The Queen v. Lehndorff Realty Developments Ltd., 86 DTC 6610, [1987] 1 CTC 42 (FCTD)

Cullen, J.:—This is an appeal from a decision of Mr. Goetz of the Tax Review Board, who upheld the appeal of Lehndorff Realty Developments Limited in respect of a reassessment for its 1974 taxation year. The issue in the appeal is the proper treatment for the purposes of the Income Tax Act of the sum of $5,222,907, paid by the defendant and claimed as a deductible expense. It had been disallowed by the Minister. It was not allowed either as a fully deductible expense or as deductible in computing the defendant’s net capital gains or losses for the year.

At the outset of the trial, counsel for the defendant raised two matters, namely, the defendant having been successful at the Tax Review Board stage of its appeal, does the onus now shift to the plaintiff to establish that its assessment is correct and who proceeds first on this appeal, the plaintiff or the defendant.

I gave reasons for my ruling from the bench and will elaborate on those reasons at this time. Also, given the wording of section 51 of the Federal Court Act, I am required in any event to file a copy of my reasons in the registry of the Court.

The points raised were interesting, and the decision difficult, given the fact that a gentleman as learned as Thorson, J. found it necessary to change his original view of the matter, and interestingly enough his first view seems to have been later supported by a decision of a superior court. As I stated from the bench, “It rather reminds me of that old case, where counsel thought they would have no difficulty when they found out who the presiding judge would be. He had already ruled in a particular way and so reliance was placed on that case but the judge reversed himself. Afterwards, when asked why, he made the comment, ‘it does not appear to appear to me now as it appears to have appeared to me then’.”

I think that is probably what happened to Mr. Justice Thorson, and I must say, after listening to the argument, and reading the case law cited, in my view Mr. Justice Thorson was correct in his second interpretation given in M.N.R. v. Simpson's Limited, [1953] C.T.C. 203 at 206; 53 D.T.C. 1127 at 1129:

Before I deal with the issue in the appeal I must comment on a preliminary question on which ! requested argument by counsel, namely, whether the following statement in Goldman v. Minister of National Revenue, [1951] Ex. C.R. 274 at 282; [1951] C.T.C. 241 at 248, is correct:

On the other hand, where the Minister is the appellant from the decision of the Income Tax Appeal Board it cannot be said that the appeal to this Court is an appeal from the assessment. There is this further difference, namely, that while the issue in the appeal is the correctness of the assessment, it is for the Minister to establish its correctness in fact and in law. The Board has power under Section 83 of the Income Tax Act to vacate or vary the assessment or refer it back to the Minister for reconsideration and reassessment. It is to be assumed that the Minister’s appeal is from a decision by which the Board has exercised one of these powers. Consequently, the Assessment has been found erroneous by a court of record and the Minister does not come to this Court with any presumption of its validity in its favour. Indeed, the reverse is true. Thus, subject to the same comments on the use of the term onus as those made previously, the onus is on the Minister to establish the correctness of the assessment. Likewise it is the Minister who should be called upon to begin.

The statement is obiter and affords another illustration of the danger involved in such a statement in matters that have not been fully argued. On further consideration, I have come to the conclusion that the statement is erroneous in several respects and ought to be corrected. The basic error lies in failure to appreciate the effect of the fact that the hearing of an appeal from a decision of the Income Tax Appeal Board to this Court is a trial de novo of the issues of fact and law that are involved. There cannot, I think, be any doubt that this is so where the appeal is by the taxpayer. It must equally be so when the Minister is the appellant. In either event the hearing in this Court must proceed without regard to the case made before the Board or the Board’s decision. Consequently, where the Minister appeals from the decision of the Board allowing an appeal from the assessment the fact that the Board found the assessment to be erroneous must be disregarded. To do otherwise would be tantamount to giving effect to the Board’s decision which would be inconsistent with the view that the hearing of the appeal from it is a trial de novo. Consequently, it was incorrect to say that because the Board found the assessment erroneous the Minister does not come to this Court with any presumption of its validity in his favour and that the onus is on him to establish its correctness. On the contrary, the true position is that on an appeal to this Court from a decision of the Income Tax Appeal Board, whether the taxpayer or the Minister is the appellant, the assessment under consideration carries with it a presumption of its validity until the taxpayer establishes that it is incorrect either in fact or in law. Thus, the onus of proving that it is incorrect is on the taxpayer, notwithstanding the fact that the Income Tax Appeal Board may have allowed an appeal from it. It follows, under the circumstances, that while the Minister, being the appellant, may be called upon to begin he may rest on the assessment so far as the facts are concerned without adducing any evidence. The onus of proving the assessment to be erroneous in fact is on the taxpayer.

