The Queen v. Lehmann Bookbinding Ltd., 95 DTC 5063, [1995] 2 CTC 129 (FCTD)

Rothstein J.:—This is an appeal by way of trial de novo from a decision dated February 26, 1992 of Judge Taylor of the Tax Court of Canada, in which he allowed the appeal of the taxpayer ("Lehmann") against assessments made by The Queen (the Minister of National Revenue) ("the Minister") for Lehmann’s fiscal years ended September 30, 1983, 1984 and 1985.

The issue is whether Lehmann’s profits are applicable to the manufacturing or processing in Canada of goods for sale. If they are, Lehmann, a Canadian-controlled private corporation, is entitled to a reduced rate of tax under paragraph 125.1(1)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), an investment tax credit under subsection 127(5) of the said Act in respect of the investment in qualified property, that is, property to be used primarily for the purposes of manufacturing or processing of goods for sale in Canada, and accelerated Capital cost allowance in respect of qualified property under the Income Tax Regulations, C.R.C. 1978, c. 945, Schedule II, Class 29.

These provisions are income tax incentives designed to encourage the production of Canadian manufactured and processed goods to be placed on domestic and foreign markets in competition with foreign manufacturers. The government’s reasons for enacting the provisions, as enunciated by the Minister of Finance are described in Hawboldt Hydraulics Inc. Estate (Trustee of) v. Canada (sub nom Coopers & Lybrand Ltd. v. Canada, [1994] 2 C.T.C. 2244, 94 D.T.C. 6541 (F.C.A.).

Canadian manufacturing and processing profits are defined in subsection 125.1 (3) of the Income Tax Act:

125.1 (3) Definitions .-In this section,

"Canadian manufacturing and processing profits".-Canadian manufacturing and processing profits of a corporation for a taxation year means such portion of the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under rules prescribed for that purpose by regulation made on the recommendation of the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease; and....

[Emphasis added.]

In the case at bar, the parties are agreed that Lehmann’s profits in question are applicable to manufacturing or processing in Canada. The issue is whether Lehmann manufactures or processes goods for sale. Lehmann says its profits arise from the manufacturing and processing in Canada of goods for sale. The Minister says that Lehmann sells labour and material. As such, he says, the lower rate of tax, investment tax credit and accelerated capital cost allowance applicable to manufacturing or producing in Canada of goods for sale is not applicable to Lehmann.

Lehmann’s business is commercial bookbinding. Approximately 70 per cent of its business involves the binding of issues or volumes of periodicals such as law reports or newspapers for libraries, educational institutions and other businesses or governments. Approximately 25 per cent of its business involves the binding of monographs, that is, printed material not in a series, such as a novel or thesis. Less than 5 per cent of its business is the restoration of old books such as old bibles. In all cases, the material to be ’’hard bound" is owned by the customer. If Lehmann loses or destroys a periodical, Lehmann must replace it. Where a customer’s material cannot be bound because of its condition, Lehmann manufactures and sells containers to hold the material, although, it appears this constitutes a very small proportion of Lehmann’s business.

Commercial bookbinding involves the examination and collating of all incoming customers’ volumes or periodicals, attaching leaves by sewing or the use of adhesives, trimming, rounding and backing of text blocks to form a smooth convex spine and the making of covers by cutting boards and covering them with cloth, leather or other material and affixing the covers to the customers’ material. Of course, the process is much more detailed and involves many intricate stages and the use of sophisticated machinery, equipment and personnel. Lehmann presented a videotape produced by the Library of Congress of the United States in conjunction with the Library Binding Institute, to which Lehmann belongs, which, together with the evidence of Mr. William Lehmann, described the book binding process in detail.

Lehmann has been in business since 1917. It is located in Kitchener, Ontario. In 1985, its sales approximated $1.3 million annually and it had approximately $700,000 in assets. Today, its annual revenues exceed $3 million and its assets are $1.6 to $1.7 million. It has 71 full and part-time employees.

At the relevant time, Lehmann was not exporting to the US or experiencing import competition from the US. However, at least one of Lehmann’s Canadian competitors does export to the US at this time.

Until August 1994, there were two lines of cases in respect of ’’the goods for sale" issue. One line arose from cases such as Nows co Well Service Ltd. v. The Queen, [1990] 1 C.T.C. 416, 90 D.T.C. 6312 (F.C.A.). Under this approach, as long as there was a sale of some goods produced by the taxpayer, the fact that work or labour was also included, did not exclude application of the relevant incentive provisions of the Income Tax Act. The reasoning of Reed J. in Halliburton Services Ltd. v. The Queen, [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.); aff d [1990] 1 C.T.C. 427, 90 D.T.C. 6320 (F.C.A.), was adopted by Urie J.A. in Nowsco, supra.

1. The relevant provisions of the Income Tax Act do not require that a taxpayer’s profits arise out of contracts for the sale of goods as defined by provincial Sale of Goods Acts;

2. There is no requirement that the contract be limited to the sale of goods and not be one of a more extensive nature involving work and labour as well as the supply of goods.

In essence, their view was that as long as there were some goods produced by the taxpayer which were included in the contract of sale, the relevant requirements of the Income Tax Act were met.

The other line of thinking originated with Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5426 (F.C.T.D.), in which the distinction between a contract for sale of goods and a contract for work and materials was recognized as relevant to a determination of eligibility under section 125.1. In that case Strayer J., as he then was, concluded that Parliament, in using the words "goods for sale or lease" in the relevant provisions of the Income Tax Act, must have had reference to the general law of sale or lease in order to give precision to that phrase in a particular case.

