The Queen v. Parsons, 84 DTC 6447, [1984] C.T.C 354, 84 DTC 6452 (FCA)

Urie, J:—This appeal from a judgment of the Trial Division was heard together with an appeal from a similar judgment in The Queen v Frederick G Vivian, Appeal No 434-83 so that the reasons herein shall apply with equal force to the Vivian appeal subject only to the appropriate adjustments in amounts necessitated by the circumstances applicable in the latter case and which amounts the parties have agreed upon, as I understand it. The Trial Division in this case allowed the respondent’s appeal from income tax assessments made by the Minister of National Revenue who had assessed as income of the respondent amounts paid by Newfoundland Design Associates Limited (“Design”) to Rex T Parsons Management Limited. In the Vivian case the name of the management company was Frederick G Vivian Management Limited and the respondent Vivian in that case had been assessed for income tax on amounts received by his management company from Design. The “management companies” will hereafter be so designated. In each case the personal assessments in issue are for their 1975, 1976, 1977 and 1978 taxation years.

The relevant facts upon which there is little dispute may be briefly stated. The shares of Design, which was incorporated in Newfoundland in 1963, were at all material times, owned equally by Parsons, Vivian and their respective wives, or by two holding companies, the voting shares of which were wholly owned by them. Design is an engineering firm. Parsons and Vivian are professional engineers licensed to practise their profession in Newfoundland. The management companies were similarly licensed as, presumably, was Design. From the date of Design’s incorporation until October 1, 1975, both the respondent and Vivian were employed by Design and rendered their engineering and management services to that company.

By Certificates of Incorporation dated September 30, 1975, the respondents Parsons and Vivian obtained voting control of their respective management companies. The objects of the companies were identical and need not be spelled out here. Suffice it to say, they were licensed to practise engineering in Newfoundland. Parsons and Vivian resigned from Design and became employees of their respective management companies. All the services which prior to October 1, 1975 they had performed for Design, were now rendered for their respective management companies. They received salaries for such services, as did their wives, from the management company bearing their names. Each management company performed services for Design for which that company was billed by the company performing the services although the work was entirely done by Parsons or Vivian, personally. The management companies entered into contracts with Design, the terms of which were strictly complied with. In fact, all documentation called for in establishing the relationships between Design, the management companies, certain trusts which were set up and Parsons and Vivian personally, was meticulously drawn and the terms strictly complied with by all parties — a fact conceded by counsel for the appellant.

Each management company maintained an office in the residence of its controlling shareholder and each had its own telephone listing. Services were offered to and performed for, clients other than Design, although the bulk of the work came from Design. Where services were required by either management company which they were unable to render themselves, Design usually, but not always, performed them and billed at the tariff rates prescribed by the Association of Professional Engineers of Newfoundland.

The learned trial judge reviewed all of the evidence relating particularly to the reasons advanced by them for the complex rearrangement of their business affairs but, for reasons that will be seen shortly, it is unnecessary for me to do so. The foregoing summary is sufficient to provide a factual understanding for the disposition which I propose for the appeals. In the result, the trial judge made the following key findings:

. . . I find that the interposition of the management companies (1) had no bona fide business purpose, (2) had, primarily, the purpose of directly reducing their income tax liabilities, (3) had, secondarily, an estate planning purpose which, in the absence of credible evidence to the contrary, must be taken to have also been solely motivated by tax and personal, not business, considerations and (4) was not a sham in the generally accepted legal sense of that word. I understand that to be the frequently cited opinion of Lord Diplock in Snook v London & West Riding Investments:

I apprehend that, if [sham] 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 . . . that for the 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” effect the rights of a party whom he deceived.

That definition appears recently to have been adopted in a number of judgments, in the context of the Income Tax Act, by the Federal Court of Appeal.* [1]

He then referred to decisions of this Court in MNR v Leon, [1977] 1 FC 249 at 256-7, Massey-Ferguson Limited v The Queen, [1977] 1 FC 760 at 772, Stubart Investments v The Queen, [1981] CTC 168; 81 DTC 5120 at 173 [5123] ff and Atinco Paper Products v The Queen, [1978] CTC 566; 78 DTC 6387 at 577 [6395]. After carefully considering the ratio decidendi of those cases, he concluded that, unlike the transactions or series of transactions in issue in Atinco and Stubart, which this Court held not to have accomplished what they purported to accomplish, in this case they did exactly what they purported to do.