[Emphasis added.]

That line of reasoning is cogent and correct. In my view, however, the taxpayer in all instances should be called upon to begin, and I so ordered.

Counsel for the defendant declared that it rendered the decision of the Tax Review Board nugatory, and he was quite correct. As I stated from the Bench, "we seem to have here an anomaly piled upon an anomaly. We have a judgment that is ignored, but this hearing is an ‘appeal’ from that judgment: we have an appeal launched by one party but the ‘respondent' is called upon to begin, and the assessment under consideration carries with it a presumption of its validity until the taxpayer establishes that it is incorrect either in fact or in law.”

Prior to the introduction of this additional stage of a taxpayer’s appeal, the taxpayer had to seek redress from an assessment by going directly to the Court. It may have been the intention of Parliament to provide an easier or less technical forum for the taxpayer, or to enable taxpayers an additional cheaper avenue of appeal, particularly when small amounts were involved. We can only speculate. Certainly, as the legislation is presently drafted the taxpayer has the option of seeking to overrule an assessment by going to the Tax Court of Canada, and if that case is lost, then appeal to the Federal Court which appeal becomes a trial de novo. Naturally the taxpayer also has the right to have his case heard directly by the Federal Court, with no obligation to have his case heard by the Tax Court of Canada. As stated from the Bench:

But there is no indication that when the matter comes before the Federal Court it is anything but a trial de novo. One can totally ignore the decision taken in that particular tribunal, can ignore the cross-examination, and in fact it seems that the legislation leaves open to the appellant, whether it be the taxpayer or the Minister, to raise completely new issues that they possibly had not raised before the Tax Review Board.

Of course, the overriding consideration is the fact that the data and information in tax matters is peculiarly within the knowledge of the taxpayer.

Thus, the onus does not shift to the Minister, the presumption of the validity of the assessment remains, which in my view requires the taxpayer to be treated as the “plaintiff" and the “defendant" is the Minister. However, to avoid confusion as much as possible, the parties in these reasons will be described as they are shown in the style of cause. The Court thereupon called on the taxpayer’s counsel to begin.

We now come back to the issues of this appeal.

Facts

The defendant is a company incorporated under the laws of Ontario. All of its issued shares were at all material times owned by a German limited partnership, Canada Grundstuecksentwicklungen Lehndorff Vermoegens- verwaltung GmbH & Co. (hereinafter referred to as “Canada Grund"). The general partner of Canada Grund is a corporation known as Lehndorff Ver- moegensverwaltung GmbH (hereinafter called “LVG").

Canada Grund is one of several German limited partnerships which have been formed by the same group of persons in Germany. The other limited partnerships are known as Canada I, Canada II, Canada III. These latter limited partnerships invest in existing Canadian rental properties. Canada Grund, on the other hand, was formed to participate in the development and resale of Canadian real estate, and is the only partnership in the group which, as yet, has been involved in that activity. Canada Grund raised capital for such participation by selling limited partnership interests in itself to European investors.

Canada Grund is described in German as Kommanditgesellschaft (KG) which basically means “limited partnership”. I am not certain if this type of limited partnership is unique to Germany, but I understand it is very common in that country. The structure is essentially the same as the structure of a limited partnership under Ontario law in that there is a General Partner known as a “Komplementar" and a group of limited partners known as “Kommanditisten”. The General Partner has the responsibility of running the affairs of the partnership and is fully liable for the debts, obligations and liabilities of the partnership. The limited partners contribute capital to the partnership but they do not have the right to participate in the day-to-day running of the partnership and their liability is limited to the capital which they have subscribed. (In this particular partnership the general partner is a German limited company LVG (referred to above), the shares of which were owned by Dr. and Mrs. Hans G. Abromeit and Mr. Jan Von Haeften.)