In Hawboldt Hydraulics Inc., supra, the Federal Court of Appeal has now adopted the approach of Strayer J. in Crown Tire, supra. The Court held that Parliament, in using the term "goods for sale or lease" had reference to the general law of sale or lease. Isaac C.J., at page 344-45 (D.T.C.

6548) of Hawboldt Hydraulics Inc. states:

I am of the opinion that the appeal should succeed and the submissions of the respondent be rejected for the following reasons. First, it is clear from the total context of the legislation, including the passages from the House of Commons Debates to which I have referred, that Parliament’s objective in enacting the legislation was encouragement of increased production of manufactured and processed goods to be placed on the domestic and international markets in competition with foreign manufacturers. That that is the activity which Parliament sought to encourage is, to my mind, plain from the debates. It is equally plain that Parliament intended to benefit manufacturers and processors who engaged in those activities. In other words, the relevant statutory provisions were designed to give Canadian manufacturers and processors an advantage over their foreign competitors in the domestic and foreign markets. It is also clear that Parliament had in mind specific target groups and specific target activities. The legislation was not intended to benefit every manufacturing activity or every manufacturer. The language of the statute is clear that the activities to be benefitted were the manufacture of goods for sale or lease and the beneficiaries, the manufacturers engaged in that activity. This is the short answer to those who say that the Crown Tire approach yields illogical results or results in a formalistic splitting of taxpayers’ activities. In my view, that is the background against which the clause should be understood and construed.

As I have said, Parliament did not define the phrase "for sale or lease" in the legislation. How then should its meaning be determined? We are invited by the modern rule of statutory interpretation to give those words their ordinary meaning. But we are dealing with a commercial statute and in commerce the words have a meaning that is well understood. In the common law, "for sale" does not mean "for use in a repair process". And I doubt that any informed commercial person would seriously say that the manufacture of parts to be used to repair a customer’s defective equipment was a manufacture of those parts for sale. Strayer J. was right, in my respectful view, to say in Crown Tire at page 415 (D.T.C. 5428) that

One must assume that Parliament, in speaking of "goods for sale or lease" had reference to the general law of sale or lease to give greater precision to this phrase in particular cases.

It is readily apparent that the facts in the case at bar are very close to those in Crown Tire. In Crown Tire the taxpayer affixed new treads to old tire casings belonging to customers. In the case at bar, Lehmann affixes hard binding to journals, newspapers and monographs owned by its customers. The only difference of any significance might be that in the case of tire repairs, a customer’s defective or inadequate tires are being repaired while in the case of bookbinding, a customer’s "loose materials" are being upgraded or are being given a greater degree of permanence; repairs are not involved. This raises squarely the question of whether Lehmann’s circumstances may be distinguished from those in Crown Tire.

In Crown Tire, Strayer J. based his decision on the distinction between contracts for sale of goods and contracts for work and materials as explained in Benjamin’s Sale of Goods, now 4th ed., (London: Sweet & Maxwell, 1992), in which the following appears at page 37:

Chattel to be affixed to land or another chattel. Where work is to be done on the land of the employer or on a chattel belonging to him, which involves the use or affixing of materials belonging to the person employed, the contract will ordinarily be one for work and materials, the property in the latter passing to the employer by accession and not under any contract of sale. Sometimes, however, there may instead be a sale of an article with an additional and subsidiary agreement to affix it. The property then passes before the article is affixed, by virtue of the contract of sale itself or an appropriation made under it. Obviously, the question whether the intention of the parties is substantially one of improving the land or principal chattel (to which the furnishing of materials is incidental) on the one hand or one of making a sale (to which the agreement to affix is incidental) on the other hand is a matter of degree, which may be difficult to determine in practice; but there is no theoretical difficulty....

The general principle seems to be that where material is to be affixed to property belonging to a customer, the contract is one for work and materials, with the property in the material passing by accession. Sometimes, however, there may be a sale of an article with a subsidiary and incidental agreement to affix it to property owned by the customer, in which case the property in the material will pass under a contract of sale of goods.

In Crown Tire, Strayer J. found that tire retreading fit within the general principle as stated in Benjamin. He wrote at pages 414 (D.T.C. 5428-29):

I believe that the situation here fits within the general principle as stated in Benjamin. With respect to the retreading of tires owned by customers, it appears to me that the customers retain ownership throughout the process.... Where a tire was retreaded, it would be returned to the same customer who supplied it. This suggests to me that the casing was seen throughout as being the property of the customer and the work and materials provided by Crown Tire were applied to that casing. This involved essentially a contract for repairs. Once the rubber material was affixed to the casing it would become the property of the owner of the casing by accession. That material could therefore not be the subject of a contract of sale since it merged with the customer’s property at the time of adhesion to it.

It appears to me that the most relevant precedents support this interpretation. In Sterling Engine Works v. Red Deer Lumber Co. (1920), 51 D.L.R. 509 (Man. C.A.) the Manitoba Court of Appeal held that where two steel plates were attached by the plaintiff to the defendant’s locomotive to repair the fire box the title in the plates passed to the defendant not by sale but by accession. In reaching this conclusion Dennistoun J.A., noted that there was no evidence to suggest that the plaintiff was a vendor of, or dealer in, steel plates and that they merely used steel plates in the course of repairing the locomotive. Similarly in the present case the evidence indicated that the plaintiff company did not sell ’’tire treads" to anyone without them being affixed to a tire casing. This reinforces the view that the provision of tire treads in the retreading process was not seen as a contract of sale.

