Chibougamau Lumber Limitée v. MNR, 73 DTC 134, [1973] CTC 2174 (T.R.B.)

The Chairman (orally):—While I am indebted to counsel for their preparation and assistance in this matter, I find it unusual that this should be the first time that this question has come before either this Board, or its predecessor, or the Federal Court. Nevertheless, there is apparently no case on all fours with the problem before me today.

This is an appeal by Chibougamau Lumber Limitée against reassessments of the Minister of National Revenue for the taxation years 1968, 1969 and 1970. The reassessments arise out of several transactions entered into by the appellant, mainly with Associates Leasing (Canada) Limited but also, on occasion, with IAC Limited and Traders Group Limited, whereby equipment would be leased, according to the appellant, from Associates or one of the other two companies, for a period of years, with an option to purchase the equipment at the end of the lease period for $1.

The Minister’s contention is that this is not a lease arrangement with an option to purchase but rather a purchase and sale agreement. He has therefore reassessed the appellant on the difference between the capital cost allowance that the appellant would have been allowed on the purchase of the various pieces of equipment and the sum of the instalment, lease or rental payment made as alleged by the appellant.

The question, then, before me is whether or not the agreements are true rental agreements or whether in fact they represent the purchase on time of the equipment mentioned in each respective contract. Exhibit A-5 is agreed to be a typical example of all the agreements in question.

Evidence for the appellant was called by its counsel through Mr Fradet, the secretary and general manager of the appellant company, to the effect that the appellant is in the “wood business” in its broadest sense, which extends from the cutting of timber to the preparation and marketing of the finished lumber products. It is therefore not too difficult to understand that very large and very expensive machinery is required in its operations. Apparently the appellant had, in the course of its operations at the material time, entered into a financial arrangement with an institution known as Roynat, which financial arrangement, although not gone into in detail, apparently limited the amount of capital expenditure that the appellant company could make. Mr Fradet says that, by leasing this equipment, the company was able to obtain the machinery necessary for its operations without breaching the contract or understanding it had with Roynat. He says that about 20% of the appellant company’s equipment was obtained in this manner.

Appellant’s Exhibit A-5 is really in two parts: The first part is on an Associates Leasing (Canada) Limited form showing the equipment involved and the payments to be made as well as the total price. In addition, although it is not evident on all the documents in so many words, there is, for example, on appellant’s Exhibit A-1, a notation that payment of a sum “plus $83.60 re: RST”—which 1 take to mean Provincial Sales Tax—will constitute the monthly payment for the contract. The contracts were usually for a period of three years but might extend to four. The evidence of the witness Bouchard, who is the Credit Manager of Associates Leasing in this city of Montreal, was that their minimum term would be six months and their maximum sixty months, the former, of course, for small accounts and the longer term for more expensive equipment. In this case, however, it is usually contracts of three years or thirty-six months with which we are involved.

The second part of the agreement is an “Option to Purchase: Supplement to Lease of Personal Property” (see Exhibit A-5), and it gives the appellant the right to purchase the property, after all payments have been made under the lease agreement, for the sum of $1. This option may be exercised at any time, but if it is exercised before the end of the instalment period, all instalments must be paid, and if it is to be exercised after the end of the instalment payment period, it must be exercised within thirty days.

The evidence of Mr Fradet is that the company’s officers would determine the equipment required through contact with dealers in the business of supplying such equipment. They would then approach Associates, who would make out the contract, after which the latter would purchase the equipment and deliver it to the appellant. This is not unusual. Because of the amount of money involved in the purchase price of this type of equipment, one would hardly expect Associates, as competent business operators, to purchase and store such equipment before they had a customer for it, which, in the instant case, was the appellant company. After the delivery of the equipment, or perhaps at the time of delivery, but, in any case, for all intents and purposes at the same time, an option agreement was entered into and the company began and continued to make the payments set out in the contract between itself and Associates—or whatever company might be involved. In all cases the contracts were completed and the options exercised, and the equipment was taken onto the books of the appellant company at the sum of $1. The evidence is that one piece of equipment, worth some $65,000, which was purchased through IAC in 1967, had been destroyed by fire some four years later, after the term of the contract with IAC had expired and after the option to purchase it for $1 had been exercised. The insurers paid the appellant company some forty or forty-five thousand dollars for its loss.

The procedure was for the company annually, or at any period that its insurers required it to do so, to evaluate the replacement value of its equipment, schedule it, and pay the appropriate premium. So that it is uncontradicted throughout, nor is there any attempt made, in the evidence of Mr Fradet or of anyone else, to deny that the equipment in all cases had a value greater than the nominal value contained in the option to purchase. The situation, then, was that the appellant company was making payments on hundreds of thousands of dollars’ worth of equipment over a period of years, was deducting these payments quite properly as an operating expense as it went along, following its allegation that this was a lease agreement, and the inference is, on the evidence, and I think from the evidence it is an inference based on fact, that Associates, or whoever the contracting party might be, was taking the capital cost allowance permitted to it under the Act. Then, at the end of the rental period, the title to the machinery was transferred to the customer (in this case, the appellant) and was written off, presumably, by Associates.