Under the partnership agreement which formed the limited partnership, an Advisory Board comprised of certain limited partners was constituted whose function was essentially to pass on important decisions of the partnership and to protect the interests of the limited partners. The partnership had its own auditors.

The defendant owned a 90 per cent interest in Amex Developments Limited (hereinafter referred to as “Amex”) and also a 90 per cent interest in Lehndorff Properties Limited. Through Amex, the defendant was involved in the development and resale of certain Canadian real estate located on St. Clair Avenue in Toronto, at the outset in conjunction with a certain Mr. Lempicki. Mr. Lempicki later quit claimed his shares in Amex to the defendant.

In or about March of 1970, the defendant, W.B. Sullivan Construction Limited (hereinafter called “Sullivan”), the Metropolitan Trust Company and LVG entered into an agreement to govern the development of certain lands located on Victoria Park Avenue in Toronto. The principal shareholder of Sullivan was Rifet Prusac. Pursuant to the agreement, interests in the recently incorporated Kashel Developments Limited (hereinafter referred to as “Kashel”) were allotted as follows:

Subsequently the five per cent interest of LVG was transferred to Navona Investments Limited (“Navona”) and Cocq Investments Limited (“Cocq”) in equal shares. Navona and Cocq are the private investment companies of Dr. and Mrs. Hans Abromeit and Mr. Jan Von Haeften respectively. The defendant, the Metropolitan Trust Company and LVG agreed to enter into a voting trust agreement whereby all of their shares would be voted by the Metropolitan Trust Company in accordance with directions given to it by the defendant and LVG. This agreement was reduced to writing on March 2, 1972.

Under the agreement of March 16, 1970, Sullivan agreed to transfer the lands on Victoria Park Avenue to Kashel in consideration of the assumption by Kashel of certain mortgages, the giving by Kashel of a mortgage to Sullivan and the payment of a certain amount of cash (which was secured by a mortgage in favour of the Metropolitan Trust Company as agent for the defendant and Sullivan). The obligation of the defendant under the agreement was to advance to Kashel 80 per cent of any additional funds necessary to develop the land and satisfy its liabilities. Sullivan was obliged to contribute 20 per cent of such necessary amounts. Although the defendant would have had no difficulty being responsible for 100 per cent, it was the defendant's view that requiring the 20 per cent of Sullivan would ensure a better business environment, namely a greater concern and commitment because of the 20 per cent contribution.

In or about August of 1971 Kashel purchased all of the common shares of Morenish Land Developments Limited (“Morenish") which in turn owned 49.9 per cent of the shares of Y & R Properties Limited (“Y & R’’) and, some time later, 73.5 per cent of the shares of Imperial General Properties Limited. On April 15, 1974, Kashel sold its .65 per cent of the shares of Y Y& R to Morenish giving Morenish 50.55 per cent of the Y & R Shares. On April 30, 1974 Kashel owned no shares directly in Y & R but the interest of Morenish in Y & R had increased to 52.37 per cent. Morenish, Y & R and Imperial General Properties were each in the business of developing Canadian real estate.

The following loans or subscription for preference shares were advanced or made by Canada Grund from 1970 to 1974 inclusive:

In the year 1971 the Canadian equivalent of one German Mark rose from .2770 to .30657. In preparing the Canada Grund financial statements for the year 1971, Deutsche Warentreuhand (the German auditors of Canada Grund) expressed concern about this fluctuation in the value of currency.

A letter agreement dated December 31, 1971 was entered into between Canada Grund, the defendant, Dr. Abromeit, Mr. Von Haeften and LVG whereby the defendant agreed to indemnify Canada Grund against certain exchange losses. These losses were to be paid out of the defendant's dividend income.

