Continental Bank of Canada v. The Queen, 94 DTC 1858, [1995] 1 CTC 2135 (TCC), aff'd at 98 DTC 6501 (SCC) after being, rev'd 96 DTC 6355 (FCA)

Bowman J.T.C.C.:—Continental Bank of Canada (”CB”) appeals from assessments for its 1986 and 1987 taxation years. Its wholly owned subsidiary, Continental Bank Leasing Corporation (”CBL”) appeals from an assessment for its 1987 taxation year. The appeals were heard together.

Overview

A number of issues were raised in the pleadings but several of those relating to CB were disposed of on consent. Essentially three remain. They arise out of a series of transactions between CB, CBL and Central Capital Corporation ("CC”) and three of its subsidiaries, Central Capital Management Inc. ("CCM”), 693396 Ontario Limited (”693396”) and 693397 Ontario Limited ("693397”).

In 1986, CB decided to sell its banking business as well as the shares of its leasing subsidiary, CBL, or the leasing business of CBL, and wind up. It sold its banking business to Lloyds Bank Canada ("Lloyds Bank") and invited offers to buy the shares of CBL or its business. A number of offers were submitted by various persons but the one that was most attractive to CB was received from CC to purchase the shares of CBL. It was assumed that such a sale would give rise to a capital gain in CB’s hands. Other offers involved a sale by CBL of its assets. The price for the assets was obviously higher than the price for the shares but this would have given rise to recapture of capital cost allowance in CBL’s hands or, had the leasing assets of CBL been rolled under section 88 into CB before they were sold, in CB’s hands. The recapture would evidently have been sheltered to some extent by accumulated losses of CB.

The sale of shares fell through largely because of certain contingent liabilities of CBL which CC was unwilling to accept without long-term warranties from CB which CB refused to give.

A resolution to the impasse was proposed by CC and accepted by CB. It involved the following sequence of steps which was to take place between December 23 and December 29, 1986:

A. A master agreement would be entered into outlining the steps that were to be taken.

B. CBL, CCM and 693396 would form a partnership.

C. The leasing assets (except for six leases that CC did not want) would be rolled into the partnership and an election filed under subsection 97(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the “Act”).

D. On the subsection 97(2) election CBL and the partnership would elect that CBL’s proceeds of disposition would be the cost amount of the leasing assets (basically their undepreciated capital cost ("UCC")). This would result in the partnership’s UCC thereof being the same amount leaving the partnership potentially liable for any recapture that might be realized on their subsequent disposition. CBL’s cost of the 99 per cent interest in the partnership received on the rollover would also be the elected amount.

E. CBL would be wound up into CB.

F. CB would sell the partnership interest to one or both of the other two partners or another company in the CC group thereby realizing roughly the same capital gain as it would have realized if it had sold the shares of CBL.

The question, broadly, is whether the scheme worked. I do not use the term scheme in any pejorative sense and by ’’work” I mean achieve its intended fiscal and commercial objectives. The Minister of National Revenue assessed CBL on the basis that the entire series of transactions that took place in December 1986 was in substance a sale by CBL of its leasing assets and assessed it on about $84,000,000 recapture of capital cost allowance ("CCA"). To protect himself the Minister also assessed CB on the basis that the profit that it realized on the sale of the partnership interest was income from an adventure in the nature of trade. It is admitted that the assessments against CB and CBL are inconsistent. He also treated as income the profit realized by CB on the sale of secured notes and subordinated convertible debentures of CB acquired by it in the course of the sale of the partnership interest.

The respondent’s position is that:

A. the membership of CBL in the partnership was a sham and that in substance the entire sequence of events was a sale of assets by CBL;

B. the use of subsection 97(2) of the Act to achieve the result contemplated here is contrary to the object and spirit of that provision and that accordingly the purported election is invalid;

C. CB was an agent of CBL;

D. the membership of CB and CBL in the partnership contravened paragraph 174(2)(i) and subsection 273(6) of the Bank Act and was therefore void; and

E. alternatively, the sale of the partnership interest by CB was an adventure in the nature of trade and the profit was taxable on income account.

Facts acts

The above summary, while useful in delineating the broad questions that need to be answered, is an oversimplification and I shall endeavour to expand on the complex factual background of the case.

CB was incorporated in 1977 by an act of Parliament as a subsidiary of IAC Limited ("IAC"), a finance and leasing company. It commenced carrying on the banking business at that time. In 1981 IAC and CB amalgamated and continued as Continental Bank of Canada ("CB"). Under the Bank Act CB, as a bank, could not carry on the leasing business and as a result Orders-in-Council were obtained permitting it to continue to hold and carry on business with the leasing assets previously held by IAC.

In October 1981 CB incorporated CBL to carry on any new leasing business. Thus, following the amalgamation, a leasing business was carried on in two entities-by CB to the extent of the leases and leasing assets owned by IAC on the amalgamation and by CBL to the extent of any new leasing business generated after October 1981.

The mid-1980s were a period of financial difficulty for smaller banks such as CB. Two other Canadian chartered banks became insolvent and financial institutions such as CB saw an erosion of depositor confidence which adversely affected their ability to attract funds needed to carry on their business. CB embarked on an aggressive campaign to restore confidence in the bank and to revive its ability to meet its liquidity requirements. These efforts did not succeed to the extent necessary to permit CB to continue as an independent institution and a purchaser for the bank’s business and assets was sought. It was determined in 1986 to sell the banking business and to wind up and dissolve. A sale of the shares of CB was not permitted by the Bank Act and therefore the banking assets and business were sold to Lloyds Bank of Canada effective November 1, 1986. Lloyds Bank did not want the leasing business that had been carried on by CB and CBL. CB therefore invited offers for the purchase of the lease portfolio of CBL.

In a booklet describing the lease portfolio which was sent to a number of prospective purchasers it stated:

The bank is prepared to sell the leases outright to a purchaser or to transfer the bank owned leases into the leasing corporation and to sell the shares of Continental Bank Leasing Corporation. The leased assets could be transferred at their current tax value or at fair market value.

Offers were received from a number of interested parties and analyzed with a view to determining their after tax effect on the shareholders. On September 18, 1986 an offer was received from CC to purchase the shares of CBL. The offering price was to be determined in accordance with a formula based on a discounted cash flow and it assumed a payment of a $40,000,000 dividend by CBL. This latter aspect of the proposal turned out not to be feasible, it appears, because CBL did not have sufficient so-called “safe income" for the purposes of section 55 of the Act.

On September 26, 1986 CB wrote to selected persons who had submitted offers requesting them to resubmit based upon enumerated common terms. The letter was divided into two parts with the headings “All Participants" and "All Participants Bidding for Shares of the Leasing Subsidiary". Under the second heading CB directed that a number of assumptions be made, including a UCC balance of about $38,500,000 and a transfer, prior to closing, by CB to CBL of the former’s lease portfolio which would increase CBL’s UCC balance by about $29,000,000.