The Sterling Engine Works case was followed by the Nova Scotia Supreme Court, Appeal Division in Scott Maritimes Pulp Ltd. v. B.F. Goodrich Canada Ltd. (1977), 72 D.L.R. (3d) 680 where it was held that a contract for replacing a rubber cover on a press roll is a contract for labour and materials and not for the sale of the rubber cover. More pertinent, perhaps, is the decision of the Exchequer Court of Canada in R v. Boultbee Ltd., [1938-39] C.T.C. 78, 1 D.T.C. 443. That case also involved a tire retreading business and the issue was whether the retreading of tires resulted in ’’goods produced or manufactured" by the defendant so as to make those tires subject to sales tax and excise tax....

The most important factor in establishing that Crown Tire’s contracts for retreading customers’ tires were contracts for work and material is, in my view, the fact that the work was done to a tire casing which the customer owned throughout. I think this distinguishes the present situation from those involved in many of the decided cases where the customer had never previously owned any part of the end product.

While the distinctions employed here may seem somewhat technical and remote from revenue law, one must assume that Parliament in speaking of "goods for sale or lease" had reference to the general law of sale or lease to give greater precision to this phrase in particular cases.

I find it difficult to distinguish the facts of the case at bar from Strayer J.’s reasoning as outlined above. I therefore turn to the arguments made by counsel for the taxpayer.

Counsel for the taxpayer says that the general rule in Benjamin, upon which Stayer J. relied, is not absolute. I agree it applies only ’’ordinarily’’. But the exception seems to be fully accounted for by Benjamin. Where there is a contract for sale of goods and an additional or subsidiary agreement to affix them to the chattels of the customer, the contract may still be characterized as one of sale of goods. That is not the case here. No actual form of contract was introduced into evidence, but I infer from the evidence that was given that there is only one stage in the contractual relationship between Lehmann and its customers. The customer seeks the binding of loose material. The affixing of materials and the work of binding is considered as one for contractual purposes. The taxpayer’s price list makes no distinction between goods and labour, and if anything, emphasizes the importance of the skill and work to be provided by Lehmann and not the materials to be supplied.

Nothing in Lehmann’s invoices suggests a sale of goods as such. The taxpayer’s invoices and statements refer, for example, to ’’binding 2 vol. books", "making 1 portfolio", "imprinting 8 call nos.’’. I am unable to conclude that Lehmann’s situation is not the ordinary one envisaged by Benjamin.

It is then submitted that this is not an accession case but one in which the materials are supplied by both the customer and Lehmann and there is a transformation of the materials into a new product, 1.e., a hard bound book. Reliance is placed on Dixon v. London Small Arms Co., [1876] 1 A.C. 632 (H.L.). However, unlike the case in Dixon, as described in Benjamin at page 38, here there is no sale or supply of materials by the customer to Lehmann at an agreed price the amount of which is first included, and then deducted, from the selling price of the hard bound book. As with tire treads in Crown Tire, in the case at bar hard binding materials are affixed to the customers’ loose volumes. I must conclude that this case is, indeed, one of property passing by accession.

Counsel for Lehmann also argues that the Crown Tire approach is referable to "repair" cases and, indeed, many of the cases, and the terminology used by the Federal Court of Appeal in Hawboldt Hydraulics Inc., refer to repairs. However, the legal distinction here, based on the general law of sale or lease, is whether the contract between the purchaser and vendor is one for the sale of goods or one for the provision of work and materials. In Crown Tire, Strayer J. says that the most important factor was that the work was to be done to a tire casing which was owned by the customer throughout. In the case at bar, the journals and other documents to which hard binding is affixed are owned by the customers throughout. I am unable to attach legal significance to the distinction between repair and non-repair cases where the contracts covering each are for work and materials.

Counsel for Lehmann also argues that Lehmann paid provincial and federal sales tax at the relevant time and that such taxes are applicable to sales of goods. However, the liability for those taxes arises under their own Statutes. The precise provisions of those statutes were not provided to me. In any event, I do not think that it automatically follows that because a taxpayer pays provincial or federal sales tax, its profits are derived from the manufacturing or processing in Canada of goods for sale, as that term is used in the Income Tax Act.

Nor is it significant that Lehmann’s financial statements refer to "sales", "cost of goods sold" or "inventory". These are designations provided by Lehmann’s accountants. In circumstances such as in the case at bar, the designations used by accountants in financial statements have no bearing on whether or not Lehmann is entitled to the relevant incentives provided by the Income Tax Act.

Lehmann’s counsel says that Lehmann assumes a risk inherent in the sale of goods because its sales are based on a price list in which there is no breakdown between labour and materials. I acknowledge that Lehmann does assume a greater risk than if its sales were made on a cost plus or other basis in which the risk of not covering all costs would be reduced or eliminated. But I do not see how the assumption of risk associated with selling according to a price list, which does not distinguish between labour and materials, converts a sale from one of labour and materials to one of goods.

Lehmann’s counsel also argues that the warranty applicable to Lehmann’s contracts is indicative of a contract of sale of goods. The warranty states:

Warranty: We warrant that the binding represented by us as conforming to the Library Binding Institute Standard For Library Binding complies with all requirements of the Library Binding Institute Standard For Library Binding as amended. This statement is made pursuant to sections 2.0 and 3.0 of the Library Binding Institute Standard for Library Binding issued by the Library Binding Institute, and applicable federal and state laws relative to representations by a seller to a purchaser regarding the quality of a product and its adherence to a standard.

