Shaw v. The Queen, 89 DTC 5194, [1989] 1 CTC 386 (FCTD), aff'd 93 DTC 5213 (FCA)

McNair J.:—These actions are appeals by the plaintiffs, pursuant to subsection 172(1) of the Income Tax Act, from a decision of the Tax Court of Canada dismissing their appeals from reassessments of their income for the 1979, 1980 and 1981 taxation years. The Minister’s reassessments were made on the basis of adding to their respective incomes aliquot portions of the moneys received for gallonage payments during those taxation years. By consent, the actions were tried together on common evidence.

The plaintiffs live in Fort Erie, Ontario. In 1969 they formed a partnership under the firm name and style of Green Acres Service to buy and operate an automobile service station, and the firm bought the service station property (hereinafter sometimes referred to as the "subject property") located at 1326 Garrison Road, in Fort Erie. The actual site is within three to four miles of the United States border. The deed of the subject property was registered in Mrs. Shaw's name, but she held title to the same in trust for herself and her husband as partnership property. From 1969 to May 31, 1975 the partnership operated a service station business on the subject property, doing so pursuant to a sales and equipment loan agreement dated January 1,1973 with BP Oil Limited (hereinafter sometimes referred to simply as "BP") and a crosslease arrangement between the parties.

On June 1, 1975 the plaintiffs, as partners in the enterprise of Green Acres Service, executed an agreement for the sale of all the partnership assets, except for the subject property, to themselves in trust for Jack Shaw Enterprises Limited, a corporation about to be incorporated in which they would be controlling shareholders (hereinafter sometimes referred to as the "corporation"). Jack Shaw Enterprises Limited was incorporated under the Business Corporations Act of Ontario on June 26, 1975. The plaintiffs were at all material times the only directors and shareholders of the corporation. The fiscal years of the partnership and the corporation both end on the last day of May in each calendar year.

Since the sale agreement of June 1, 1975 the corporation operated the service station business on the subject property under the exclusive dealership agreement with BP and the subsisting cross-lease arrangement. Since that date the corporation has paid rent to the partnership for the use of the subject property.

On January 1, 1976 a new sales and equipment loan agreement was entered into between BP Oil Limited and Norma Shaw and Jack A. Shaw by which it was agreed that they would purchase gasoline and other petroleum products exclusively from BP at BP's prices in effect at the time of delivery. On the same date the Shaws executed a new head lease of the subject property in favour of BP Oil Limited for a term of ten years ending on December 31, 1985, and BP reciprocated by subleasing the demised premises to Norma Shaw for the same term less one day. The net effect of the crosslease arrangement was to cancel the fixed annual rental of $6,000 per year, leaving BP obligated to pay Norma Shaw as additional annual rental the gallonage payments calculated in accordance with the volume formula set out in the head lease. These payments were remitted monthly by cheque, based on the volume of gasoline sold by the dealership during the preceding month. The sublease from BP Oil Limited to Norma Shaw contained in clause 4 the usual sublessee covenant against assigning or subletting the demised premises, but with the following consent provision added thereto, viz. :

Notwithstanding anything hereinbefore contained, the sublessor hereby consents to the sublessee subletting the within property to Jack Shaw or Jack Shaw Enterprises Limited.

During its 1979, 1980 and 1981 fiscal years, the corporation paid the partnership the following rent:

During the same fiscal years, BP paid the following gallonage payments as additional rental under the head lease, calculated on the basis of the volume of gasoline sold from the subject property:

The cheques for these gallonage payments were made payable to Mrs. Shaw and were endorsed by her and deposited to the credit of the corporation's account with the Royal Bank of Canada. In fact, this practice had been consistently followed under the previous dealership and cross-lease arrangement since June of 1975.

By three notices of reassessment, each dated April 29, 1983, the Minister reassessed the plaintiffs' respective incomes for the 1979, 1980 and 1981 taxation years by adding the following amounts thereto:

The amounts so added pursuant to these reassessments represent one- half of the difference between the gallonage payments received from BP and the rent paid by the corporation to the partnership.