On October 1, 1986, CC wrote to CB confirming that CC would buy the shares of CBL for $156,600,000, payable either $125,280,000 in cash on closing together with $31,320,000 in Class A subordinated voting shares of CC or $162,600,000 in cash on closing. In that letter CC stated that it would be prepared to work with CB in maximizing the after tax return to CB. This statement was repeated in subsequent letters.

Also, on October 1, 1986 the board of directors of CB resolved that “The business of the bank be wound up and that the bank be voluntarily liquidated and dissolved pursuant to section 287 of the Bank Act’.

Further negotiations ensued culminating in an agreement dated October 15, 1986 between CC and CB. The letter agreement dated October 15, 1986 contained a condition that CC was to be satisfied with the income tax filing position taken by CBL in the preceding five taxation years and the proposed filing position for the year ending October 31, 1986. The transaction was to close on November 1, 1986 at a price of $151,600,000.

Once it was decided to accept CC’s offer, CB wrote to other persons who had offered to purchase the shares or business of CBL. The basis for the refusal was stated in each case to be that the particular offer "did not provide the maximum after tax return to the bank". Some of the offers had been for the assets of CBL and were higher than the price ultimately agreed on with CC for the shares of CBL.

On October 22, 1986 CB issued a press release in which it announced that it had reached an agreement in principle with CC for the sale of the shares of CBL at a price of approximately $160,000,000 payable in part in notes of CC and part by a convertible debenture of CC.

On October 31, 1986 CB applied to the Minister of Finance for letters patent dissolving the bank.

On November 1, 1986 CB transferred its leasing assets (those previously held by IAC prior to the amalgamation of IAC with CB) to CBL in contemplation of the sale of the shares of CBL to CC.

The sale by CB of the shares of CBL and CC did not close. One reason was that CC was dissatisfied with certain of the leases held by CBL. This was not, however, fatal to the transaction as the unsatisfactory leases could be removed from CBL. What was fatal was CC’s conclusion that CBL was not a corporation whose principal business was the renting or leasing of leasing property because 90 per cent of its gross income was not from such leasing business within the meaning of subsection 1100(16) of the Income Tax Regulations and therefore the limitation on the deduction of capital cost allowance in subsection 1100(15) would apply. CB, itself in the course of winding up, was not prepared to assume for a period of several years the contingent liability of a possible assessment of tax denying a substantial portion of the CCA that had been claimed.

CC consulted its own lawyer in an attempt to find a resolution to the impasse and the scheme, which I sketched out briefly earlier in these reasons, was devised. Basically it involved CBL’s rolling the assets into a partnership under subsection 97(2), winding-up into CB, distributing its partnership interest to CB at its cost base under section 88 and having CB sell the interest to CC or one of its subsidiaries. The idea of such a stratagem was not new. It had been bruited about for years but I have never heard of its being done and, if anyone ever did have the temerity to try it, never with such speed, aggressiveness or on so grand a scale. The purpose was to replicate the tax effects of the sale of the shares of CBL which had fallen through.

The parties entered into a master agreement on December 23, 1986. It seems to have been cobbled together at white heat and late at night. Parts of it, particularly amounts, were written in longhand by Mr. James Baillie, counsel for CB. The closing took place late in the evening on December 23, 1986 at the offices of CB’s solicitors. Since the events that occurred between December 23, 1986 and December 29, 1986 are central to the determination of these issues it is important that each discrete step be examined in some detail.

The parties to the master agreement were CB, CBL, CC, CCM, 693396, 693397 and 153587 Canada Limited ("153587").

The agreement recites that by the letter of intent of October 15, 1986 CB and CC agreed in principle that CC would acquire all of the shares of CBL but that the transaction had been revised and was now as set out in the master agreement.

The agreement provided that the following steps would be taken:

A. CC would arrange for CBL to acquire on December 23, 1986 certain specific assets upon the payment of cash and the assumption of liabilities, provided that the liabilities would be taken over by the intended partnership and that CBL, the proposed amalgamated successor to CBL, would be exonerated. The assets were a drag line leased to Trans Alta Utilities Limited and the lease of the drag line. The transaction involved the assumption of liabilities of about $13 million, the incurring of liabilities of about $7.2 million, and the payment of $700,868. Under a separate letter agreement CBL could require CC to acquire the drag line and assume all liabilities relating to it if the master agreement was not signed by 9:00 a.m. December 24, 1986. The assets were acquired by CBL.

B. On December 24, 1986 CBL and 153587 were to amalgamate and an amalgamation agreement was entered into "as of" December 24, 1986 and continued as Continental Bank Leasing Corporation ("CBL"). The amalgamation took place and its effective date was December 24, 1986. The purpose of the amalgamation was to create a new year end for CBL on December 23. The one preferred share owned by CC was redeemed and CB became the sole shareholder of CBL, the amalgamated corporation.

C. A partnership, to be called Central Capital Leasing, was to be formed immediately after the redemption of the preferred share of CBL. The partners were to be CBL and CC’s two subsidiaries, 693396 and CCM. A partnership agreement was signed by these companies. It is not clear from the evidence whether it was signed on December 24, the date as of which it is stated on the signature page to have been executed, or at the closing on December 23, prior to the effective date of the amalgamation. Although the timing of the sequence of events may be important I do not think that this particular point is material.

Section 3.01 contained certain representations and warranties. CBL expressly declined to give the following representations and warranties which were given by the other two companies:

(b) it is duly registered and qualified to carry on business and has and will continue to have all requisite authority, licences and permits to carry on the business of the partnership and to enable the partnership to own or lease property where the activities, or the property or assets of the partnership render or will render such registration, qualification, authority, licence or permit necessary;

(d) it can fulfill its obligations as a partner without violating the terms of its constating documents, by-laws or any agreement to which it is or will become a party or by which it is or will become bound or any law or regulation applicable to it;

(g) neither the execution and delivery of this agreement nor the consummation of the transactions which it contemplates will:

(i) contravene or violate or result in the breach (with or without the giving of notice or lapse of time, or both) of or acceleration of any obligation under:

(1) any law, ordinance or governmental rule or regulation to which it is subject,

(2) any judgment, order, writ, injunction or decree of any court or of any government official, agency or instrumentality which is applicable to it,

(3) its articles, letters patent, act of incorporation or by-laws or any amendments thereto or restatements thereof, or

(4) the provisions of any agreement, arrangement or understanding to which it is a party or by which any of them is bound.

The reasons given for this reluctance to include these representations and warranties were not altogether illuminating. Possibly they were based on a concern that for CBL to carry on a business in partnership was a contravention by CB of paragraph 174(2)(i) or subsection 273(6) of the Bank Act. It is a little surprising that anyone seriously contemplating a partnership would do so with someone who declined to represent that it could lawfully fulfil its obligations as a partner. Presumably this did not matter to CC as the arrangement was only a temporary means to an end.

The partnership agreement contained a number of other unusual provisions. Sections 11.01 and 11.02 read as follows:

11.01 Interest of leasing. Reference is made to an agreement (the “master agreement") dated December 23, 1986 among the Continental Bank of Canada, Leasing, Central Leasing, CCMI, Central Capital Corporation, 693397 Ontario Limited and 153587 Canada Limited which sets out a sequence of transactions to include the sale of the interest of leasing to the Continental Bank of Canada and then by the Continental Bank of Canada to Central Leasing and 693397 Ontario Limited. Paragraph A-7 of the master agreement is incorporated herein and made a part of this agreement.

