Produits LDG Products Inc. v. The Queen, 76 DTC 6344, [1976] CTC 591 (FCA)

Pratte, J (concurred in by Le Dain, J and Hyde, DJ):—This is an appeal against a decision of the Trial Division dismissing appellant's appeal against assessments of its income tax for 1965, 1966 and 1967. By these assessments the Minister of National Revenue refused to allow appellant to deduct in calculating its income certain sums which it paid into a pension fund set up for the benefit of certain of its employees. The deductions which were not allowed are as follows: for each of the years 1965 and 1966 the sum of $2,783.50, representing appellant’s contribution to the pension fund to cover current service of its participating employees, and the sum of $45,540 to cover their past service; and for the year 1967 the sum of $3,000, paid to cover current service of its employees. The trial judge upheld the Minister’s decision and ruled that paragraph 11 (1)(g) and subsections 76(1) and 137(1) of the Income Tax Act did not allow appellant to deduct these amounts in calculating its income.

Appellant company operates a wholesale business in electrical appliances. The business is in sound condition. Its founder, Mr Maurice Germain, remains the prime mover of the company. He is its president and principal shareholder. The limited number of other shareholders own only a few shares each. They are, in addition to certain former employees, Mrs Lucie D Germain, who is the wife of Mr Maurice Germain, and Mr Claude Germain, his brother.

In 1956 appellant entered into a contract with the London Life Insurance Company setting up a pension plan for its employees. This pension plan is still in force and Mrs Lucie D Germain is the only employee of appellant who does not participate.

In 1965 appellant set up another pension plan which was intended to obtain additional benefits for some of its employees. The point at issue in this case is deductibility of the contributions made to this Supplementary pension fund. Accordingly, we must consider the circumstances of its establishment and of the contributions which appellant paid into it.

Mr Maurice Germain decided to set up this new pension plan after he learnt of the existence of section 76 of the Income Tax Act. He wished to take advantage of the deduction allowed by this provision.

On February 1, 1965 the directors of appellant adopted a by-law:

(a) “approving and adopting” the pension plan, the text of which was attached to the by-law;

(b) “approving and adopting” a draft notarized contract between the company on the one hand and three “trustees”, Maurice Germain, Lucie D Germain and Claude Germain, on the other hand:

(c) authorizing Mr Maurice Germain and Mrs Lucie D Germain to sign the pension plan and the notarized contract on behalf of the company;

(d) authorizing officers of the company to deposit the plan, the notarized contract and any other necessary documents at the office of the Deputy Minister of National Revenue.

The main provisions of the pension plan, the text of which was attached to the by-law, can be summarized as follows:

(a) only executives in the employ of appellant, who are designated as such by the board of directors, may participate in the pension plan;

(b) an employee wishing to participate in the plan must submit an application form containing various items of information to the company, authorizing the employer to deduct his contributions to the pension fund from his salary;

(c) on reaching retirement age, a participating employee is entitled to a pension equivalent to 70% of his salary (or, more precisely, to 70% of his average salary for the six years when his salary was highest), minus the amount of pension which he would receive under the first pension plan set up through the London Life Insurance Company;

(d) the plan is financed by the contributions of the company and the participants; the provisions of the plan on this point read as follows:

(1) BASIC CONTRIBUTION FOR CURRENT SERVICE:

Each Member of the Plan will contribute a maximum of FIFTEEN HUNDRED DOLLARS ($1,500.00) per year by salary deductions minus the regular contribution to the group annuity Policy No GA540N issued by the London Life Assurance Co.

The employer will contribute each year a maximum of FIFTEEN HUNDRED DOLLARS $(1,500.00) for each Member of the plan minus the regular contribution made on behalf of the said Member to the group annuity Policy No GA540N issued by the London Life Assurance Co.

(2) BASIC CONTRIBUTION FOR PAST SERVICE:

The Company shall contribute to the Pension Fund amounts which on the advice of the Actuary are estimated to be necessary to provide the benefits of this Plan with respect to service prior to the effective date of the Pian.

(e) the company will set up a fund into which the contributions made under the plan will be paid; this fund will be separate from the assets of the company and will be used for the sole benefit of the employees participating in the plan; the latter will have no recourse against the plan, against the trustees administering the plan, or against the company;

(f) the plan will be administered by the trustees who are also responsible for administration of the fund; these trustees will be appointed by the company and, until new provisions are drawn up, they will be those named in the notarial deed to be signed by the company and the three trustees;

(g) the company reserves the right to terminate the plan but cannot, if it does so, prejudice rights acquired by the participating employees.

