The Queen v. Clark, 74 DTC 6242, [1974] CTC 305 (FCTD)

Cattanach, J:—This is an appeal by Her Majesty the Queen from a decision of the Tax Review Board, by which decision that Board allowed the appeals of the defendant from assessments to income tax made by the Minister of National Revenue for the defendant’s 1966 and 1967 taxation years, which taxation years coincided with the calendar years. In assessing the defendant for the two taxation years in question the Minister in computing the defendant’s income from farming had disallowed as a deduction the sums of $9,595 and $11,042.39 which had been claimed by the defendant as deductible expenses in the respective years.

There is no dispute as to the facts which are clear cut and relatively simple. This I attribute to the completely honest and frank testimony given by the defendant, Mr Clark, who did not attempt to colour his evidence in favour of himself but who gave a truthful recital of the facts, including his own intention, in the knowledge that the oath he swore was binding on his conscience.

The defendant had been engaged in farming and ranching for his whole life in the immediate area of Shaunavon, Saskatchewan.

Prior to 1966 he operated some 23,000 acres of which approximately 11,000 acres were freehold and the balance of 12,000 were held under Crown leases. Approximately 6,700 acres, or about 10 sections of the freehold, were under cultivation producing grain crops. The remaining 4,300 acres and 12,000 of leasehold land were devoted to grazing cattle.

In 1966 on the advice of an estate planner the defendant caused to be incorporated a limited joint stock company under the name of Clark Farms Limited in which the only shareholders were himself, his wife and his son. He described this company as a family corporation, which it is.

On March 31, 1966 the defendant sold almost all his farm land, all machinery and every head of cattle that he owned to the company. He excepted 2 /2 acres on which the family home stood. It is my recollection of the evidence that about a section and one-half was not sold to the company on March 31, 1966 but was rented to it and that this section and a half was sold to the company in 1973.

Accordingly after March 31, 1966 the income of the defendant was derived from rentals payable and dividends from the company. He also received annual instalments of the sale price of the farm land, machinery and cattle.

Because of this arrangement the defendant knew that his income would be substantially reduced but in the years 1966 and 1967 his income was higher in those years because of final Wheat Board payments for grain delivered by him in previous years.

For this reason the defendant wished to “average” his income over the future years. He had previously resorted to the averaging provisions in Section 42 of the Income Tax Act. Having done so he could not have resort to those provisions for five years which period would not expire in time to benefit the defendant.

Therefore he needed an expense in his 1966 and 1967 years to carry the income from those years into subsequent years when his income would be less and the incidence of tax would be correspondingly less.

The defendant thereupon sought the advice of a chartered accountant as to how to achieve this purpose.

The proposal was that the defendant should buy cattle towards the end of his taxation year upon the understanding that a vendor of the cattle would buy them back at the same price less a sales commission at the outset of the defendant’s next taxation year.

It is not clear from the evidence whether the accountant suggested this type of transaction or whether the defendant knew of the practice and sought the accountant’s advice as to the legitimacy and the efficacy thereof to meet the defendant’s avowed purpose.

It is clear from the evidence that this practice was commonplace. Mr Lang, a livestock dealer in Swift Current, Saskatchewan, testified to this effect and that he was not averse to accommodating his customers in this manner. He would sell cattle to a customer at the end of the customer’s taxation year on the distinct understanding that the customer would sell the same cattle back to him at the same price, less a commission, at the beginning of the customer’s next taxation year. He knew that he was doing this so that the customer would incur an expense in the taxation year in which the purchase was made. Mr Lang testified that he had obtained legal advice as to his position in transactions of this kind to the effect that he was not prohibited from entering into such transactions. Mr Lang carried on his business through a company known as Lang Cattle Co, Ltd, the taxation year of which ended March 31, whereas the taxation years of his customers coincided with the calendar year. That is not the issue before me but Mr Lang stood to earn substantial commissions within a very short time which he would personally report as income. The cattle would not leave the possession of Mr Lang but remained in some feed lot, nor was any effort made by the purchaser to obtain delivery of the cattle. It may be that title passed to the purchaser but, in my view, in the circumstances of the present appeal that fact is immaterial. Mr Lang carried a type of insurance on the cattle while in his feed lot whereby the purchaser was compensated for any loss of the cattle.