11.02 Partnership agreement. In view of the matters set out in section 11.01, it would not be appropriate to suggest any continuing participation of Leasing or the Continental Bank of Canada as partners after completion of the sequence of transactions referred to in section 11.01. Accordingly, immediately upon completion of the transactions described in section 11.01, this agreement shall be amended so that:

(a) neither Leasing nor the Continental Bank of Canada shall any longer be shown as a party hereto;

(b) the following provisions shall be deleted,

(i) the reference to ’’Leasing" in the second recital,

(ii) the fourth recital in its entirety,

(iii) the reference to "Leasing" in subsection 1.01(1),

(iv) the word "Subject to Article XI" in the first line of section 3.02,

(v) the concluding two sentences of section 7.01, and

(vi) this article.

This provision was, according to Mr. Baillie, put in at his insistence. He was concerned about any residual legal effects of having CB’s name in any way associated with the partnership. The cautious corporate approach to details of this sort is in marked contrast to the fiscal aggressiveness of the overall scheme. These provisions underline the ephemeral nature of CBL’s and CB’s intended involvement in the partnership and they cast doubt upon the seriousness of the parties’ avowed intent to go into business in partnership together. Whether that doubt is sufficient to destroy the fiscal effectiveness of the entire scheme is a matter which I shall have to deal with in due course and in light of the authorities.

The agreement provided that the first fiscal period of the partnership would end on December 27, 1986 and thereafter each fiscal year would commence on December 26 in each year and end on December 27 in each succeeding year. Therefore the plan was that CBL would be partner for three days and would be allocated income up to December 27. Neither it nor CB would be a partner at the end of the next fiscal year and for the portion of that fiscal period in which CB was to be a partner (up to December 29, 1986) it would presumably be allocated nothing.

The next step was for CBL and the two numbered companies to contribute assets or cash to the partnership. A schedule to the partnership agreement, stated to be executed on December 24, 1986, involved a contribution by CBL to the partnership of its leasing assets (presumably not including the leases to which CC took exception), the assumption by the partnership of the related liabilities, and the execution and filing of an election by CBL and the partnership under subsection 97(2) in which the elected amount was to be the UCC to CBL of the depreciable assets, the cost amount of the land or the amount of the liabilities assumed. In the result an election under subsection 97(2) was filed on January 29, 1987 in which the agreed amounts were $3,142,135 in respect of cash and assumed liabilities, $52,723 for the land, $64,989,724 for the depreciable property and $1 for goodwill. The fair market value of the depreciable property was shown to be $151,031,120. 693396 and CCM contributed cash and each received a .5 per cent interest in the partnership.

The next step in the sequence was for CBL to distribute to CB, on CBL’s winding-up, the 99 per cent partnership interest. This was done by an agreement dated December 27, 1986. Assuming the transfer took place on December 27, it would mean that CBL had been a partner for three days, December 24, 25 and 26, but would not be a partner at the end of the partnership’s first fiscal period on December 27, 1986.

By an agreement dated December 24, 1986 CB agreed to sell to 693396 and 693397 the 99 per cent partnership interest that it was to receive from CBL. The closing date was to be December 29, 1986. The purchase price was to be $130,071,985, of which 693396 would pay $11,824,725 for one-eleventh of the 99 per cent partnership interest and 693397 would pay $118,247,260 for the remaining ten- elevenths.

By an assignment agreement dated December 24, 1986 CB assigned its partnership interest to the two numbered companies. The witnesses testified that the date of December 24 appearing on the assignment was a mistake and it should have been the 29th. Also, I note that one party to the agreement was 699397 Ontario Limited, not 693397. The error seems to have been corrected in the body of the agreement. Perhaps one should not allow oneself to be diverted from the main issues by technical errors of this sort which were no doubt attributable to the lateness of the hour, the speed at which the whole thing was put together and the impending festive season.

By an agreement made as of the December 23, 1986 Lloyds Bank agreed with Central Capital Leasing, the partnership, to manage the lease portfolio for a fee. Central Capital Leasing had no employees. The leasing business of CBL had been managed by employees of CB and these, or most of them, had gone over to Lloyds Bank when the banking business was sold. It is not known when the management agreement was signed. It would appear that whatever managing, if any, had to be done over the Christmas period when CB and CBL were involved in the partnership, was probably done by the same individuals who had always managed the portfolio.

Two resolutions were passed by the directors of CB and CBL. On December 19, 1986 the directors of CB passed a resolution approving the master agreement, at least according to a certificate signed by an officer of CB on December 24, 1986. It is not clear what draft the directors of CB had before them on the December 19. The earliest draft in evidence is dated December 22 and the final version was still being worked on during the evening of December 23. It is therefore hard to know just what, if anything, the directors of CB approved on December 19. A resolution with the identical wording was passed by the board of directors of CBL on December 23, according to the certificate signed by the same officer.

Both resolutions contained the same recitals, as follows:

WHEREAS certain assets and related leases are to be transferred to Central Capital Corporation by Continental Bank Leasing Corporation; and

WHEREAS it appears desirable to effect the foregoing, to enter into a sequence of transactions on December 23, 1986; and

WHEREAS the sequence of transactions will be effected through the execution of a series of documents including a master agreement, a partnership agreement, an asset transfer agreement, an administration agreement, and a partnership interest transfer agreement; and

WHEREAS the capitalized terms in this resolution have the meaning attributed to them in a master agreement attached hereto.

Mr. Olsson, counsel for the respondent, contended, with some force, that the first recital accurately depicted the intentions of the board of directors and the true substance of the transaction. It is one piece of evidence that must be weighed in the context of all of the evidence.

On December 29, 1986 CB purchased from CC $95,000,000 in 11 per cent secured notes and $35,000,000 in nine per cent convertible debentures. There were certain adjustments with the result that the purchase price for the securities was $130,071,985. CC paid this amount to its two numbered subsidiaries, 693396 and 693397, who paid it to CB as the purchase price of the 99 per cent partnership interest. The notes and debentures received by CB from CC were subsequently disposed of and a profit of $5,697,900 was realized.

In 1987, 693396 and 693397 sold their partnership interests to another company in the Central Capital group, the Mortgage Insurance Company of Canada ("MICC"). Any recapture of CCA generated by the subsequent sale by the partnership of the leases was offset by reserves claimed by MICC as an insurance company. Mr. Olsson objected to this evidence as irrelevant and I am inclined to agree that it is of marginal relevance, if any. It does indicate, for what it is worth, however, that one of the parties to the alleged sham was prepared to accept the tax consequences of the structure adopted, i.e., the lower UCC of the leasing assets and the consequent potential for tax on the recapture of CCA.

On February 4, 1987, 693397 sent to CBL a cheque from the partnership, Central Capital Leasing, in the amount of $130,726

in respect of Continental Bank Leasing Corporation’s net earnings as the 99 per cent partner of Central Capital Leasing for the captioned period.