On February 26, 1965 the contract referred to in the plan, signing of which had been authorized by the by-law of February 1, was executed before the notary P A Lamarre. This contract was between appellant company as the “donor” and three “trustees”, Mr Maurice Germain, Mrs Lucie D Germain and Mr Claude Germain. Its main provisions are in summary as follows:

(a) the parties declare that the donor company has set up a pension plan (a copy of which is attached to this contract), and that the contract is concluded with the following aim:

. . to provide a Trusteeship basis for carrying out the terms and conditions of the Plan as therein referred to, and the donation hereby made and those hereinafter to be made pursuant to the provisions hereof are thus made in consideration of the services rendered or to be rendered to the Donor by the beneficiaries of the Plan.

(b) the company gives the trustees the sum of $100 for the benefit of beneficiaries under the pension plan; the company also indicates its intention of paying other sums of money to the trustees in the future for the purposes of the plan; these funds shall constitute a trust fund which the trustees shall administer and dispose of in accordance with the provisions of the plan and of this contract;

(c) the trustees shall buy ordinary or preferred shares in the donor company with the money in the trust fund;

(d) the company may at any time modify the agreement and replace the trustees.*

The contract, the plan and the by-law were sent to the Minister of National Revenue. On March 25, 1965, over the signature of Mr Maurice Germain, appellant also sent a duly completed application for registration of the new pension plan to the Minister. In this application it was stated that six employees, five men and one woman, would participate in the plan. Attached to the form were, among other documents, an employer’s certificate and an actuarial certificate. The employer’s certificate, signed by Mr Maurice Germain on behalf of appellant, gave certain information about the six employees of appellant. Among these six employees were Mr Maurice Germain, Mrs Lucie D Germain and Mr Claude Germain. The actuarial certificate, which was based on information contained in the employer’s certificate, read in part as follows:

The unexpended liabilities of the Pension plan for the Executives of Produits LDG Products Inc have been calculated to be $210,860.00 as of February 1st, 1965.

This amount may be paid by instalments of $45,540.00 per annum, payable annually in advance—over a period of five (5) years.

The actuarial certificate also stipulated the contributions to be paid into the retirement fund by each employee. This information indicates that, as counsel for the respondent stressed, the plan was intended to benefit mainly Mr Germain and his wife:

“It is possible to say a great deal about the legal consequences under Quebec law of the adoption by appellant of the pension plan and of the concluding of the alleged donor contract. It is, however, not necessary to deal at length with this difficult point, since respondent did not claim that the pension fund, assuming that it was not simply a sham, wae not validly established.

On April 14, 1965 the Revenue Minister informed Mr Germain that the pension plan as drafted had been accepted for registration for the purposes of paragraph 139(1)(ahh) of the Income Tax Act. On February 3, 1966 appellant was advised that the Minister, on the advice of the Superintendent of Insurance, had approved for the purposes of section 76 payment to the pension fund of the sum of $210,860, mentioned in the actuarial certificate as being payable for past service of the participating employees.

On February 26, 1965 appellant had made the first of the payments for which it is claiming a deduction. All these payments were made in the same way: appellant issued a cheque in favour of the fund, which in return gave him its cheque for a similar amount in payment of preferred shares issued by appellant. After this payment appellant, as far as its liquidity was concerned, was in exactly the same situation as before. The preferred shares of appellant which were thus acquired by the pension fund were non-voting shares with a par value of $10, giving the right to a cumulative annual dividend of 6%; they could be repurchased at the option of appellant’s directors. Each year the company paid to the fund the dividends to which it was entitled; these amounts were also immediately reinvested in the preferred shares of appellant.

Early in 1967 it appears that appellant learned of the possibility that the Minister disputed the deductibility of its contributions to the pension fund. Appellant then stopped its contributions to cover past service of its employees, although it continued to make contributions to cover the current service of its employees up to 1970 inclusive.

To conclude this account of the facts I would add that in 1969 appellant adopted a by-law modifying the terms of the pension plan, and in addition repurchased the preferred shares held by the fund. It would seem that the company did so to ensure that its pension plan would conform to the requirements of a regulation adopted in 1966 under a statute of the Province of Quebec.

The trial judge accordingly held that, in calculating its income for 1965, 1966 and 1967, appellant could not deduct the amounts which it had contributed in those years to its supplementary pension plan. He held, first, that these payments were not deductible under paragraph 11 (1)(g) and subsection 76(1), and he also concluded that subsection 137(1) forbade the deduction of these contributions.

Counsel for the respondent strongly supported the findings of the Trial Division. He said that appellant was not entitled to the deductions it had claimed because the pension plan in question was only a sham. He maintained that the contributions made to the fund to cover the past service of employees were not deductible because they did not fulfil the conditions prescribed by subsection 76(1). Finally, he contended that in any case the deductions claimed could not be allowed without contravening subsection 137(1).