There is no doubt that what is normally being sold includes materials as well as labour. However, the fact that Lehmann sells according to a warranty that refers to a "product", does not mean that the sale is one of goods and not one for labour and materials. Warranties are often given to cover repairs or other services in which materials are also supplied. The fact that a warranty refers to "product" is not determinative.

Conclusion

Provisions of the Income Tax Act often involve "line drawing" by Parliament. The question in this case is where Parliament has drawn the line and whether Lehmann’s transactions fall on one side of the line or the other. As recognized by Isaac C.J. in Coopers & Lybrand, in using the words "goods for sale or lease" Parliament must have intended to exclude certain types of manufacturing and processing from the income tax incentives at issue here.

One approach to interpreting the words "goods for sale" is by reference to the general law of sale or lease. However, having regard to the purpose of the income tax incentives, it is not obvious to me why Parliament would have drawn the line between profits eligible for these incentives, and those not, based on the common law distinction between a contract for the sale of goods on the one hand, and contracts for labour and materials on the other. Nonetheless, I am bound by Hawboldt Hydraulics.

The Minister’s appeal must be allowed.

Appeal allowed.

Minister of National Revenue v. Sand Exploration

[Indexed as: Sand Exploration Ltd. et al., M.N.R. v.]

Federal Court-Trial Division (Rothstein J.), on application for an order to suspend the operation of orders made pursuant to section 231.2, June 5, 1995 (Court File No. T-243-95).

Income tax-Federal-Income Tax Act, R.S.C. 1985, c. 1 (5th Supp)-231.2-Canadian Charter of Rights and Freedoms-8-Federal Court

The respondents applied for an order suspending the operation of orders made pursuant to section 231.2 requiring the respondents to provide information relating to unnamed persons. Although the respondents filed no evidence, the motion stated that the orders had been appealed to the Federal Court of Canada. In addition, counsel for the respondents made submissions to show that there was a serious issue at stake, that the respondents would suffer irreparable harm, and that the balance of convenience favoured the respondents. In particular, counsel argued that there was irreparable harm because the appeal would be rendered nugatory if the stay was not granted. On the other hand, the Minister filed evidence showing that he would suffer irreparable harm by further delay because such delay could result in his assessments becoming statute-barred.

HELD:

A court can only make decisions based on evidence and the respondents did not file any evidence. The assertions in the motion and the submissions of counsel are not evidence. Furthermore, even if the refusal to grant a stay renders the appeal nugatory, that is not synonymous with irreparable harm. There must be some evidence as to why the disclosure required by the orders would cause irreparable harm to the respondents. The court cannot be left to speculate. The respondents did not prove irreparable harm. Finally, the Minister did file evidence demonstrating that he would suffer irreparable harm if further delay resulted in limitation periods being missed, thereby causing him to lose the opportunity to reassess taxpayers. Application dismissed.

Max Weder for the applicant.

Lorne Scott for the respondent.

Rothstein J.:-Th is is an application for an order suspending the operation of orders made pursuant to section 231.2 of the Income Tax Act requiring the respondents to provide information relating to unnamed persons. The motion states that the orders have been appealed to the Federal Court of Appeal and that it is just in the circumstances to suspend the orders pending appeal. Reliance is placed on Rule 341 A.

In the case of an application to stay execution of a court order, the Court will normally consider whether there is a serious issue at stake, irreparable harm to the parties and the balance of convenience.

No evidence was filed in support of these considerations by the respondents. The Minister filed evidence in opposition to the motion for the stay.

Nonetheless, even in the absence of evidence, counsel for the respondents says it is obvious there is a serious issue. For example, he says there is a question as to whether section 231.2 of the Income Tax Act contravenes section 8 of the Charter of Rights and Freedoms in respect of the requirement on third parties to disclose the names of unnamed persons. He also says it is obvious that the appeal will be rendered nugatory if the stay is not granted and that this constitutes irreparable harm. In terms of the balance of convenience, he says the respondents are innocent third parties who are not the subject of reassessment by the Minister.

Counsel for the Minister denies there is a serious issue. He says the decision appealed from is based on factual considerations with which the Court of Appeal will not interfere. As to irreparable harm, he says the Minister will suffer such harm by further delay. The affidavit of Brian Kennedy dated June 1, 1995, concludes:

As a result, if the order of Mr. Justice Rothstein is stayed than [sic] the taxation years of any unnamed purchasers of the seismic data in 1990 and 1991 are most likely becoming "statute- barred" under subsection 152(4) of the Income Tax Act [if they have not already become so] and that unless misrepresentation is involved, the Minister of National Revenue will be unable to reassess those taxation years.

This stay application must be dismissed if for no other reason than for lack of evidence. It is fundamental that a Court may only make decisions based on evidence. While I do not doubt the words of the motion that a notice of appeal has been filed, the motion is merely the submission of counsel. The assertions in a motion do not constitute evidence. I have no evidence before me to prove that the notice of appeal has been filed. Without that evidence there is no basis for the stay application.

However, even if a requirement that there be evidence that a notice of appeal has been filed might be considered unnecessarily particular (which I do not concede), and even if a serious issue might be derived from a reading of the reasons appealed from, irreparable harm certainly requires cogent evidence. Even if the refusal to grant a stay renders an appeal nugatory, this is not synonymous with irreparable harm. The Court has said on numerous occasions that evidence of irreparable harm must be clear and not speculative. The respondents, by the orders sought to be stayed, are required to disclose the names of unnamed persons which, if they are successful on appeal, they would not be required to disclose. But there is no evidence of the consequences to the respondents of such disclosure. There must be some evidence as to why such disclosure would cause irreparable harm to the respondents. The Court cannot be left to speculate. The respondents have not proven irreparable harm.