The captioned period was the "fiscal year 12/24/86—12/27/86".

As noted above, if the transfer of the partnership interest to CB took place on December 27, 1986, CBL could not have been a partner at the end of the fiscal period. CB, ostensibly the partner on December 27, 1986, and not CBL, should have received the distribution. It was, however, CBL that included the amount in its income.

The Minister, in assessing CBL for the taxation year ending October 31, 1987 included $84,348,900 in its income as

recaptured capital cost allowance on transfer of Leasing assets to Central Capital Leasing Partnership.

To protect his position the Minister also assessed CB on $83,052,657 as a "trading gain on sale of Central Capital Leasing Partnership interest."

These assessments cannot, of course, both stand. They are admittedly inconsistent. The Minister has of course an obligation to protect the public revenues and it was entirely appropriate for him to proceed on alternative and contradictory bases.

In addition the Minister assessed CB on the profit of $5,697,000 realized on the disposition of the notes and securities which it purchased from CC.

Analysis

I shall deal first with the last of these issues. I have no difficulty in concluding that the profit of $5,697,000 on the disposition of the notes and securities is on income account. The bank is a money lender and securities of this type are its stock in trade. This was not a simple acquisition of an investment which it held and subsequently disposed of in the manner in which an investor deals with stocks and bonds. In disposing of the securities it engaged the services of brokers and exchanged some of the securities for different ones, which it sold. Essentially CB, in purchasing CC’s notes and debentures, loaned money to CC and realized a profit on the transaction. The transaction does not take on a different complexion because the purpose of the loan was to enable CC to engage in the subsequent series of steps involving CBL’s portfolio of leases. The point is so obvious that further elaboration or citation of authority would be superfluous.

The more difficult question is the efficacy of the overall scheme. Mr. Olsson contended with consummate skill and persuasiveness that the scheme failed for four basic reasons:

A. The participation of both CB and CBL in the partnership was illegal because of the provisions of the Bank Act.

B. The partnership, insofar as it purported to make CB and CBL partners, was a sham.

C. If CB and CBL’s participation in the partnership was not a sham it was not within the object and spirit of subsection 97(2).

D. In any event the sequence of transactions was merely an alternative method of selling the leasing assets, in substance.

He contended as well that CB was the agent of CBL and that CB’s profit on the sale of the partnership interest was taxable on income account as the profit from an adventure in the nature of trade.

Illegality

The provisions of the Bank Act upon which the respondent relies are the following:

Paragraph 174(2)(i):

(2) Except as authorized by or under this Act and in accordance with such terms and conditions, if any, as are prescribed by the regulations, a bank shall not, directly or indirectly,

(i) acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or a limited partnership.

Subsection 273(6):

(6) When the Governor in Council has approved a sale agreement, the selling bank may thereafter carry on business only to the extent necessary to enable the directors to carry out the sale agreement and wind up the business of the bank.

The following provisions are also relevant:

Subsection 18(1):

(1) A bank has the capacity and, subject to this Act, the rights, powers and privileges of a natural person.

Subsection 20(1):

(1) No act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act.

Subsection 174(17):

(17) A bank that contravenes any of paragraphs (2)(a), (c), (f), (h), (i) or (j) is guilty of an offence and liable on summary conviction to a fine not exceeding five hundred dollars in respect of each contravention.

There can be little doubt-indeed the point was not challenged-that the entry into the partnership by CBL constitutes a breach by CB of paragraph 174(2)(i) of the Bank Act. The contravention of the Bank Act is a contravention by CB in that it is an "indirect" investment or participation in a partnership by a "bank" as defined in section 2 of the Bank Act, which reads:

"bank" means a bank to which this Act applies.

Subsection 13(1) of the Bank Act provides:

This Act is the charter of and applies to each bank named in Schedule I or IT, and, except as otherwise provided, does not apply to any other bank.

CB is named in Schedule I.

The words ’’directly or indirectly" are in my view broad enough to cover a participation in a partnership through a subsidiary that is not a bank.

It is less clear that the entry into the partnership by CBL constituted an infraction of subsection 273(6) of the Bank Act. It was an aspect of the winding-up.

I do not however think that the conclusion that CB contravened the Bank Act in itself is sufficient to invalidate the scheme. The Bank Act itself provides a nominal penalty and, under subsection 20(1), preserves the validity of the impugned act. The respondent’s position would deprive the bank of the capacity to commit an illegal act and would make the act ultra vires the bank, a result which, I should think, would erode the effect of subsection 18(1). Mr. Olsson’s position was that the prohibition in paragraph 174(2)(i) and 273(6) of the Bank Act rendered the appellant’s participation in the partnership legally ineffective, at least as against the Minister of National Revenue* [1]

He contended that the transaction fell within paragraph (2)(a) of Mr. Justice Estey’s guidelines in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 at page 579 (C.T.C. 317; D.T.C. 6324). In support of the proposition that the entering into the partnership was legally ineffective he relied upon The Bank of Toronto v. Perkins (1882), 8 S.C.R. 603 which held that a prohibition in the Banking Act rendered the taking of a certain type of security by the bank null and void.

That case predated the present provisions of the Bank Act and I do not think it would be decided in the same way today. The words of subsection 20(1) are clear and it seems obvious that Parliament, in providing in paragraph 174(17) a penalty for a contravention of the Bank Act, con- templated that an act that is contrary to the Bank Act, albeit punishable by a fine, was not invalid. The illegality of an act does not connote invalidity. Either the illegal act was ultra vires or it was not. Parliament’s intent is clear that the principle of ultra vires does not apply to infractions of the Bank Act of the type involved here.

In light of these conclusions it is unnecessary for me to refer to the numerous cases cited by counsel. The question is what did the appellants in fact do, not what did the law permit them to do.

Sham

This leads logically to the next question: did the appellants enter into the various transactions that they purported to, or was the elaborate series of steps envisioned by the master agreement a mere camouflage for what was in substance a single event, i.e., a direct sale of assets by CBL to CC? In cases of this type expressions such as sham, cloak, alias, artificiality, incomplete transaction, simulacrum, unreasonableness, object and spirit, substance over form, bona fide business purpose, step transaction, tax avoidance scheme and, no doubt, other emotive and, in some cases, pejorative terms are bandied about with a certain abandon. Whatever they may add, if anything, to a rational analysis of the problem, apart from a touch of colour in an otherwise desiccated landscape, they do not exist in separate watertight compartments. They are all merely aspects of an attempt to articulate and to determine where "acceptable" tax planning stops and fiscal gimmickry starts.

Shams are more easily recognized than defined. The classic definition of sham is found in the judgment of Diplock L.J. in Snook v. London & W. Riding Invest. Ltd., [1967] 1 All E.R. 518 at pages 528-29:

As regards the contention of the plaintiff that the transactions between himself, Auto-Finance, Ltd. and the defendants were a "sham", it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure; Stoneleigh Finance, Ltd. v. Phillips, that for acts or documents to be a "sham", with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a "shammer" affect the rights of a party whom he deceived. There is an express finding in this case that the defendants were not parties to the alleged "sham". So this contention fails.