Between June and December of 1972 a mortgage loan which Canada Grund had advanced to Kashel was repaid. This repayment gave rise to an exchange loss of $140,899 in the hands of Canada Grund. The defendant had not yet received any dividend income from its subsidiaries, so it was unable to pay Canada Grund (pursuant to the December 31, 1971 agreement) the exchange losses suffered by it to that date.

By an agreement dated January 2, 1973, between the defendant and Canada Grund, the agreement of December 31, 1971 was amended.

Towards the end of 1973 and the beginning of 1974, the Foreign Investment Review Act and amendments to the Land Transfer Tax Act were proposed by the federal and provincial governments respectively. In response to these proposals, which were enacted on April 9, 1974, it was proposed by Dr. Abromeit on behalf of the defendant that the interests of the defendant be transferred to Lehndorff Corporation, the common shareholders of which were all Canadian residents. Mr. Prusac, the principal of Sullivan, objected strongly to this proposal and commenced an action in the Supreme Court of Ontario against the defendant, claiming $50 million damages and seeking an injunction preventing the proposed transfer. This action was eventually settled by Sullivan purchasing the interests of the defendant, Navona and Cocq in Kashel. This sale involved in part the repayment by Kashel of some loans To Canada Grund, the assignment of some other loans of Kashel to the purchaser and also resulted in the restructuring of Morenish's indebtedness with Canada Grund. These events triggered the obligation of the defendant to pay to Canada Grund the foreign exchange losses against which it had been indemnified in the letter agreement dated December 31, 1971 as modified by the agreement dated January 2, 1973.

The aggregate amount of exchange losses suffered by Canada Grund was $5, 059,370 plus interest in the amount of $163,537 in respect of loans to and investments in preference shares of corporations in which the defendant had a substantial interest.

The defendant paid those amounts to Canada Grund in 1974 and deducted in computing its income for the 1974 and deducted in computing its income for the 1974 taxation year the above sums of $5,059,370 and $163,537.

The Minister of National Revenue in assessing the defendant in respect of its 1974 taxation year refused to allow the deduction in computing its income of $5,222,907. The Minister also refused to allow the deduction of the sum of $5,222,907 as a loss on capital account.

As indicated earlier, the proposed Foreign Investment Review Act and new provincial Land Transfer legislation triggered the problems faced by the defendant. Given the necessity of Canadian ownership, and the defendant's proposal for a transfer to Lehndorff Properties Limited, and the refusal of Rifet Prusac to accept that proposal, the defendant, without consent, moved to make the changes they deemed essential. Mr. Prusac sued for $50 million which lawsuit was eventually settled, but the successful partnership between Dr. Abromeit and Mr. Prusac of course ended. I am satisfied on the evidence that had there been no changes to the legislation referred to above, the business would have continued because it had become so successful.

It was clear from the evidence that the two agreements signed in 1971 and 1973, requiring compensation for foreign exchange losses, did not envisage immediate payment, and indeed the first agreement limited repayment to one source, namely, dividends, and of course only when available. The subsequent agreement dated January 2, 1973 enlarged upon the sources it might look to for payment of the foreign losses but did not impose a deadline for repayment.

The lawsuit by Mr. Prusac was the catalyst that brought about the breakup of the successful business venture. With the termination came the obligation by the defendant to pay the foreign exchange losses.

Although the agreements were not attacked as a sham by the plaintiff, it was strongly argued that it was a poor piece of business by the defendant because it received no consideration and was really an accommodation to satisfy the auditors and the Advisory Board. I cannot agree. Dr. Abromeit, as good and as credible a witness as I've ever heard, made it quite clear that if money was to be raised and then loaned to the Canadian operation, the agreements had to be signed. This was his clearly stated evidence. He conceded that the lawyers might have been more thorough and put in more clauses or explanations, but there was no doubt in his mind that the consideration was the continued flow of money needed to purchase and develop properties; a failure to sign this obligation to compensate for foreign exchange losses would have jeopardized a significant flow of capital.