. . . What was purported to be done was, in fact, done; what was done to achieve the desired result: the reduction of tax, was a valid, complete, transaction, or series of transactions, and nothing less. Only if the definition of “sham” adopted in Leon remains valid can the Plaintiffs fail. It is apparent from its later judgments that the Court of Appeal has not taken the refusal of leave to appeal by the Supreme Court of Canada as approving that definition. Those later judgments raise doubts as to its validity.

The law is not clear. In tax matters, while the burden of proof of facts rests generally upon the taxpayer, the burden of demonstrating that the law clearly imposes the tax sought to be levied invariably rests upon the fisc. [sic] The appeals from the assessments are allowed with costs.

It is from those judgments that these appeals were brought in Toronto.

Argument on the appeals commenced on June 6, 1984 but did not conclude on that day. As a result, the hearing was adjourned to resume in Ottawa on June 25, 1984 and was completed on that day. In the meantime, the Supreme Court of Canada pronounced judgment on June 7, 1984 in the appeal from the judgment of this Court in Stubart Investments Limited v The Queen, supra. Each of the parties was given an opportunity to prepare and file supplementary memoranda of fact and law as to the effect of the Stubart decision on the cases at bar. Each counsel availed himself of this opportunity and, in fact, the appeals were fully argued both on the pre- and post-Stubart arguments. It is my opinion that that decision effectively disposed of all attacks on the impugned judgments, for the reasons which I shall set out briefly hereafter.

In his original memorandum of fact and law, counsel for the appellants couched his objection to the judgments appealed from in the following way:

The Deputy Attorney General of Canada respectfully submits that the learned trial Judge after concluding that

(a) the interposition of the management company had no bona fide business purpose;

(b) by the definition of sham as determined by this Court in Leon

“. . . the interposition of the management companies was a sham.”

(c) the facts of the present case are not different from Leon

erred at law in failing to conclude that the Leon decision of this Court governed the present appeals.

Mr Justice Estey in the Stubart case, after discussing the three House of Lords decisions in W T Ramsay Ltd v IRC (1981), 2 WL R 449, CIR v Burmah Oil Co Ltd (1981), 42 TR 535 and Furniss (Inspector of Taxes) Appellant v Dawson, et al (as yet unreported, delivered by the House of Lords on February 9, 1984) as they relate to the necessity for a transaction to have a “business purpose” if it 1s, perhaps, successfully to survive scrutiny in tax avoidance schemes, put the issue in the Canadian context in this passage from his reasons for judgment at 308 [6317]:

. . . Section 137 might arguably apply on the grounds that the transaction falls within the reach of the expression “artificial transaction” but the taxing authority has not advanced this position in support of the tax claim here made. However, there remains the larger issue as to whether Canadian law recognizes, as a principle of interpretation, that the conduct of the taxpayer, not dictated by a genuine commercial or business purpose, and being designed wholly for the avoidance of tax otherwise impacting under the statute, can be set aside on the basis of Furniss, supra, or Helvering, supra, as though the transaction were, in fact and in law, a “sham”.

After a thorough analysis of applicable case law from the United Kingdom, the United States, Australia and Canada, Mr Justice Estey concluded at 314 [6322] that:

I would therefore reject the proposition that a transaction may be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose. . . .

Later on, in the guidelines he propounded for the use of courts in such cases, Estey, J said that where the facts record no bona fide business purpose for a transaction, section 137 [now 245] may be found to be applicable. That section was not relied upon by the appellant in these appeals.

The first of the alleged errors in the trial judgment is thus disposed of since the learned trial judge had found that, although there was no real business purpose in the creation of the management companies, the transactions were valid, subsisting, were what they purported to be and were both acted upon and relied upon by the parties. In other words, the lack of business purpose was, in the circumstances of these cases, irrelevant for the purposes of determining whether or not their income should be taxable in their hands.