The statement has been adopted in Canada on many occasions. I shall therefore endeavour to consider its application to the facts of this case.

We may start from the solid footing that CB and CC had an agreement in principle to purchase the shares of CBL. The deal fell through. Had it proceeded as originally planned CB would have realized a capital gain and the potential for recapture on the leasing assets would have remained in CBL to be dealt with by CC. These factors obviously influenced the price that was negotiated. CC bargained for a lower price because of its acceptance of potential recapture in CBL which it anticipated it could absorb in some way within its own corporate group. CB accepted a lower price than it would have had CBL sold assets and become taxable on the recapture. Evidently a capital gain in CB was more advantageous to it.

When the deal fell through because of the inability to resolve the problem of CBL’s contingent tax liabilities the new partnership structure was devised involving a rollover by CBL to the newly formed partnership, the winding-up of CBL and the sale by CB of the partnership interest to companies in the CC group. One thing is clear. Notwithstanding the pious assertions of a number of witnesses that they intended to enter into a partnership with the other parties, CB’s and CBL’s intention was patently not to go into the leasing business in partnership with CC as a long-term commercial venture. The whole object of the exercise was precisely the opposite-to get out of that business. The partnership was merely a means to that end. It was a structure designed to enable CB and CBL to divest themselves of the leasing assets at a tax cost roughly equivalent to that which they would have incurred on the sale of CBL’s shares. The partnership was a form of legal package which was intended to encapsulate the potential recapture which inhered in the leasing assets and ensure a capital gain to CB.

One of the appellants’ witnesses, in an unguarded moment at the end of his cross-examination by Mr. Olsson, stated, in speaking of CC, "They wanted the assets". Counsel for the respondent quite rightly pounced on this statement. I would of course not base a decision on an unfortunate remark by one witness in the course of a six-day trial, but in a sense he was quite right. Of course it was the assets that CC wanted, but to get them they had to take them in a particular way.

Does this make the transaction (or parts of it) in the form in which it was conceived and executed a sham? I do not think so. The legal relationships between CB and CC, who were at arm’s length, were real. Although brief they were not illusory. If at any point during the short participation of CBL or CB a third party were to ask CB or CBL "Are you a partner in the partnership Central Capital Leasing?" they could not be heard to say "No, we are not. Our participation in the partnership is nothing more than a camouflage to disguise a sale of assets. This whole elaborate structure is merely an exercise with smoke and mirrors designed to fool the tax department". The relations between the parties, notwithstanding the examples of sloppiness to which I have referred above, [2] were binding. The law has, I believe, come a long way in its view of what constitutes a sham since the days of Gibson Bros. Industries Ltd. v. M.N.R., [1972] C.T.C. 221, 72 D.T.C. 6190; M.N.R. v. Leon, [1976] C.T.C. 532, 76 D.T.C. 6299; and Dominion Bridge Co. Ltd. v. The Queen, [1975] C.T.C. 263, 75 D.T.C. 5150 (F.C.T.D.); affd [1977] C.T.C. 554, 77 D.T.C. 5367 (F.C.A.). If the legal relationships are binding and are not a cloak to disguise another type of legal relationship they are not a sham, however much the tax result may offend the Minister or, for that matter, the court, and whatever may be the overall ulterior economic motive. When something is a sham the necessary corollary is that there is behind the legal facade a different real legal relationship. If the legal reality that underlies the ostensible legal relationship is the same as that which appears on the surface, there is no sham.

Substance versus form; agency

Related to the sham argument is Mr. Olsson’s submission that the elaborate structure involving the partnership was in substance a transfer of the leasing assets from CBL to CC. Central to this argument is the position that CB was an agent of CBL for the purpose of transferring the leasing assets to CC or its subsidiaries. The agency argument, standing by itself, does not assist the Crown unless one is also prepared to ignore the partnership and treat the assets distributed on the winding up of CBL as the leasing assets and not the partnership interest. This would involve treating the partnership, or at all events, CBL’s participation in it, as a sham. Tempting as it may be, given the transitory, indeed ephemeral, nature of the participation of CB and CBL in the partnership, I am not prepared to take that step.

The double-barrelled sham/agency argument, if accepted, would result in CBL being taxable on the recapture, as assessed. If sham is rejected but agency accepted, CB would, as agent for CBL, have disposed of the partnership interest on behalf of CBL and CBL would be liable for tax on the capital gain. If it is accepted that the partnership participation by CBL is a sham, but the agency argument is rejected, CB, as beneficial owner of the assets following the winding up of CBL, would be liable for tax on the recapture that was assessed in the hands of CBL, having acquired the property under section 88 at CBL’s UCC. Other possible combinations may be postulated but they all illustrate the danger of tinkering with elaborate structures in which some interrelated aspects are left intact and others are, in essence, excised from the sequence. If the Minister is not prepared to say that the entire structure is a sham it is difficult to see the logic of removing portions thereof and at the same time recognizing the validity of other portions that depend upon the validity of those that the Minister refuses to recognize.

The agency argument is based principally upon paragraphs 5 and 6 of the indenture dated December 27, 1986 between CBL and CB relating to the distribution of the partnership interest on the winding up of CBL. Paragraph 1 reads as follows:

1. The transferor does hereby grant, bargain, assign, transfer, convey and set over unto the transferee, its successors and assigns, all the right, title and interest of the transferor in and to the following asset:

(a) a partnership interest acquired pursuant to a partnership agreement between Continental Bank Leasing Corp., Central Capital Management Inc., and 693396 Ontario Ltd. dated December 24, 1986

To HAVE AND TO HOLD unto the transferee, its successors and assigns, to and for its and their sole and only use forever.

Paragraphs 5 and 6, on which the respondent relies, are as follows:

5. The transferor hereby irrevocably constitutes and appoints the transferee, its successors and assigns, the true and lawful attorney of the transferor for and in the name of or otherwise on behalf of the transferor with full power of substitution to do and execute all acts, deeds, matters and things whatsoever necessary for the assignment, transfer and/or conveyance of any interest in the property, assets and business both real and personal, and both moveable and immoveable wherever situate of the transferor to the transferee, its successors and assigns.

6. The power of attorney set forth herein is granted by the transferor to the transferee in contemplation of the dissolution of the transferor, and the aforementioned power of attorney being coupled with an interest shall not be revoked by the certificate of dissolution being issued by the Ministry of Consumer and Commercial Relations or be otherwise revoked.

I do not read paragraphs 5 and 6 as constituting CB an agent of CBL for the purpose of selling to CC whatever was distributed to CB on the winding up. Paragraph 1 is an absolute conveyance of CBL’s beneficial interest in the partnership. To suggest that CB was intended, as CBL’s agent, to convey to CC or its subsidiaries the property received from CBL is not consistent with the intent expressed in paragraph 1. Paragraphs 5 and 6 are normal boiler plate in winding-up agreements and are designed to facilitate the gathering in of the subsidiary’s assets. They do not constitute the parent the agent of the subsidiary for all purposes and certainly not for the purpose of dealing with property that has been distributed to the parent.