It was suggested in cross-examination, and also argued by counsel for the plaintiff, that other sources of funds were available which would enable the development to proceed. Not so, stated Dr. Abromeit because few financial institutions would lend beyond 80 per cent whereas with the funding from Europe 100 per cent was available, and, I dare say, with much less red tape. If proof were needed to support Dr. Abromeit’s opinion, one has but to look at the fact that after the lawsuit and the transfers that took place, Rifet Prusac had to look to the European source for the necessary mortgage money, not having been able to secure it from financial institutions, despite Prusac’s excellent business track-record. Before Dr. Abromeit began his partnership with Sullivan, in order to test its ability to meet commitments and to repay, that firm had been loaned money by way of mortgage and it was promptly repaid. Mr. Prusac’s business acumen in the development field was well established even before he and Dr. Abromeit got together, and I suggest was enhanced by that fortuitous business arrangement.

It was also suggested to Dr. Abromeit that he could have borrowed from the bank to pay dividends, and that in fact was possible and had occurred on other occasions. Dr. Abromeit condemned this and suggested it was not good business practice or good business ethics to engage in such a procedure except on a very short timeframe basis. His evidence here was straightforward and impressive.

As to the agreement being an accommodation, I have to disagree with the plaintiff. It is important to remember that at all times the General Partner was accountable to the independent auditors and to the Advisory Board before any funds could be advanced and forwarded from Germany. Certainly, as one of three members of the General Partner, Dr. Abromeit was in the best position imaginable to influence the flow of funds but that advice or recommendation was always subject to review and explanation.

It was Dr. Abromeit's considered business opinion, and his evidence emphasizes this, that to borrow the necessary funds in Europe, chiefly Germany, a clear certificate from the independent auditors was essential.

In summary then we have heard evidence about the nature of a “‘limited partnership" in Germany, the essential feature of the business arrangement between Canada Grund and the defendant, the obligation of the defendant to secure the financing of the properties to be developed (Mr. Prusac providing the skills of a developer), the essential ingredient that at least 80 per cent of the financing was to be provided by the defendant (Sullivan had a 20 per cent commitment which was later reduced as the business proved successful), and the necessity for this flow of funds from Germany because the amount of capital needed was not available from the usual financial institutions in Canada (and certainly not to the degree the defendant supplied).

The obligation to pay the exchange losses immediately was imposed by factors outside the control of the defendant, but it is clear the payment had to be made.

Other avenues may have been possible as a source of funding the foreign exchange losses but if so they have not been identified and no evidence was called by the plaintiff to establish this point. Dr. Abromeit left no room for doubt that other sources just were not available and methods suggested by the plaintiff were attacked either as poor business ethics or not good business practices.

In GABCO Limited v. M.N.R., [1968] C.T.C. 313 at page 323; 68 D.T.C. 5210 at 5216 Cattanach, J. wrote:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or this Court coming to the conclusion that no reasonable businessman would have contracted to pay such an amount having only the business consideration of the appellant in mind. [Emphasis is mine.]

In that case the amount paid to a son and a shareholder was in dispute. In this appeal we have the Minister suggesting other possibilities, in effect substituting the Minister’s judgment for that of the businessman Dr. Abromeit.

There is no doubt that the defendant was engaged in a business and expected significant profits. The defendant's obligation to the Kashel operation is clear also — to provide financing. Indeed Dr. Abromeit would not even approach Mr. Prusac about the defendant's obligation to pay foreign exchange losses because he knew Mr. Prusac would see that as the defendant's problem.

As to the extent of the defendant's liability in the 1971 and 1973 agreements, the figure of $5 million was put to the witness Dr. Abromeit by counsel for the plaintiff and the reply was: “‘Yes, that was certainly in the ballpark of our consideration. ’

The agreements were entered into for good business reasons and to produce a profit. The amount paid is clearly an expense within the meaning of paragraph 18(1)(a) of the Income Tax Act. The Minister's assumption was wrong, and as stated in argument by counsel for the defendant, “overwhelmingly demolished" and the assessment cannot therefore stand.

The appeal is dismissed with costs to the defendant.

Appeal dismissed.