1. The Real or Imaginary Nature of the Pension Plan

Counsel for the respondent several times used the English expression “sham” to describe the pension plan. We must remember that this English word does not have any magical qualities. A sham is a pretence, that is, in law, a fictitious or bogus act. In the case at Dar it must be ascertained whether appellant, when it set up its pension plan, intended to set up a genuine retirement plan, with all the legal consequences that would involve, or whether it merely wished to appear to do so, with the aim of cheating the tax authorities.

In support of his claim, counsel for the respondent relied particularly on the fact that, after the pension fund was set up, appellant seemed to ignore the provisions of the plan it had adopted. Appellant did not bother to observe certain formalities provided for in the plan as for example the adoption of a resolution designating the employees who could participate in the plan. Moreover, appellant stopped paying its contributions to cover past service as soon as it learned that the deductibility of its contributions was in dispute. It was claimed that, in so doing, appellant demonstrated that it did not consider itself obligated by the plan, which from that point on should be considered a mere sham.

This argument is not convincing. It is true that appellant ignored a number of the formalities contemplated in the plan, but I cannot draw from this any conclusion either favourable or unfavourable to respondent’s argument. These irregularities might well be attributed merely to the fact that this case involved a small business where all matters were dealt with informally. It may also be thought that if, wnen it set up its plan, appellant had intended merely to create a sham to fool third parties, it would have made an effort to observe all the external formalities required, so as to ensure that its pretence would not be discovered. I am unable to infer anything from the fact that appellant stopped making contributions as soon as it learned that the deductibility of its contributions was in dispute, except that appellant seems to have behaved at that point as any other reasonable person would have in similar circumstances.

Counsel for the respondent also contended that the manner in which payments to the fund had been made demonstrated the bogus and artificial nature of the plan. He maintained that after it had made its contribution, the company was in the same financial situation as before. This latter statement is not correct. The fact is that the company’s liquidity remained the same after as before the payments. To my mind, it is not possible to deduce from this that the plan was a sham, especially if we bear in mind, as the trial judge observed, that [TRANSLATION] “in the case at bar, reinvestment of the moneys paid into the fund in preferred shares does not seem to be an essential provision of the plan”.

II. Requirements of Subsection 76(1)

It is now established that a special contribution to a retirement fund, payment of which has been approved by the Minister under subsection 76(1), can nevertheless not be deducted if it does not satisfy the other conditions of deductibility determined by this provision (see MNR v Inland Industries Limited, [1974] SCR 514; [1972] CTC 27; 72 DTC 6013).

Respondent maintained that the contributions made by appellant to cover the past service of its employees do not satisfy the requirements of subsection 76(1) because

(a) these contributions were paid to a pension fund which was not obliged to pay to the beneficiaries the benefits which made the payments necessary;

(b) these contributions were not paid on the recommendation of an actuary;

(c) the contributions were not made in such a way as to be irrevocably transferred to the fund.

In my opinion, each of these arguments must be dismissed:

(a) Obligation of Fund to Beneficiaries. It is only necessary to read the plan to see that the participating employees will be entitled to fixed pensions, and that appellant will be obliged to pay the necessary amounts into the fund to allow it to pay these pensions. The fact that appellant had the right to terminate the plan in no way alters this conclusion: as long as the plan lasted, the obligation remained. Moreover, the fact that participating employees were not concerned about sending an application form for participation to appellant seems to me in the circumstances to be unimportant. This informality, in my opinion, did not prevent the employees from becoming “members” of the pension fund.

(b) Actuarial Certificate. Even if we admit, as respondent maintained, that the actuary underestimated the salaries of participating employees, the value of his certificate is not affected. In fact, in spite of the error, it remained true that the fund’s resources had to be increased by “an amount not less than the payment indicated” in the certificate.

(c) Payment. It is undeniable that there were close ties between appellant and the trustees. In my opinion, however, there is no evidence enabling us to conclude that the trustees were mandataries of appellant and that, as a result, the payment made to them was not a genuine and irrevocable payment.

II. Subsection 137(1)

We have now to consider the last argument made by respondent, an argument expressly adopted by the trial judge: that the deductions claimed could not be allowed under subsection 137(1) because, if they were allowed, this “would unduly or artificially reduce the income” of appellant.

The only reason given by the Trial Division for its conclusion, and respondent did not suggest any other, was that appellant’s principal aim in setting up its retirement plan was not to ensure that its employees received a pension, but rather to secure tax benefits for itself.

Assuming that appellant acted from the motives imputed to it in the judgment a quo (I, for my part, would have been tempted to conclude that the company was acting in the interests of its principal shareholder rather than in its own), it would not follow, in my opinion, that subsection 137(1) should apply here. There is nothing reprehensible in seeking to take advantage of a benefit allowed by the law. If a taxpayer has made an expenditure which, according to the Act, he may deduct when calculating his income, I do not see how the reason which prompted him to act can in itself make this expenditure nondeductible. I therefore believe that in the case at bar there is no reason to apply subsection 137(1).

For all these reasons, I would allow the appeal with costs.