Generally speaking it requires extremely compelling evidence for one company-even a subsidiary-to be regarded as an agent of another (Denison Mines Ltd. v. M.N.R., [1971] C.T.C. 640, 71 D.T.C. 5375 (F.C.T.D.) at page 661-62 (D.T.C. 5388-99), aff'd on another issue [1972] C.T.C. 521, 72 D.T.C. 6444 (F.C.A.), and [1976] S.C.R. 245, [1974] C.T.C. 737, 74 D.T.C. 6525. It is even more difficult to regard a parent as its subsidiary’s agent.

So far as the broader question of substance versus form is concerned, we should at least be clear on what we are talking about when we use the elusive expression "substance over form". Cartwright J. (as he then was) said in Dominion Taxicab Assn. v. M.N.R., [1954] S.C.R. 82, [1954] C.T.C. 34, 54 D.T.C. 1020 at page 85 (C.T.C. 37-38; D.T.C. 1021):

It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Acts its substance rather than its form is to be regarded.

His Lordship did not elaborate but in light of other authorities I do not think that his words can be taken to mean that the legal effect of a transaction is irrelevant or that one is entitled to treat substance as synonymous with economic effect. The true meaning of the expression is, I believe, found in the judgment of Christie A.C.J.T.C.C. in Purdy v. M.N.R., [1985] 1 C.T.C. 2294, 85 D.T.C. 254 (T.C.C.), at pages 2295-96 (D.T.C. 256), where he said:

It must be borne in mind that in deciding questions pertaining to liability for income tax the manner in which parties to transactions choose to label them does not necessarily govern. What must be done is to determine what on the evidence is the substance or true character of the transaction and render judgment accordingly.

Viscount Simon in delivering the judgment of the House of Lords in CIR v. Wesleyan and General Assurance Society (1948), 30 T.C. 1 l,said at page 25:

It may be well to repeat two propositions which are well established in the application of the law relating to Income Tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it.

In Front & Simcoe Ltd. v. M.N.R., [1960] C.T.C. 123, 60 D.T.C. 1081, Cameron J. said at page 132 (D.T.C. 1085):

In Simon’s Income Tax, Second Ed., Vol. 1, page 50, the author, after referring to a number of decisions, states:

The true principle, then is that the taxing Acts are to be applied in accordance with the legal rights of the parties to a transaction. It is those rights which determine what is the "substance" of the transaction in the correct usage of that term. Reading "substance" in that way, it is still true to say that the substance of a transaction prevails over mere nomenclature.

See also In re Ralli's Settlements; Ralli Brothers Ltd. v. I.R.C., [1966] A.C. 483 at page 515, per Lord Pearson.

Similarly, in Friedberg v. Canada, [1992] 1 C.T.C. 1, 92 D.T.C. 6031 (F.C.A.), Linden J. said at page 2 (D.T.C. 6032):

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax.

A clear exposition of the idea is found in The Principles of Income Taxation by Hannan and Farnsworth (London, 1952, Stevens & Sons Limited). The authors devote an appendix to a discussion of form and substance and at page 549 the following appears:

Often the best-and, perhaps, the only-means of determining the substance of a transaction is to refer to the result which it produced or was intended to produce. But where the same or a similar result could have been brought about by two different methods, the adoption of either method is not necessarily a mere matter of form. To argue otherwise is generally to confuse the substance with the effect: it is something like saying that two roads from one place to another are the same because they lead to the same destination.

A recent statement of the principle is found in Canada v. Antosko, [1994] 2 C.T.C. 25, 94 D.T.C. 6314. Iacobucci J. stated at page 30 (D.T.C. 6319), after referring to the decision of Estey J. in Stubart Investments:

However, the courts will not permit the taxpayer to take advantage of deductions or exemptions which are founded on a sham transaction. Such a situation would arise where (at page 572 (C.T.C. 313, D.T.C. 6320-21)):

The transaction and the form in which it was cast by the parties and their legal and accounting advisers [can] be said to have been so constructed as to create a false impression in the eyes of a third party, specifically "the taxing authority".

In this case, the respondent agrees that this transaction cannot be characterized as a sham. There was a legally valid transfer of the assets of the company to the appellants, and a subsequent transfer to them of the company’s debt obligations.

And at page 31 (D.T.C. 6319-20):

Estey J. relied at page 578 on the following passage from Dreidger, Construction of Statutes (2nd ed. 1983), at page 87 (C.T.C. 316, D.T.C. 6323):

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

It is this principle that must prevail unless the transaction is a sham or is to blatantly synthetic as to be effectively artificial. As Estey J. concludes at page 580 (C.T.C. 317, D.T.C. 6324):

.. where the substance of the Act, when the clause in question is contextually construed, is clear and unambiguous and there is no prohibition in the Act which embraces the taxpayer, the taxpayer shall be free to avail himself of the beneficial provision in question.

The principle is determinative of the present dispute. While it is true that the courts must view discrete sections of the Income Tax Act in light of the other provisions of the Act and of the purpose of the legislation, and that they must analyze a given transaction in the context of economic and commercial reality, such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed: Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, [1988] 2 C.T.C. 294, at page 194 (C.T.C. 304); see also Symes v. Canada, [1993] 4 S.C.R. 695, [1994] 1 C.T.C. 40, 94 D.T.C. 6001.

The IRC v. Duke of Westminster, [1936] A.C. 1, 19 T.C. 40 (H.L.), is more often referred to by name than it is quoted. Since it is firmly entrenched in our law it is worthwhile repeating the words of Lord Tomlin at pages 19-21 (A.C.):

Apart, however, from the question of contract with which I have dealt, it is said that in revenue cases there is a doctrine that the Court may ignore the legal position and regard what is called ’’the substance of the matter," and that here the substance of the matter is that the annuitant was serving the Duke for something equal to his former salary or wages, and that therefore, while he is so serving, the annuity must be treated as salary or wages. This supposed doctrine (upon which the Commissioners apparently acted) seems to rest for its support upon a misunderstanding of language used in some earlier cases. The sooner this misunderstanding is dispelled, and the supposed doctrine given its quietus, the better it will be for all concerned, for the doctrine seems to involve substituting "the incertain and crooked cord of discretion" for "the golden and streight metwand of the law." Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. This so-called doctrine of "the substance" seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.

The principal passages relied upon are from opinions of Lord Herschell and Lord Halsbury in your Lordships’ House. Lord Herschell L.C. in Helby v. Matthews observed: "It is said that the substance of the transaction evidenced by the agreement must be looked at, and not its mere words. I quite agree;" but he went on to explain that the substance must be ascertained by a consideration of the rights and obligations of the parties to be derived from a consideration of the whole of the agreement. In short Lord Herschell was saying that the substance of a transaction embodied in a written instrument is to be found by construing the document as a whole.

Support has also been sought by the appellants from the language of Lord Halsbury L.C. in Secretary of State in Council of India v. Scoble. There Lord Halsbury said: "Still, looking at the whole nature and substance of the transaction (and it is agreed on all sides that we must look at the nature of the transaction and not be bound by the mere use of the words), this is not the case of a purchase of an annuity." Here again Lord Halsbury is only giving utterance to the indisputable rule that the surrounding circumstances must be regarded in construing a document.

