, to make and file an affidavit verifying such a list in Form 21, and to serve a copy thereof on the appellant.

On the question of costs, I note that the motions’ judge awarded costs to the respondent in respect of the respondent’s motion to amend the statement of claim and to strike a portion from the statement of defence as well as in respect of the appellant’s motion to file a Rule 448 list. Since success on the appeal is divided, I would make no order as to costs either in this court or in the Trial Division.