While the failure of the respondents to prove irreparable harm is, in my view, fatal, I would add that the Minister has filed evidence demonstrating why he will suffer irreparable harm if delay results and limitation periods are missed, thereby causing him to lose the opportunity to reassess taxpayers.

In the absence of evidence supporting the stay application by the respondents, and having regard to the evidence filed by the Minister, I must dismiss this stay application.

Application dismissed.

Minister of National Revenue v. Sand Exploration

[Indexed as: Sand Exploration Ltd. et al., M.N.R. v.]

Federal Court-Trial Division (Rothstein J.), on review of an order of Muldoon J. of the Trial Division, May 19, 1995 (Court File No. T-243-95).

Income tax-Federal-Income Tax Act, R.S.C. 1985, c. 1 (5th Supp)-18(l)(a),

By way of ex parte application, the Minister was granted an order which required the respondents to provide a list of all persons who had been sold seismic data relating to certain properties. The Minister required that the list include the full names and addresses of the purchasers and the dates seismic data were purchased. On March 6, 1995, within 15 days of service of the order, the respondents brought a motion under subsection 231.2(5) for a review of the authorizations granted by the court. There were two issues: (a) whether section 231.2 entitled the Minister to obtain a court authorization to require third parties to provide the names of taxpayers who the Minister believed were not complying with the Act, and (b) if section 231.2 provided such entitlement, whether the evidence in this case was sufficient to justify the court issuing such an authorization. The evidence revealed that the four respondents were in the business of selling seismic data -data which may indicate the location of oil or gas far underground. This data was sold to investors. The Minister’s first concern was that the sale price of the seismic data was inflated solely for the purpose of providing an excessive tax deduction for those investors. In addition, since the evidence of exploration activity arising from the sale of the seismic data was non-existent or inadequate, the Minister was also concerned that there was no bona fide intention to explore for oil or gas using the seismic data and therefore the purchases of the seismic data had no business purpose and were not deductible in their entirety.

HELD:

With respect to the first issue, subsections 231.2(2) and (3) refer to information or documents "relating to one or more unnamed persons". In view of such provision, it would be pointless to permit the Minister to obtain information about unnamed persons without naming the persons. Accordingly, there was no absolute prohibition from obtaining the names of taxpayers from third parties. With respect to the second issue, paragraph 231.2(3)(a) and (b) were complied with because the group of unnamed persons, purchasers of seismic data from the four respondents, was ascertainable. Paragraph 231.2(3)(c) was also complied with because there was direct evidence from K, an auditor with Revenue Canada, which supported his concern that the purchases of seismic data were not made for business purposes or as exploration expenses. Finally, paragraph 231.2(d) was complied with because there was no partnership or other tax shelter in which it was reasonable to expect that each investor would know the names of other investors. Accordingly, the information required was not otherwise more readily available. In the result, the Minister had complied with all the requirements of subsection 231.2(3) and such compliance ensured that the Minister, in seeking the names of unnamed taxpayers from third parties, was not conducting a fishing expedition, but a serious inquiry. Application dismissed.

Mr. Weder for the applicant.

Mr. Scott and Mr. Zang for the respondents.

Cases referred to:

James Richardson & Sons, Ltd. v. M.N.R., [1984] 1 S.C.R. 614, [1984] C.T.C. 344, 84 D.T.C. 6325;

R. v. Bruyneel, [1986] 1 C.T.C. 295, 86 D.T.C. 6119;

The Queen v. 311326 Alberta Ltd., [1993] A.J. No. 25; The Queen v. Duncan, [1991] 2 C.T.C. 360, 91 D.T.C. 5615.

Rothstein J.:-This is a review, pursuant to subsection 231.2(5) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), of an order of Muldoon J., a judge of this Court. The sequence of events giving rise to this review are as follows:

On or about February 6, 1995, the applicant Minister of National Revenue ("Minister"), by way of ex parte application, applied to this Court for an order, pursuant to subsection 231.2(3) of the Act, authorizing the imposition of requirements by the Minister on the respondents pursuant to subsection 231.2(1). Under the requirements, the respondents were to provide a list of all persons who had been sold interests in certain seismic data. In support of the application the Minister relied upon the affidavit of Brian Kennedy dated January 31, 1995.

Muldoon J. granted the orders requested by the Minister and ordered the respondents to provide a list of all persons who were sold seismic data relating to certain properties. The Minister required the list include the full names and addresses of the purchasers and the dates seismic data were purchased. No other information was requested because, according to counsel, all other information could be obtained from the purchasers once they are known and contacted.

On or about March 2, 1995, the Minister forwarded to the respondents the requirements authorized by the order of Muldoon J. The requirements provided that the information was to be supplied within 30 days of that date (March 2, 1995).

On March 6, 1995 the respondents brought a motion returnable on March 7, 1995 for, amongst other things, a review of the authorizations granted by Muldoon J. The motion was adjourned on consent to April 27, 1995 and was further adjourned to May 11, 1995 to enable counsel for the respondents to cross-examine Mr. Kennedy on his affidavit.

The issues on this application of the respondents are: (a) whether section 231.2 of the Act entitles the Minister to obtain a court authorization to require third parties to provide the names of taxpayers who he believes are not complying with the Act, and (b) if section 231.2 provides such entitlement, whether the evidence in this case is sufficient to justify the Court issuing such an authorization.