Neither of these passages in my opinion affords the appellants any support or has any application to the present case. The matter was put accurately by my noble and learned friend Lord Warrington of Clyffe when as Warrington L.J. in In re Hinckes, Dashwood v. Hinckes he used these words: "It is said we must go behind the form and look at the substance....but, in order to ascertain the substance, I must look at the legal effect of the bargain which the parties have entered into." So here the substance is that which results from the legal rights and obligations of the parties ascertained upon ordinary legal principles....

And Lord Russell of Killowen at pages 24-25:

The commissioners and Finlay J. took the opposite view on the ground that (as they said) looking at the substance of the thing the payments were payments of wages. This simply means that the true legal position is disregarded, and a different legal right and liability substituted in the place of the legal right and liability which the parties have created. I confess that I view with disfavour the doctrine that in taxation cases the subject is to be taxed if, in accordance with a Court’s view of what it considers the substance of the transaction, the Court thinks that the case falls within the contemplation or spirit of the statute. The subject is not taxable by inference or by analogy, but only by the plain words of a statute applicable to the facts and circumstances of his case. As Lord Cairns said many years ago in Partington v. Attorney-General (1869), L.R. 4 H.L. 100, 48 T.C. 14: "As I understand the principle of all fiscal legislation it is this: If the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be." If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good. That is what this House did in the case of Scoble; that and no more. If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties, and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.

And Lord Wright at pages 30-31:

And what the legal effect is as between the covenantor and the covenantee must determine for revenue purposes the character of the payments actually made.

And once it is admitted that the deed is a genuine document, there is in my opinion no room for the phrase "in substance." Or, more correctly, the true nature of the legal obligation and nothing else is "the substance”.

The principle to be deduced from these authorities is simply this: the essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not the nomenclature that governs. The Minister, conversely, may not say to the taxpayer ’’You used one legal structure but you achieved the same economic result as that which you would have had if you used a different one. Therefore I shall ignore the structure you used and treat you as if you had used the other one”.

The form of the legally binding relations that CB, CBL and CC entered into cannot, therefore, be ignored. They were not shams. They did not involve calling one legal relationship by another name. Their ultimate purpose was, of course, to transfer the leasing assets from CB’s corporate umbrella to that of CC. That does not, however, warrant a disregard of the legal relations effected to achieve that purpose.

The Fraser and Smythe cases

Counsel for the respondent relied upon Fraser v. M.N.R., [1964] S.C.R. 657, [1964] C.T.C. 372, 64 D.T.C. 5224. That case is sometimes cited in support of the proposition that the legal form of a transaction may be ignored in favour of its presumed economic substance. I do not think that it goes that far. There, a land trader put the land into a company and sold the shares, contending that this somehow turned the deal into a capital transaction. Mr. Justice Judson rejected the argument, saying that the sale of shares was simply an alternative method of putting through the taxpayer’s real estate transactions. This did not involve treating the sale of shares as in substance a sale of land. It was merely a common sense recognition of the fact that whether land or shares were sold the whole transaction was, from beginning to end, an adventure in the nature of trade. Fraser does not assist the respondent.

To the same effect counsel for the respondent contended that Smythe v. M.N.R., [1970] S.C.R. 64, [1969] C.T.C. 558, 69 D.T.C. 5361, supported the view that one should look at the beginning and the end of a series of steps and ignore the intervening transactions. I do not regard Smythe as having so sweeping an effect. It involved a complex set of transactions designed to extract the corporation’s undistributed income. Mr. Justice Judson held that on the evidence there was a winding-up of the corporation resulting in a distribution of funds to a shareholder and that accordingly the provisions of subsection 81(1) were precisely met. Here, if we look at the last step in the series of transactions envisaged by the master agreement we have two subsidiaries of CC owning a partnership interest, with all of the tax consequences that that conclusion entails. The Smythe case cannot support the conclusion that there was in substance a sale of depreciable property by CBL to CC.

Object and spirit

Mr. Olsson contended that to give effect to the election filed under subsection 97(2) of the Income Tax Act on the rollover of the leasing assets to the partnership would be contrary to the object and spirit of subsection 97(2). To recognize the partnership but refuse to give effect to the election would result in a disposition for proceeds equal to the fair market value of the partnership interest received by CBL and a consequent recapture of CCA. This, incidentally, was not one of the bases upon which the assessment was made or sought to be supported.

Taxing statutes obviously have as their principal object the raising of revenues for public purposes. In the context of that object they have other subsidiary social purposes that need not be enumerated here. The determination of their ’’spirit", if it is something different from their object, is a more difficult task. The traditional view, at least until Stubart, was that the spirit was to be found in the words of the statute and nothing more. As Thorson P. said in Fasken Estate v. M.N.R., [1948] C.T.C. 265, 4 D.T.C. 491, at page 275-76 (D.T.C. 495), after quoting from Lord Cairns in Partington v. Attorney-General (1869), 4 E & I App. 100 at page 122, and Lord Halsbury in Tennant v. Smith, [1892] A.C. at page 150,

It is the letter of the law, and not its assumed or supposed spirit, that governs. The intention of the legislature to impose a tax must be gathered only from the words by which it has been expressed, and not otherwise.

The strict construction rule has of course been modified in Stubart, supra, where Estey J. said at page 315 (D.T.C. 6322):

It seems more appropriate to turn to an interpretation test which would provide a means of applying the Act so as to affect only the conduct of a taxpayer which has the designed effect of defeating the expressed intention of Parliament. In short, the tax statute, by this interpretative technique, is extended to reach conduct of the taxpayer which clearly falls within "the object and spirit” of the taxing provisions. Such an approach would promote rather than interfere with the administration of the Income Tax Act, supra, in both its aspects without interference with the granting and withdrawal, according to the economic climate, of tax incentives. The desired objective is a simple rule which will provide uniformity of application of the Act across the community, and at the same time, reduce the attraction of elaborate and intricate tax avoidance plans, and reduce the rewards to those best able to afford the services of the tax technicians.

I understand the rule of interpretation that requires a court to construe a statute in accordance with its "object and spirit" to mean simply this: the words of the statute are of course of primary importance, since it is through them that Parliament has expressed its intention. Nonetheless, an interpretation that is inconsistent with, or defeats, the obvious purpose of a provision is to be avoided unless the plain words compel a different interpretation. The words must be construed within the context of the act as a whole and, where the meaning is difficult to determine, or if two or more interpretations are possible, recourse should be had to the scheme of the act or the regime that it seeks to govern.

In Trans-Canada Investment Corp. v. M.N.R., [1953] C.T.C. 353, 53 D.T.C. 1227 (Ex. Ct.), Cameron J. said at page 360 (D.T.C. 1231):

I agree that it is possible to interpret the language of the section as requiring that the dividend must have been received directly from the paying corporation. But in my view, there is another interpretation that may be put upon it, an interpretation which I think is more consonant with the intention of Parliament as I deem it to be from the language itself.