By three notices of objection, each dated June 8, 1983, the plaintiffs objected to the reassessments of their income, but the Minister confirmed the same by notice of confirmation dated December 30, 1983 on the ground that the amounts were properly included in computing their income by virtue of sections 3, 9(1) and 56(4) of the Income Tax Act. The plaintiffs appealed their reassessments to the Tax Court of Canada and the appeals were dismissed by a decision mailed to them on February 12, 1985. In so reassessing the plaintiffs, the Minister assumed, inter alia, that the right to receive the rent payments from BP was not transferred or assigned to the corporation.

The case raises two paramount issues, namely:

1. Who was beneficially entitled to the gallonage payments from BP during the years in question—the corporation or the plaintiffs?

2. If the corporation was beneficially entitled to the gallonage payments, does subsection 56(4) of the Income Tax Act nevertheless require that such payments be included in the plaintiffs’ incomes?

The statutory provisions most relevant to the determination of these issues are subsections 9(1) and 56(4) of the Income Tax Act, S.C. 1970-71-72, as amended, which read:

9.(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

56.(4) Where a taxpayer has, at any time before the end of a taxation year (whether before or after the end of 1971), transferred or assigned to a person with whom he was not dealing at arm's length the right to an amount that would, if the right thereto had not been so transferred or assigned, be included in computing his income for the taxation year because the amount would have been received or receivable by him in or in respect of the year, the amount shall be included in computing the taxpayer's income for the taxation year unless the income is from property and the taxpayer has also transferred or assigned the property.

On the first issue, the plaintiffs’ position is that the beneficial right to the gallonage payments in the years in question belonged to the corporation by virtue of the sale agreement of June 1, 1975. Counsel for the plaintiffs argues forcibly that such right was transferred by paragraph 1 of the agreement, which is reproduced hereunder with underlining emphasis for the words on which he lays particular stress:

1. The Vendor hereby sells to the Purchaser and the Purchaser hereby purchases from the Vendor as of the 1st day of June, 1975, all the personal property and assets, movable and immovable and including but without limiting the generality of the foregoing all incomes, monies, rights, leases, franchises, materials, supplies, book debts, accounts receivable, negotiable and non-negotiable instruments, judgments, securities, choses in action, existing and future revenue and all other property and things of value, tangible and intangible, legal or equitable as of the 1st day of June, 1975. . . . Goodwill is to be valued at $2.00.

Plaintiffs' counsel submits that a broad interpretation of the operative words of the sale agreement make it abundantly clear that the corporation was to acquire all the property and assets of the service station business heretofore carried on in partnership, including the right to gallonage payments from BP. He cites authority for the proposition that rent is an assignable chose in action which may be recovered by the assignee suing in his own name, and no notice to the debtor is necessary to perfect title as between assignor and assignee. Plaintiffs’ counsel submits that if the sale agreement should leave any element of doubt or uncertainty regarding the right to gallonage payments being vested in the corporation, then the conduct of the parties in carrying out its terms becomes relevant in determining what was really intended. Counsel urges that the conduct of the plaintiffs, viewed in this perspective, makes it abundantly clear that all BP’s gallonage payments belonged to the corporation by virtue of the 1975 sale agreement.

As to the second issue, plaintiffs' counsel takes the position that subsection 56(4) of the Act does not apply because it is simply an anti-avoidance provision directed to the switching of income in non-arm's length transactions. Plaintiffs’ counsel argues that there is no element of tax avoidance involved in the present case because the amounts received by the plaintiffs from the corporation in taxable rent, salaries and dividends during the taxation years in question greatly exceeded BP's gallonage payments to which the corporation was beneficially entitled and on which it paid income tax. It follows, in his submission, that there was no net amount transferred by the Shaws to their corporation that connoted a tax avoidance scheme which might trigger the application of subsection 56(4). He maintains that the reassessments in the present case, relying as they do on the application of subsection 56(4), create an unfair system of double taxation.

Secondly, plaintiffs' counsel argues that subsection 56(4) does not apply to the transfer of a business to a corporation where the business was actively carried thereafter by the corporation. He submits that the plaintiffs did not transfer to the corporation their right to an amount of money that would have been received or receivable by them as income. Rather, they transferred to the corporation for valuable consideration their right to carry on the service station business with the intent that the corporation would henceforth carry on that business for its own account.