Whether the chartered accountant whom the defendant consulted suggested such a plan or advised the defendant that such a plan would achieve the defendant’s desired end the defendant, in either event, did adopt such a plan.

On December 23, 1966 the defendant purchased from Lang Cattle Co, Ltd, $9,595 worth of cattle. The defendant expended a dollar amount because that was the amount of expense that he wished to incur in his 1966 taxation year to reduce his income in that year by that amount. It turned out that, at the current market price, $9,500 would buy 95 heifers at $100 a head. The additional amount of $95 was commission payable to Lang Cattle Co, Ltd. The amount of the expenditure was material to the defendant but the number of head of cattle he purchased was not. The defendant did not at any time take physical possession of the cattle. They remained in a feed lot where they had been at the time of the sale. Lang Cattle Co, Ltd made no effort to physically deliver the cattle to the defendant.

The defendant paid Lang Cattle Co, Ltd for the cattle by cheque for the amount of $9,595 which Mr Lang, the president of the vendor, deposited in a special bank account of the company which was, in effect, a trust account. That was Mr Lang’s practice at that time, which he discontinued. The inference that might be drawn from this circumstance is that Mr Lang set aside the amount so received from the defendant to be available for the repurchase of the cattle from the defendant and so is indicative of the arrangement between them.

However in view of the positive evidence of the defendant that when he bought the cattle from Lang Cattle Co, Ltd on December 23, 1966 it was agreed that the cattle would be sold back to the vendor at the beginning of the defendant’s 1967 taxation year at the same price of $9,595 less the sales commission of Lang Cattle Co, Ltd of $95 and the evidence of Mr Lang to like effect reliance on such an inference is not necessary. That evidence merely affords confirmation of that arrangement.

On January 3, 1967 the defendant sold the cattle back to Lang Cattle Co, Ltd and received in payment therefor the purchaser’s cheque in the amount of $9,500 which he negotiated.

When the defendant’s 1967 year was drawing to its close the defendant entered into an identical arrangement with Lang Cattle Co, Ltd, the only differences being the date upon which he pur- chased cattle from Lang Cattle Co, Ltd, the number of cattle he bought, the amount he paid for the cattle and the date upon which Lang Cattle Co, Ltd purchased the identical cattle back from the defendant in accordance with the understanding between them.

On December 21, 1967 the defendant purchased cattle from Lang Cattle Co, Ltd for the amount of $11,042.39. Again the cattle remained in the physical possession of Lang Cattle Co, Ltd and no attempt was made to physically deliver the cattle to the defendant. The defendant paid the vendor for the cattle by cheque in the appropriate amount which was negotiated by the vendor.

On January 3, 1968 the defendant sold the cattle back to Lang Cattle Co, Ltd for $10,877.39 being the same price for which he had purchased them less a nominal amount of $165 for the vendor’s sales commission.

The cheque by which Lang Cattle Co, Ltd paid the defendant for the cattle was dated January 3, 1968 but it was evident from the testimony of Mr Lang that this cheque was post-dated and in all likelihood had been handed to the defendant on December 21, 1967. This inference follows from the fact that the cheques used by Lang Cattle Co, Ltd in the conduct of its business are numbered consecutively. The cheques immediately preceding and following the cheque issued to the defendant and dated January 3, 1968 were both dated in December 1967.

It is, therefore, illogical that the sequence of cheque numbers and dates should be broken by the insertion of a cheque dated January 3, 1968 if that cheque had not been post-dated. Further in cross- examination of Mr Lang he admitted that on at least two occasions when he had entered into similar accommodation arrangements to oblige his customers he had handed those customers post-dated cheques at the time of the sale of cattle to the customers in anticipation of payment on the sale of the cattle back to him at the beginning of the customers’ next taxation year.

The fact of Mr Lang giving post-dated cheques to his customers in these circumstances demonstrates that there was an arrangement between him and his customer that he would buy the cattle back at the same price, less a sales commission charge, immediately after the conclusion of the customer’s taxation year.