In Caledonian Railway v. North British Railway (1881), 6 A.C. 114, Lord Selborne said at page 122:

The more literal construction of a statue ought not to prevail if it is opposed to the intentions of the Legislature as apparent by the statute, and if the words are sufficiently flexible to admit of some other construction by which the intention can be better effectuated.

Again, in Shannon Realties v. St. Michel (1924), A.C. 192, it was stated that if the words used are ambiguous, the Court should choose an interpretation which will be consistent with the smooth working of the system which the statute purports to be regulating.

In Highway Sawmills Ltd. v. M.N.R., [1966] S.C.R. 384, [1966] C.T.C. 150, 66 D.T.C. 5116, Cartwright J. (as he then was) said at page 393 (C.T.C. 157-58, D.T.C. 5120):

The answer to the question what tax is payable in any given circumstances depends, of course, upon the words of the legislation imposing it. Where the meaning of those words is difficult to ascertain it may be of assistance to consider which of two constructions contended for brings about a result which conforms to the apparent scheme of the legislation.

What, then, is the "object and spirit" of subsection 97(2)? I am not sure what its spirit, if any, is,-spirits tend to be somewhat elusive—but its object seems rather straightforward. It is to permit a taxpayer to transfer assets to a partnership in return for a partnership interest without triggering the immediate tax result that such a transfer would normally entail. Tax is not avoided; it is deferred and the potential tax is preserved within the partnership until the assets are disposed of, unless, of course, a second rollover is subsequently made to a corporation under section 85. That deferral is not obtained without a certain hidden cost. Both the assets within the partnership and the partnership interest have, for the purposes of the Income Tax Act, a lower cost base than they would have had if no subsection 97(2) election had been filed. This may result in an element of potential double taxation but it is something that taxpayers are normally informed of by their advisors and are prepared to live with. The apparent premise upon which the rollover provisions of both section 85 and subsection 97(2) are based is that where a taxpayer transfers assets to a corporation or a partnership and receives as consideration shares or a partnership interest, as the case may be, for a portion of the value of the assets exceeding the ‘cost amount", the taxpayer’s real economic position has not been enhanced. The interest in the assets is merely being held in a different vehicle.

That, then, is the object and spirit of subsection 97(2), nothing more or less. I do not see how a taxpayer who avails itself of that provision, with both its advantages and potential disadvantages, can be said to have acted in contravention of its object and spirit. In Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106 (F.C.A.), Irvcal was inserted in a tax haven between the foreign supplier and the domestic purchaser for the sole purpose of increasing the price paid by the purchaser and thereby reducing the tax payable to Canada. It never had in any real sense possession of the oil and its ownership of it for a scintilla of time during which the price was increased could at best be described, as the trial judge in the case did, as metaphysical. The Federal Court of Appeal held at page 5114 that the tax avoidance scheme involved in that case "did not offend the Income Tax Act". If that scheme did not offend the Income Tax Act I would be hard pressed to see how this one did.

Capital gain versus income

As an alternative to assessing CBL the Minister also assessed CB on the gain realized on the sale of the partnership interest to 693397 and CCM as an income gain. The gain was essentially the difference between CBL’s cost (the elected amount under subsection 97(2), which was passed on to CB under section 88), and the proceeds of the sale. It appears that the gain was about the same as that which would have been realized by CB if it had sold the shares of CBL.

The sole basis for treating the gain as being on income account is the immediate foreordained resale as part of the overall scheme and the predetermined profit. In the normal course a purchase followed by an immediate resale would justify an inference that the operating motivation for the acquisition was the profit. In this case the resale and the profit were determined in advance. Does this single factor so predominate that no other consideration can prevail? It would serve no purpose to review the multitude of authorities that have been decided in this area, but it is useful, as an opening measure, to consider the case in light of the traditional tests. A number of the more important considerations were set out by Mr. Justice Rouleau in Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.):

1. The nature of the property sold. The property was a partnership interest, customarily a capital asset. Partnership interests are not as a rule commodities that are bought and sold.

2. The length of the period of ownership. The property was held for only a couple of days-December 27, 1986 to December 29, 1986.

Mr. Justice Rouleau stated at page 263 (D.T.C. 6423):

Generally, property meant to be dealt in is realized within a short time after acquisition. Nevertheless, there are many exceptions to this general rule.

[Emphasis added.]

3. The frequency or number of other similar transactions by the taxpayers. CB has never dealt in partnership interests before or since.

4. Work expended on or in connection with the property realized. There was none unless one includes the insertion of additional assets into CBL (the drag line) and the removal from CBL of six leases that CC did not want.

5. The circumstances that were responsible for the sale. These circumstances have been fully outlined above. They include the proposed dissolution of CB and CBL, the collapse of the sale of CBL’s shares and the desire to replicate the tax consequences of that sale through the partnership arrangement.

6. Motive. The motive was to liquidate CB’s assets at a tax cost roughly equivalent to that which would have been incurred if the shares of CBL had been sold.

Ultimately the answer to the question boils down to a determination of fact and to the court’s assessment of all of the evidence. I do not think that the traditional tests applicable in a land trading case are necessarily applicable here. Quite simply this is not a case of trading in partnership interests as a speculator or trader might deal in lands or securities. The shares of CBL were, in CB’s hands, obviously capital assets. Accepting, as I do, the validity of the transfer to the partnership, the partnership interest was a capital asset in CBL’s hands and it preserved that quality on its transfer on the winding up of CBL. The Crown’s position would be that during a period of three days, December 27, 28 and 29, 1986 during which title to the partnership interest was held by CB, it lost that quality and became trading stock. That conclusion is not, in my view, sustainable. I do not think that this aspect of the corporate transaction had the indica of a speculative trading venture. [3]

Mr. Justice Noël said in Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.) at page 162 (D.T.C. 5105):

The inference of an intention to make a profit by a rapid resale can also flow from the fact that the purchaser did, in fact, resell almost immediately at a profit, but only if there exists no satisfactory explanation for this rapid resale.

It would be unrealistic to focus solely on CB’s acquisition on the winding up of CBL and resale of the interest without considering the entire context. The reasons for the immediate resale in the context of a composite transaction forming an integral part of the winding up are sufficient to dispel the inference that CB was engaged in a speculative profit making scheme. It is not infrequent for assets, on the winding-up of a subsidiary, to be transferred to the parent at the subsidiary’s cost amount under section 88, and immediately resold. Similarly, assets may be rolled by a taxpayer into a corporation at their cost amount under section 85 and immediately resold at a profit. If the assets are not inventory in the subsidiary’s or the transferor’s hands they do not become inventory in the parent’s or transferee’s hands simply because of the rapid resale.

Conclusion

The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons and with the consent to judgment that was filed. In light of the complexity of the issues dealt with in the appeals and in the partial settlement that was filed, counsel for the appellants are directed to prepare drafts of the formal judgments and, after approval as to their form by counsel for the respondent, to submit them to the Court for signature.

Counsel for both parties are invited to make representations as to the appropriate disposition of costs. These representations may be in writing if all counsel agree. Otherwise counsel may communicate with the registrar to determine a convenient time for oral argument on the question of costs.

Appeal allowed in part.