The third submission made by plaintiffs’ counsel is based on the doctrine of beneficial receipt which, he says, is a fundamental principle of Canadian income tax law. Elaborating on this theme, he argues that subsection 56(4) would only apply to transferred amounts which otherwise would have been received or receivable by a taxpayer in respect of a taxation year and which, because of such receipt or receivability, would have to be included in computing the taxpayer's income for that year. It follows, in his submission, that an amount which is received or receivable by a taxpayer is not required to be included in his income if he is not beneficially entitled to it but instead is obligated on receipt to hand it over to the person who is beneficially entitled thereto. This, he maintains, is the situation in the present case with respect to the cheques for the gallonage payments received by Mrs. Shaw. The mere receipt or receivability of the amounts represented by those cheques does not require, in his submission, that such amounts be included in the plaintiffs’ income. Plaintiffs’ counsel stresses the fact that Mrs. Shaw was legally obliged upon receipt of the gallonage payments to turn them over to the corporation as the person beneficially entitled to them. This suffices, in his submission, to take the case outside the ambit of subsection 56(4).

Plaintiffs' counsel further submits that the cross-leases between the Shaws and BP Oil Limited were purposely intended to circumvent the tied selling prohibition against volume price discounts contained in section 31.4 of the Combines Investigation Act by characterizing the payments designed to effect such discounts as additional, variable rent payable under a lease. He says that his clients regarded the exclusive dealership agreement and cross-lease arrangement with BP as a package deal essential to the operation of the service station business, from which they concluded, and rightly so, that the gallonage payments properly belong to the corporation and not to them.

Alternatively, plaintiffs’ counsel submits that the additional rent and the head lease itself are property within the broad definition of the word in the Act, both of which were assigned to Jack Shaw Enterprises Limited by the 1975 sale agreement, thereby falling within the exclusionary words of subsection 56(4). Finally, he submits that if there is a reasonable uncertainty or factual ambiguity resulting from any lack of explicitness in subsection 56(4), the uncertainty or ambiguity should be resolved in favour of the plaintiffs, citing in support of this propostion Johns-Manville Canada Inc. v. The Queen, [1985] 2 C.T.C. 111; 85 D.T.C. 5373, 5384 (S.C.C.) and Stubart Investments Limited v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305, 6322 (S.C.C.).

Defendant's counsel puts his case very simply. He submits, firstly, that the right to receive the additional or variable rent payable under the head lease remained vested in the Shaws and was not transferred to Jack Shaw Enterprises Limited. That being so, subsection 9(1) of the Act is capable of standing alone in taxing the same as income from a property, and that is the end of the matter.

Defendant's counsel agrees that the service station business was transferred from the partnership to the corporation but, in his submission, such transfer did not include the variable rent or the cross-leases or the underlying realty. He argues that these continued to remain the property of the Shaws. He also points out that the court must deal with what the plaintiffs actually did and not concern itself with what they might have done. Alternatively, defendant's counsel submits that if the right to the gallonage payments is found to have been transferred to the corporation then this automatically invokes the application of subsection 56(4) so as to include these payments in the Shaws' income. He urges that the additional or variable rent payable by BP under the head lease is something which runs with the land with the result that the rental payments must be characterized as receipts from a property rather than income from a business. Finally, defendant's counsel presses the argument that the nub of the whole matter with respect to the application of subsection 56(4) comes down to this: the right to income may have been transferred, but the property from which the right derived, whether the real estate or the leases, was not transferred.