The respondents also challenged the constitutional validity of section 231.2 as being in contravention of section 8 of the Canadian Charter of Rights and Freedoms which involves unreasonable search and seizure. However, the respondents did not comply with section 57 of the Federal Court Act, R.S.C. 1985, c. F-7 which requires at least ten days’ notice to the Attorney General of Canada and all provincial Attorneys General of the constitutional challenge. As a result the constitutional issue was not argued before me.

Section 231.2 provides:

231.2(1) Notwithstanding any other provision of this Act, the Minister may, subject to subsection (2), for any purpose related to the administration or enforcement of this Act, by notice served personally or by registered or certified mail, require that any person provide, within such reasonable time as is stipulated in the notice,

(a) any information or additional information, including a return of income or a supplementary return; or

(b) any document.

(2) The Minister shall not impose on any person (in this section referred to as a "third party") a requirement under subsection (1) to provide information or any document relating to one or more unnamed persons unless he first obtains the authorization of a judge under subsection (3).

(3) On ex parte application by the Minister, a judge may, subject to such conditions as he considers appropriate, authorize the Minister to impose on a third party a requirement under subsection (1) relating to an unnamed person or more than one unnamed person (in this section referred to as the "group") where the judge is satisfied by information on oath that

(a) the person or group is ascertainable;

(b) the requirement is made to verify compliance by the person or persons in the group with any duty or obligation under this Act;

(c) it is reasonable to expect, based on any grounds, including information (statistical or otherwise) or past experience relating to the group or any other persons, that the person or any person in the group may have failed or may be likely to fail to provide information that is sought pursuant to the requirement or to otherwise comply with this Act; and

(d) the information or document is not otherwise more readily available.

(4) Where an authorization is granted under subsection (3), it shall be served together with the notice referred to in subsection (1).

(5) Where an authorization is granted under subsection (3), a third party on whom a notice is served under subsection (1) may, within 15 days after the service of the notice, apply to the judge who granted the authorization or, where the judge is unable to act, to another judge of the same court for a review of the authorization.

(6) On hearing an application under subsection (5), a judge may cancel the authorization previously granted if the judge is not then satisfied that the conditions in paragraphs (3)(a) to (d) have been met and the judge may confirm or vary the authorization if the judge is satisfied that those conditions have been met.

This section allows the Minister, for any purpose related to the administration or enforcement of the Act, to require any person to provide information or documents. Where the Minister seeks information or documents from a third party respecting an unnamed taxpayer, the Minister must first obtain the authorization of a judge. The Minister may apply to the judge ex parte and where the judge is satisfied as to the matters specified in subsection (3) by information on oath, such authorization may be granted. Where authorization is granted on an ex parte application, the third party required to provide the information may, within 15 days, apply to the judge granting the authorization or where that judge is unable to act, to another judge of the same Court, for a review of the authorization. On the review, the reviewing judge may cancel, confirm or vary the authorization. It is the respondents’ application for review of the authorization granted by Muldoon J. on February 6, 1995 pursuant to subsection 231.2(3) that gives rise to this decision.

As to the first issue, counsel for the respondents submits section 231.2 is intrusive in that it establishes a procedure whereby a third party may be required to provide the Minister with information about other taxpayers. He says the provision must therefore be construed restrictively. In this case he says the Minister simply seeks a list containing the names of unidentified taxpayers, not information relating to them, and that the provision of such a list not contemplated by the section.

He relies primarily on James Richardson & Sons, Ltd. v. M.N.R., [1984] 1 S.C.R. 614, [1984] C.T.C. 344, 84 D.T.C. 6325, and R. v. Bruyneel, [1986] 1 C.T.C. 295, 86 D.T.C. 6119 (B.C.C.A.). While he concedes these decisions were rendered before the enactment of section 231.2, he says that subsection (1) is essentially the same as subsection 231(3) of the Act which applied at the time those decisions were rendered. [1]

In Richardson, Wilson J. held that the Minister, in seeking the names of unnamed commodity traders was trying to check generally on those traders’ compliance with the Act. She also held that subsection 231(3) did not authorize such a survey, and that the subsection was only available

to obtain information relevant to the tax liability of some specific person or persons if the tax liability of such person or persons is the subject of a genuine and serious inquiry.

In Bruyneel the B.C. Court of Appeal observed that what the Minister was seeking were the names of taxpayers and not information relating to tax liability. The Court decided, on the facts, that the Minister was not entitled to the names he sought.

While Richardson and Bruyneel provide a useful background, it is important to note that the relevant legislation is different today than at the time of those decisions. The strict approach adopted in those decisions was necessitated by a broad statutory provision which, if interpreted too broadly, left open the possibility of abuse by tax enforcement officials. In Richardson at page 622 (C.T.C. 349-50, D.T.C. 6329), Wilson J. outlines the mischief that could result from a broad interpretation of the former subsection 231(3):

The language of subsection 231(3) of the Income Tax Act is unquestionably very broad and on its face would cover any demand for information made to anyone having knowledge of someone else’s affairs relevant to that other person’s tax liability. It would, in other words, if construed broadly, authorize an exploratory sortie into any taxpayer’s affairs and require anyone having anything to contribute to the exploration to participate. It would not be necessary for the Minister to suspect noncompliance with the Act, let alone to have reasonable and probably grounds to believe that the Act was being violated as required in subsection 231 (4). Provided the information sought had a bearing (or perhaps even could conceivably have a bearing) on a taxpayer’s tax liability it could be called for under the subsection.