As to the allegation that “the interposition of the management of the management companies was a sham” according to the definition of sham in the Leon case, Estey, J had this to say at 312 [6319]:

. . . Leon, supra, at its highest is a modification of the sham test, but it seems to me to have been isolated on its factual base by Massey-Ferguson, supra.

At page 313 [6320] he reiterated that the Supreme Court of Canada in MNR v Cameron, [1974] SCR 1062 at 1068 had adopted the definition of sham restated by Lord Diplock in Snook v London and West Ridings Investments, Ltd, supra, who found that no sham was there present because no acts had been taken:

. . . which are intended by them to give to third parties or to the courts 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.

Since counsel for the appellant conceded that, using this test, there was no sham in these cases, the second allegation of error fails.

As to the facts here being not different from those in Leon, I merely need say that the transactions in these appeals were found by the trial judge to be valid and complete transactions in every respect. I agree with that conclusion. They were, thus, unlike those in Leon and Atinco, supra, in that they were in law valid, fully complete transactions in the same way that the transaction in the Stubart case was found by the Supreme Court to be. The third allegation of error cannot, therefore, withstand scrutiny.

Upon the resumption of the appeals, counsel for the appellant argued that

(a) the moneys paid to the management companies, should be taxed in the hands of those who earned it, namely, Parsons and Vivian;

(b) the income in dispute was not income from a business carried on by the management companies on their own behalf — at most, at law, the only relationship created by Parsons and Vivian with their respective management companies was but a simple agency relationship between them and the bare incorporations so established;

(c) the income in dispute is income from employment and as such is not the income of the management companies — it is the income of Parsons and Vivian who earned it;

(d) the fact of its diversion does not alter its taxability whether pursuant to legal arrangements or otherwise, and

(e) the appearance created by the documentation is not reality.

Dealing with (e) first, I gather that this means the transactions must be shams. The trial judge found them not to be shams and, as I understood him, appellant’s counsel conceded that “sham” within the Snook definition thereof, was not present on the facts of this case. That he was found to make such a concession is clear from the record as I read it. This ground, therefore, must fail.

As to the other four grounds, the facts and circumstances all lead “inexorably to the conclusion” that the formation of the management companies, the resignation of Parsons and Vivian from Design, their employment by the management companies, the operation of those companies in the business of professional engineering whose major, but not only, client was Design, from premises distinct from Design and without one tittle of evidence of an agency relationship with anyone, were full, complete and legal transactions. The two management companies were not “bare incorporations” — they were fully clothed with all the legal relationships properly documented and acted upon. To ignore them would be to ignore the legal realities of corporate entities and the complete transactions created by the valid agreements which they entered into, particularly those between the management companies and Design. Neither Parsons nor Vivian was ever entitled to receive directly the amounts paid by Design to the management companies pursuant to those agreements nor could they, personally, have sued Design for the recovery of unpaid moneys. There is absolutely no evidence that the moneys received from Design were received as an agent, trustee or nominee of either Parsons or Vivian. The evidence is all to the contrary. Therefore, these attacks, too must fail.

I should not leave this appeal without quoting Mr Justice Estey at 313 [6320] of his opinion. It is wholly applicable to these appeals and brings the fallacy of the appellant’s case into sharp focus in respect of the element of sham which, while certainly not so couched, has to be the essence of the appellant’s supplementary argument.

.. . The documents establishing and executing the arrangement between the parties were all in the records of the parties available for examination by the authorities. There has been no suggestion of backdating or buttressing the documentation after the event. The transaction and the form in which it was cast by the parties and their legal and accounting advisers cannot be said to have been so constructed as to create a false impression in the eyes of a third party, specifically the taxing authority. The appearance created by the documentation is precisely the reality. Obligations created in the documents were legal obligations in the sense that they were fully enforceable at law.

There is, in short, a total absence of the element of deceit, which is the heart and core of a sham. The parties, by their agreement, accomplished their announced purpose. The transaction was presented by the taxpayer to the tax authority for a determination of the tax consequence according to law. I find no basis for the application in these circumstances of the doctrine of sham as it has developed in the case law of this country.

For all of the foregoing reasons the attempts to distinguish the Stubart case fail. I would, accordingly, dismiss both appeals with costs.