As to the first issue, the Minister’s reassessments were based on two factual assumptions, namely: (1) that the right to receive the gallonage payments from BP was not transferred or assigned to Jack Shaw Enterprises Limited; and (2) that the subject property was partnership property of the plaintiffs and that they had agreed to divide equally any rental payments therefrom. The tax auditor, Mr. A. Fulop, took the view in his report that there could be no landlord and tenant relationship between the corporation and the partnership because the subject property had been legally leased to BP Oil Limited. Plaintiffs' counsel pointed to the inconsistency between this and the defendant's pleaded admission as to the existence of a sub sublease of the subject property from the plaintiffs to the corporation. The report on objection or appeal of the appeals officer, J. Martynuk, seems to resolve this inconsistency by its elaboration of the facts supporting the decision to tax the gallonage payments as rental income in the plaintiffs' hands. The report reads in part as follows:

Statement of Facts:

Mr. & Mrs. Shaw bought the service station in Fort Erie in 1969. Legal title to the property was registered in Mrs. Shaw's name, with all assets being used in the partnership (1969 to 1975 the Shaws operated the station as a partnership). In 1975 "Enterprises" was incorporated to carry on the business, with the service station itself remaining in Mrs. Shaw's name.

The Combines Investigation Act prevents the oil companies from paying their exclusive distributors “preferential discounts". BP does, however, lease a dealer's property, and pay him rent based on the volume of gasoline bought by the dealer. BP’s practice which is standard in the oil industry, involves three contracts:

A Sales and Equipment Loan Agreement:

The dealer will buy gasoline exclusively from BP at the list price. Under the Head Lease, BP rents the property from the dealer for a fixed minimum rent plus an “additional amount" based on number of gallons the dealer buys from BP. Under the Sub-Lease BP rents the property back to the dealer, charging the minimum rent under the Head Lease. Since the minimum rents under both leases are equal, no such rent is actually paid. These cross-leases permit BP to call the gallonage discounts "additional" rent payable under the Head Lease.

In 1975 the Shaws sold the business to Enterprises (their limited company). They sold all rights, leases, franchises, goodwill, existing and future revenue and all other things of value inherent in the business, except for the real estate.

The gallonage payments are made by BP to Mrs. Shaw, since she is the registered, or legal owner of the property rented to BP. These payments are reported as income by the company. In return, Enterprises paid rent to the Shaws.

The payments for the periods in question are:

	5/31/79	5/31/80	5/31/81
Gallonage payments received from BP	$36,055.23	$75,293.46	$80,887.06
Rent Enterprises paid to partnership	$30,000.00	$40,000.00	$49,000.00
Difference	$ 6,055.23	$35,293.46	$31,887.06

Taxpayer maintains these gallonage payments are actually "purchase discounts" from BP which could not be granted without violating the rules of the Combines Act. The taxpayer's representative, Mr. Fitzsimmons, feels that the gallonage payments are “purchase discounts" that BP terms “additional” rent. The payments should be revenue from the business, and Mrs. Shaw is only a conduit through which the payments flow. Enterprises was legally entitled to possession of the property as sub-tenant, and as such was required to pay rent to the Shaws.

Audit has reassessed the Shaws personally for the “additional rent".

Plaintiffs’ counsel makes the further argument that there is no basis in law for the method of assessment applied in the present case, which simply amounted to netting out the difference between the gallonage payments received from BP and the rent paid by the corporation to the partnership and taxing such difference in the hands of the partners. His submission, if I apprehend it correctly, is simply that this method of reassessment is neither fish nor fowl in terms of taxing the profit from a business or property in an all or nothing sense.

In my view, the first issue turns on the point of which party was beneficially entitled to the BP gallonage payments in the years in question, that is, the corporation or the partnership.

The 1975 sale agreement was a pre-incorporation contract within the meaning of subsection 19(2) of the Business Corporations Act, R.S.O. 1980, c. 54, which reads as follows:

19.(2) A corporation may adopt a pre-incorporation contract entered into in its name or on its behalf, and thereupon the corporation is entitled to the benefits and is subject to the liabilities that were contracted in its name or on its behalf and the contractor ceases to be entitled to such benefits or to be subject to such liabilities.