Counsel for the Minister submits, and I accept, that section 231.2 was enacted to address these difficulties. By contrast with subsection 231(3), subsections 231.2(2) and (3) expressly provide a process with which the Minister must comply in order to require third parties to provide information or documents relating to unnamed taxpayers. A ministerial requirement to third parties to provide information about another person’s tax affairs now requires a Court authorization. Pursuant to subsection 231.2(3) there must be evidence on oath that: the person is ascertainable; the purpose is to verify compliance by the person with the Act; it is reasonable to expect, on any grounds, non-compliance with the Act; and the information is not otherwise more readily available. Forcing the Minister to comply with this procedure addresses the mischief identified in Richardson and is intended to prevent fishing expeditions.

Although section 231.2 addresses many of the problems associated with seeking information about unnamed taxpayers under the former subsection 231(3), I still agree with counsel for the respondents that a procedure by which the Minister may require third parties to disclose information about unnamed taxpayers is intrusive. I further agree that the restrictive approach mandated in Richardson remains valid. See The Queen v. 311326 Alberta Ltd., [1993] A.J. No. 25 (C.A.). Further I think the fact that the Minister may obtain a court authorization ex parte places an obligation on the Minister to act in the utmost good faith and ensure full and frank disclosure of information. See for example, The Queen v. Duncan, [1991] 2 C.T.C. 360, 91 D.T.C. 5615, at page 367 (D.T.C. 5620) (F.C.T.D.). For all these reasons, the standard to be met by the Minister in making an application for court authorization under subsection 231.2(3) is high.

Having said this however, I do not agree with counsel for the respondents when he says that a third party cannot be required to provide a list of names of theretofore unnamed persons pursuant to a court authorization. Subsections 231.2(2) and (3) refer to information or documents ’’relating to one or more unnamed persons". I do not see why such information could not include the names of the unnamed persons. Indeed, to provide information about unnamed persons without naming the persons seems to me pointless. If the Minister, provided he obtains court authorization, is entitled to require from third parties information about unnamed persons he must also be able to obtain their names. What would be the point of authorizing the Minister to require information about unnamed persons if their names could not be required to be provided at the same time?

Intrusion into the privacy of individuals is always a sensitive matter, especially when third parties, who themselves may have valid reasons for not wanting to disclose, are required to provide the information. Undoubtedly this is the reason Parliament saw fit to require the Minister to obtain Court authorization for such intrusion upon satisfying the Court of the matters specified in subsection 231.2(3). But provided the requirements of this subsection are met, such intrusion is authorized. There is no absolute prohibition from obtaining the names of taxpayers from third parties and indeed section 231.2 now provides a procedure for obtaining such information.

With respect to the second issue, counsel for the respondents argues that even if section 231.2 allows for a requirement on third parties to provide the names of unnamed taxpayers, the criteria listed in subsection 231.2(3) have not been met in this case. This assertion by counsel requires a close examination of the facts in this case, the reasons why the Minister chose to seek the names of unnamed persons from the respondents, and the Minister’s adherence to the strictures of subsection 231.2(3).

The Minister’s rationale is disclosed in the affidavit of Brian Kennedy, an auditor with Revenue Canada, and the cross-examination on that affidavit. The four respondents were in the business of selling seismic data-data which may indicate the location of oil or gas far underground. This data was sold to investors. The Minister’s first concern is that the sale price of the seismic data is inflated solely for the purpose of providing an excessive tax deduction for those investors. According to the evidence an investor may acquire seismic data for say $100,000, paying $15,000 in cash and executing a promissory note for the balance of $85,000. Under the agreement signed by the purchaser, if the purchaser does not pay the amount evidenced by the promissory note, he is not liable for it. The vendor’s only recourse is to recover possession of the seismic data. In such a scenario, a taxpayer in the 50 per cent tax bracket would be entitled to deduct $100,000 from his income for a tax saving of $50,000. The cost to him would be the $15,000 that he paid in cash for the seismic data. His net gain would be $35,000.

Mr. Kennedy produced on cross-examination three appraisals indicating that the seismic data was grossly inflated in value, e.g., certain seismic data purchased by the taxpayer for $100,000 had a value of $21,000, as appraised by Revenue Canada. If the appraisals are correct, the amount the purchasers may deduct for income tax purposes is excessive.

The Minister also says evidence of exploration activity arising from the sale of the seismic data is non-existent or inadequate. Letters were written to known investors respecting exploration activity but the responses were unsatisfactory, and did not satisfy the Minister the seismic data was acquired for a purpose envisioned by the Act. If there was no bona fide intention to explore for oil or gas using the seismic data, the expenditure for the data would not have been incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) of the Act or as a ’’Canadian exploration expense” within the meaning of that term in subsection 66.1(6) of the Act. If the transactions had no business purpose, or were not Canadian exploration expenses, the purchasers would not be entitled to any deduction.

Mr. Kennedy says he identified 12 (originally 14) persons or companies who have purchased seismic data from the four respondents but he believes there may be more purchasers, the names of whom he does not know. He comes to this conclusion because, from the information he has, the total purchases of interests in specific seismic data does not total 100 per cent.

Although originally arguing only that paragraph 231.2(3)(c) had not been complied with, respondents’ counsel ultimately argued the Minister has not satisfied any of the criteria in subsection 231.1(3). I will deal with each paragraph in turn.

(a) the person or group is ascertainable;

Respondents’ counsel says ascertainability means there must be some hard evidence there are some unnamed investors. He says this evidence is missing in this case. He says Mr. Kennedy admits he is not certain if seismic data was sold to purchasers in addition to those already known. In his affidavit Mr. Kennedy says:

I have identified approximately 14 purchasers of the seismic data but I believe that there are additional purchasers based on my examination of the percentage interests purchased by the identified parties which do not total 100% of the seismic data purchased from any of the selling parties.