However in view of the evidence of the defendant and Mr Lang that the arrangement between them was that the cattle sold by Lang Cattle Co, Ltd to the defendant on December 23, 1966 and December 21, 1967 would be bought back immediately upon the conclusion of the defendant’s 1966 and 1967 taxation years at the same price, less sales commission, as was done on January 3, 1967 and January 3, 1968, it is not necessary to rely upon the obvious inference that the vendor’s cheque dated January 3, 1968 had been given to the defendant on December 21, 1967, or thereabouts, in anticipation of the resale of the cattle on January 3, 1968 and that that was the agreement between them.

During the hearing much testimony was directed to the fact that the defendant on purchasing the cattle gave his cheques in payment therefor to Lang Cattle Co, Ltd which negotiated those cheques and that Lang Cattle Co, Ltd in turn gave its cheques to the defendant on the repurchase of the cattle from which cheques were also negotiated by the defendant. The obvious reason for so doing was to lay the foundation for argument that the transactions were real and were not “sham” transactions.

Still further testimony was directed to the question whether title in the cattle passed to defendant as well as to the obligation of the defendant to resell the cattle to Lang Cattle Co, Ltd.

Because of the fact that, in both instances, the cattle were sold back to the vendor by the defendant at the purchase price the latter question becomes immaterial.

Mr. Lang testified that he fully expected that the cattle would be sold back to the company, that the market price was stable at that season and would remain so over the short period of time in contemplation, that he was most willing to repurchase the cattle, that he knew the purpose of the arrangement with his customer and that he would be extremely disappointed if a customer reneged on the arrangement.

On his part, the defendant testified that it was his intention, which he implemented, to sell the cattle back to Lang Cattle Co, Ltd, that he considered himself bound to do so, that it was not his intention to make a profit on the cattle and that his sole purpose was to incur expenses by the two purchases in his 1966 and 1967 taxation years to reduce income tax in those years because he wanted to carry the income of those years into subsequent taxation years when his income would be less.

Subsequent to the defendant transferring all of his farming assets to Clark Farms Limited on April 1, 1966 the cattle transactions above described were the only transactions that he engaged in of a farming character. In the pleadings it was admitted that the defendant was engaged in the business of farming before and after April 1, 1966.

Counsel for the defendant stressed that the Income Tax Act contains many special provisions whereby concessions are made to farmers. That is so. Farmers are permitted to average their income over a period of five years, they compute their income on a cash basis with special provision being made for delayed wheat payments and for accelerated capital cost allowances.

These are special provisions applicable to farmers but the existence of those special provisions does not make general paragraph 12(1)(a) and section 137, which are applicable to all taxpayers, inapplicable to farmers.

Paragraph 12(1 )(a) provides as follows:

12. (1) In computing income, 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 property or a business of the taxpayer,

It was contended on behalf of the defendant, as I understood the contention, that legal tax reduction is a business end in itself and accordingly because the defendant was admittedly a farmer the transactions in which the defendant engaged as above described were farming transactions and as such were deductible expenses incurred by him.

In support of this contention counsel relied upon B James v MNR, [1973] CTC 457; 73 DTC 5333. In that case my brother Gibson said at page 469 [5341]:

. . _., If it is resolved as a fact that a taxpayer in a taxation year Is “farming”, then “farming” is one of that person’s businesses and therefore a source of his income for the purpose of section 3. . . .

I do not consider that James v MNR (supra) is a parallel case nor an authority for the proposition advanced on behalf of the defendant.

The first question before Mr Justice Gibson was whether the appellant was a farmer, and not merely a “hobby farmer”, in which latter event the expenses incurred would be “personal or living expenses”. Having resolved that the appellant was engaged in the business of farming and in so concluding he considered that if what the taxpayer was doing was farming that then a reasonable expectation of profit is only one of the indicia to be considered in reaching that determination, the next question before Mr Justice Gibson was whether there was a combination of farming and some other source of income. He decided that there was a “combination”.

Here it is conceded that the defendant was engaged in the business of farming. That being so does not relieve the defendant from the provisions of paragraph 12(1)(a) that an expense incurred by him must be for the purpose of gaining or producing income from the business of farming in order to be deductible. The fact that income was not gained or produced is immaterial if that was the purpose of incurring the expense.