The contract itself contains the usual provisions that are contained in rental agreements, many of which are the same as one would find in a British “hire-purchase” agreement, or, in a common law province, in a conditional sales contract. In other words, it is, in effect, a “net- net” arrangement: ail expenses and upkeep are those of the appellant, the title remains in Associates (or whatever company is handling the contract) until the end of the term of instalments, and certain restrictions are contained in the contract as to the location, etc, in which the equipment may be used.

It is, I think, agreed by both parties that the overall operation and activity of the appellant company must be looked at in the light of the contracts. As has been said in many cases and by many tax writers, the mere designation of a document as a lease or as a purchase- and-sale agreement by the parties thereto will not of itself constitute that document a lease or a purchase-and-sale agreement, nor will a clause in the objects of a limited company specifying that it is to be an investment company preclude the possibility of its making a profit in the form of a capital gain from its investments, in certain instances. One must consider all the evidence and all the activities that took place and try to determine as closely as possible what the intention of the parties was when the documents were brought into being.

Many cases have been cited on the general principles, one being that of Joseph Ages et al v MNR, [1971] Tax ABC 86; 71 DTC 86, a decision of the former Chairman of the Tax Appeal Board, who mentions in the last paragraph of his reasons, at page 88 [87]:

I know of no authority for the proposition that money received as rent initially can later be treated, under the Income Tax Act, as having been paid on capital account by reason of a subsequent happening.

I agree completely with that comment, and I would agree completely with the conclusion that he came to in that case, because there was no doubt whatsoever in his mind, nor in my mind on reading his report of the case, that it was indeed a rental agreement that he was dealing with. I cite this one case, of the many presented to me, to show that, where it is a question of fact and not one turning on a precise principle of law, there is seldom any help to be found in the reported cases.

The question of whether or not the agreements are a sham has also been raised, and the case of MNR v James A Cameron, [1972] CTC 380: 72 DTC 6325, has been cited, and at page 384 [6328] thereof, there is a comment by Lord Justice Diplock in Snook v London & West Riding Investments, Ltd, [1967] 1 All ER 518 at 528. Halfway through that comment he says, with reference to the word “sham”:

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.

I think that is a precise statement of, and an acceptable definition of, the oft-used and more often abused term “sham”.

What, then, are the facts dealing with these contracts? We have allegedly two parties dealing at arm’s length in all respects within the meaning of the Income Tax Act. Whether or not at common law or in day-to-day layman’s language they were dealing at arm’s length is another matter. It is obvious that there was a great deal of business done between them and that Associates had, almost exclusively, the entire business of the appellant in this type of contract. Why, then, do we find the sale of an asset worth at least $40,000 at a price of $1 if the agreement is not a sham, or if it is not an artificial transaction intended to convey to others, or to the Court, some arrangement between the parties that did not in fact exist?

In my view, he parties never intended the option and the contract to be a true reflection of the arrangements between them in each of these transactions. I cannot conceive, and it would strain. the credulity of the Court to believe, that an internationally successful company would convey to a stranger at a nominal price an asset worth such an amount when obviously, had it been a repossession, it could, as Associate’s own local manager testified, “easily have been disposed of for a price satisfactory to meet our needs”. They were not bad businessmen, and they were not, in my view, dealing at arm’s length as an ordinary citizen would anticipate that term to mean.. The agreements were not, in my view, executed in. the manner, or penned in the manner, in which they were intended to operate between the parties. There is no reason whatsoever for a sound businessman to forsake a proft of such magnitude unless it is an attempt to hide the true intention of the parties to the agreements. To allow such a transaction to succeed would, in my view, be to allow. the appellant company to artificially increase the capital cost allowance afforded to it under the Regulations passed under the authority of the Income Tax Act; it would prevent any recapture on the sale of a capital asset by Associates: and it would clearly, under section 137 of the Income Tax Act, afford a means of doing indirectly wnat could not be done directly under the provisions of the said Act. Jt is true tnat everyone, in theory at least, is entitled to “avoid”, as distinguished from “evade”, such tax as is legally possible. All too much attention is paid, on occasion, to that phrase, but it has caused such concern to Parliament in the past years that the legislators, in their wisdom, have eroded that long-established principle by the enactment of the so- called ‘'ministerial discretion” sections of the Act.

In summary, then, in my view, in each instance these contracts represented no more than a purchase on a time-payment plan by the appellant, and were not, by any stretch of the imagination, leases in the true legal sense of the term. I think that the approach that the Minister’s representative has taken in assessing the appellant in this instance is right both in law and in fact, and that the appeal must therefore be dismissed.

Appeal dismissed.