A resolution of the directors of Jack Shaw Enterprises Limited passed on June 26, 1975 authorized the corporation to assume the benefits and obligations of the sale agreement of June 1,1975, including the acquisition of the operating assets of the partnership business known as Green Acres Service. It further authorized payment of the stipulated consideration by way of a demand, non-interest bearing promissory note in the sum of $22,530.39 and the allotment and issuance of 100 fully paid and non-assessable common shares for the balance of $1,100. Authorization was given as well for the subsection 85(2) election. Paragraphs (e) and (f) of the resolution provided as follows:

(e) The Company do lease from Jack Shaw and Norma Shaw the lands and buildings on which the Green Acres Service business is operated at a rental of $1,000 per month on a net/net basis; and

(f) The Company do assume all benefits and obligations arising out of an agreement between Norma Shaw and Jack Shaw as Lessee and dealer and Supertest Petroleum Corporation, ("BP") Limited with respect to the operation of the said business.

There can be no doubt that the 1975 sale agreement was a preincorporation contract which was adopted and ratified by the corporation. The only question concerns the legal rights and obligations that flowed therefrom. The sale agreement sold and transferred to the corporation all the property and assets of the business heretofore carried on in partnership, with the exception of the real estate. Notwithstanding that the first recital therein employed the limited phraseology of "certain of the assets" in reference to what was agreed to be sold and purchased, the operative words of paragraph 1 of the agreement refer to the sale and purchase of all the personal property and assets agreed to be sold including, inter alia, all incomes, rights, leases, franchises, existing and future revenues and all other things of value, plus goodwill valued at $2. In my view, the appeals officer, Mr. Martynuk, correctly summarized in the statement of facts in his report what was actually agreed to be sold.

The notes of the plaintiffs’ former solicitor, Ivan R. Cairns, who drew the sale agreement according to instruction received from the Shaws and their accountant, Eric Seidel, contained a notation “including rental income". These notes and the transcript of Cairns’ evidence in the proceeding before the Tax Court of Canada were made evidence in the present case. Plaintiffs’ counsel directed Mr. Cairns on re-examination to the rental income notation, and the following testimony was elicited:

BY MR. FITZSIMMONS: Q. Correct me if I am wrong, but I think you said — you read word for word what your notes said, and your notes said, “including rental income”. I want to ask you, do you have any recollection of what your notes meant when they referred to “including rental income"?

A. I believe it refers to all amounts which would be payable under either of the two agreements with the petroleum company.

Q. The two agreements . . .

A. Being the agreement which was in the name of Norma Shaw going to BP, and secondly, the agreement going the other way.

MR. FITZSIMMONS: Thank you. Those are all the questions I have, Your Honour.

Mr. Cairns was asked during his examination-in-chief about the instructions taken for drawing the sale agreement and whether he had addressed his mind to the question of who would be entitled to the gallonage payments after the sale agreement was signed, and the following evidence was given:

Q. What were your instructions?

A. We had looked at the operations of the partnership and considered whether the underlying real estate should be transferred from the partnership to the corporation. The decision ultimately was that the real property would not be transferred, or the decision was that outside of the rental that would be charged by the partnership to the corporation, all other payments involving the operation of the service station would be for the account of the corporation.

Q. When you say “all other payments" in connection with the operation of the service station, does that include or does it not include the gallonage payments under the head lease?

A. That would include it.

The evidence in the case establishes that from and after June 1, 1975, BP’s gallonage payments continued to be remitted in the same way by monthly cheques payable to Mrs. Shaw in amounts representing the volume of gasoline purchased and sold by the dealership during the preceding months. The corporation paid BP by cheque for the price of all gasoline and petroleum products purchased each month, and there was no offset of these amounts against BP's gallonage payments. As previously indicated, Mrs. Shaw endorsed the gallonage cheques and deposited them in the corporation's account. The gallonage payments were reflected in the corporation's sales income. The evidence also shows that the Shaws met with the accountant early in each fiscal year for the purpose of determining the fair market rent payable by the corporation to the partnership for the use of the subject property. It is also clear from the evidence that the corporation paid all the expenses associated with the subject property, including utilities, insurance, licences and taxes. These expenditures were similarly reflected in the financial statements of the corporation. Mr. Shaw stated on cross-examination that there was an oral sublease of the land from the partnership to the corporation. Mr. Seidel’s evidence was to the effect that he understood there was a rental agreement between the Shaws and the corporation, but that he had never seen a formal lease document. He asserted under cross- examination that they were simply following the practice established at the time of the 1975 sale agreement.