There is no impediment to a taxpayer from so arranging his affairs in accordance with the law as enacted so as to attract a minimum of tax. However in the present appeal it is crystal clear that the outlay the defendant made in the purchase of cattle in his 1966 and 1967 years and the immediate resale in the next succeeding taxation years to the vendor at the same price by pre-arrangement was for the sole purpose of reducing his tax in those years and was not laid out for the purpose of gaining or producing income from his business of farming within the meaning of paragraph 12(1)(a).

It follows, therefore, that the appeal must be allowed.

In view of the conclusion I have reached it is not necessary to express an opinion on the other ground upon which counsel for the plaintiff relied, that is, that the sums of $9,595 and $11,042.39 which the defendant claimed as deductions in his 1966 and 1967 taxation years are not properly deductible since they are expenses which would unduly or artificially reduce the defendant’s income in those years contrary to subsection 137(1) of the Income Tax Act which reads:

137. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

IF, contrary to the view I have expressed, I had accepted the defendant’s submission that the transactions were not ones to which paragraph 12(1)(a) applied, then I would have had no hesitation in holding that these were deductions in respect of expenses incurred in respect of transactions which, if allowed, would unduly or artificially reduce the income of the defendant and that consequently their allowance as deductions is forbidden by the terms of subsection 137(1).

I turn now to the question of costs.

Subsection 178(2) of the Income Tax Act now in force provides:

178. (2) Where, on an appeal by the Minister other than by way of cross-appeal, from a decision of the Tax Review Board, the amount of tax that is in controversy does not exceed $2,500, the Federal Court, in delivering judgment disposing of the appeal, shall order the Minister to pay all reasonable and proper costs of the taxpayer in connection therewith.

Before the Tax Review Board two separate appeals were filed, one against the Minister’s assessment of the defendant for his 1966 taxation year and the second from the Minister’s assessment of the defendant for his 1967 taxation year.

In Helen D Davis v MNR, [1964] Ex CR 851; [1964] CTC 227; 64 DTC 5036, Thurlow, J held that filing a combined notice of appeal to the Tax Appeal Board from an assessment for one taxation year with the assessment for another taxation year was precluded by the Income Tax Act and the rules of the Board and that such a combined appeal from assessments for two years was irregular and ineffective to institute an appeal for the two years or either of them.

Subsequent to this decision the Act was amended to permit assessments for more than one year being combined in one notice of appeal but the legislative scheme of the Income Tax Act remains that taxes thereunder are imposed on a yearly basis. Therefore the computation of income and the assessment to tax thereon must be done in each taxation year (see MNR v Gustavson Drilling (1964) Ltd, [1972] FCR 92 at 105-6; [1972] CTC 83 at 97; 72 DTC 6068 at 6078).

It follows that, in the present appeal, while there is but one statement of claim, that statement of claim is a combination of two appeals each from an assessment for a different year. Before the Federal Court on appeal from the Tax Review Board is by way of a hearing de novo so that the subject matters of the appeal are the defendant’s assessments for his 1966 and 1967 taxation years.

In Exhibit 19 it was agreed between the parties that the amount of tax in controversy in the 1966 taxation year was $4,491 and in the 1967 taxation year the amount of tax in controversy was $708.

Since the amount in the 1966 taxation year was in excess of $2,500 it follows that Her Majesty is entitled to Her taxable costs with respect to the appeal of the assessment for that year.

The amount of tax in controversy in the assessment for the defendant’s 1967 taxation year was less than $2,500 from which it follows that the Minister shall pay the defendant’s costs applicable to the appeal of the assessment for that year.

Both appeals are within Class I of the Tariff of Fees. I take as a premise that the costs of the respective parties are equal and that the costs with respect to the appeals of such assessments are identical.

In accordance with Rule 344(1) I, therefore, direct that costs of each appeal shall be in a lump sum in lieu of taxed costs which I fix in the amount of $1,200.

The costs of each appeal offset each other which is tantamount, in the result, to there being no order as to costs.