I think Mr. Kennedy’s affidavit sufficiently demonstrates the group is ascertainable. I do not follow the argument that the Minister must know of the existence of at least one unnamed person in the group to meet the ascertainability criterion. It may be, as in Richardson, that because of cooperation from a third party the Minister may know of the existence of unnamed taxpayers, although not their names. However, in other cases, where the third parties have not disclosed any information respecting unnamed taxpayers, the Minister will not know they exist. I see no logical reason, and nothing in the wording of paragraph 231.2(3)(a), which indicates ascertainability requires the Minister to show he knows one or more individuals exist. The group, purchasers of seismic data from the four respondents, is ascertainable. If there are only 12 purchasers, the respondents will say so. If there are more, they can be identified from the respondents’ records.

In any event Mr. Kennedy states in his affidavit:

I subsequently spoke with Joe Struck, who advised me that he was acting for the four corporations and that in his view, the information concerning any other investors could not be provided without judicial authorization under subsection 231.2(3).

In a letter from Mr. Struck to Mr. Kennedy dated January 20, 1995, Mr. Struck states:

As indicated, the above-named persons believe they owe a duty to the various individuals and corporations in respect of whom you are seeking information not to disclose any confidential contractual information to any third party unless clearly required so to do.

I infer from Mr. Kennedy’s affidavit and Mr. Struck’s letter that there are other individuals in the relevant group.

(b) the requirement is made to verify compliance by the person or persons in the group with any duty or obligation under this Act;

Respondents’ counsel argues that the requirement to verify compliance by ’’the person or persons’’ with obligations under the Income Tax Act means that the person or persons must be known. I do not understand why, if the person who is the subject matter of the Minister’s application is unnamed, he must be known. As I have indicated with respect to paragraph 231(3)(a), members of the relevant group must simply be ascertainable, not known.

(c) it is reasonable to expect, based on any grounds, including information (statistical or otherwise) or past experience relating to the group or any other persons, that the person or any person in the group may have failed or may be likely to fail to provide information that is sought pursuant to the requirement or to otherwise comply with this Act; and

Respondents’ counsel submits there is no evidence that the unnamed individuals have failed to comply with the Act. However, as noted above, in his affidavit and cross-examination Mr. Kennedy explains the basis of his concerns. He says the 12 known taxpayers and the unnamed purchasers of seismic data may have acquired the data for inflated prices and not for the purpose of gaining or producing income or as a Canadian exploration expense. On cross-examination, appraisals were produced which indicated that the appraised values of the seismic data were far less than their purchase prices. If the purchase prices of the seismic data are inflated, the investors will receive a tax benefit to which they are not entitled. The appraisals obtained by Mr. Kennedy suggest such a result.

Mr. Kennedy says in cross-examination that although he has asked for information indicating the seismic data is being used for exploratory purposes, there has been very little forthcoming from the known investors to indicate this is so. If there is no business or exploration purpose for purchasing the seismic data, it may well be that the purchase price cannot properly be deducted from income for income tax purposes. The absence of information as to the use of the seismic data from known investors at least provides grounds for the concern that there may be no business or exploration purposes for the data by the investors.

Respondents’ counsel also says that Mr. Kennedy does not swear to the inflated purchases prices himself but relies only on appraisals made by others, who are not affiants in this proceeding. Certainly, it would have been preferable to have the appraisers submit their own affidavits; perhaps if the Minister had relied solely on hearsay evidence in support of his application, he may well have been unsuccessful in this review. However, even if reliance on appraisals made by others is an impediment to the Minister’s inflated price assertion, it would not affect his second assertion. In short, the Minister’s failure to introduce affidavits sworn by the appraisers themselves is, in the circumstances of this case, not fatal to his application because the evidence supporting his concern that purchases of seismic data were not made for business purposes or as exploration expenses is direct evidence of Mr. Kennedy under oath, as it was given in the course of his cross-examination.

(d) the information or document is not otherwise more readily available.

It is submitted by respondents’ counsel that the names of the unnamed investors could more readily be available by asking other known investors or through an audit of the vendors. I disagree. This is not a partnership or other tax shelter in which it is reasonable to expect that each investor would know the names of other investors. Further, I agree with counsel for the Minister that for the Minister to obtain the names of unnamed investors by way of an audit of the vendors would be to do indirectly what the Minister is not allowed to do directly. To obtain the names of unnamed persons from third parties, the Minister must seek a court order. He cannot, and should not, circumvent that requirement by performing an audit without judicial authorization to obtain the names of such investors. That is what subsections (2) and (3) of section 231.2 are intended to cover.

From the affidavit of Brian Kennedy and his cross-examination, I am satisfied the Minister has complied with subsection 231.2(3) in this case. In my view, compliance with subsection (3) ensures the Minister, in seeking the names of unnamed taxpayers from third parties, is not conducting a fishing expedition, but a serious inquiry. I am satisfied, even on a restrictive interpretation of the subsection 231.2(3), that the Minister has satisfied these requirements in this case.

I would therefore vary the authorizations granted by Muldoon J. only with respect to particulars of service and response by the respondents. Counsel for the Minister shall prepare a draft order consistent with these reasons and submit it to counsel for the respondents and the Court. He Shall, without delay, make arrangements for a conference call with counsel for the respondents and the Court at which time the parties may seek directions respecting time limits and other particulars of service and responses, costs and other necessary details. The order will be finalized after the conference call.

Order accordingly.