In Firestone Tire and Rubber Co. Ltd. v. Commissioner of Income Tax, [1942] S.C.R. 476; [1942] C.T.C. 254 a case involving the interpretation of a contract for the purpose of ascribing income tax liability as between a federally incorporated company and a British Columbia company carrying on a wholesale dealership business within the province, Rinfret, J. stated at page 482 [261-2 C.T.C.]:

It must be admitted that the wording of the contract under discussion makes the case a difficult one, for, to borrow the words of Viscount Haldane in Michelin Tyre Company Limited v. MacFarlane (Glasgow) Limited [(1916), 55 Sc.L.R. 35, at 39].

The decision must turn on the right reading of agreements which have aimed at putting into writing the methods of men whose concern has been with practical results in business, rather than with exactitude in legal definition.

But, as stated by Pollock M.R. in The Commissioners of Inland Revenue v. The Eccentric Club Limited [(1923), 12 Tax C. 657, at 690].

It is a well-established principle that, in revenue cases, regard must be had to the substance of the transactions relied on to bring the subject within the charge to a duty, and that the form may be disregarded.

And in order to get at the substance of the transactions between the appellant and the MacKenzie Company it will undoubtedly be helpful to examine the "methods" followed by them in the carrying out of the contract, as they have been explained in the course of the evidence given at the trial. "There is no better way of seeing what the parties intended than seeing what they did under the agreement" (Chapman v. Bluck [(1838), 4 Bing. N.C. 187, at 193]; Pearson v. Ries [(1832), 8 Bing. 178, at 181].

The plaintiffs’ basic submission is that the right to the BP gallonage payments was effectively transferred and conveyed to the corporation by virtue of the 1975 sale agreement. The whole service station package is said to be comprehended by the sales agreement and the renewals of the sales and equipment loan agreement and head lease and sublease executed on January 1, 1976 in replacement of their predecessors, as complemented by evidence of the conduct of the parties in carrying out the terms thereof. Plaintiffs’ counsel points out that the new dealership agreement and head lease and cross-lease were contractually interrelated and linked together by their very terms, and argues that this is further evidence that they were regarded as being integral to the service station operation.

Essentially, the Crown's position on the first issue is that the 1975 sale agreement accomplished nothing more than the transfer of certain of the operating assets of the service station business, leaving the underlying realty and leases and the rentals therefrom still vested in the partnership. This is said to be further buttressed by the fact that the directors' resolution of January 2, 1976 related specifically to the new sales and equipment loan agreement executed the day before, and omitted any reference to the new cross-leases executed concurrently therewith.

On January 2,1976 the directors of the corporation passed the following resolution:

BE IT RESOLVED THAT:

The Company do assume the benefits and obligations of a sales and equipment loan agreement dated January 1, 1976 made between BP Oil Limited and Norma Shaw and Jack Shaw as dealer, the latter parties having entered into the agreement on behalf of the Company.

The fact remains that there was indeed a terminological, if not contractual interrelationship, between the new dealership and cross-leases executed on January 1, 1976. Clause 26 of the new dealership agreement gave the right to "terminate this lease" upon 90 days written notice by either party and went on to provide:

. . . In the event of such termination occurring at other than the end of a lease year, the rental shall be adjusted to the date of such termination and any overpayment or underpayment of rent as the case shall be, shall be paid or repaid forthwith, and the gallonage to the date of termination shall be deemed to be the annual gallonage.

This termination clause is identical in wording to the one contained in clause 9(f) of the new head lease. Clause 9(d) of the head lease gave the lessee an option to terminate in the event of the termination or cancellation of either of the sublease and dealership agreement being entered into concurrently therewith. Clause 9(d) of the sublease contained a similar termination option with respect to the termination or cancellation of "the Sales and Equipment Loan Agreement being entered into concurrently here with affecting the use of the demised premises". Clause 4(d) of the sublease was a covenant on the part of the sublessee to purchase exclusively from the sublessor, BP, all the sublessee's requirements of petroleum and anti-freeze products. As indicated earlier, clause 4(h) of the sublease contained an express term indicating the consent of the sublessor, BP, to the subletting of the demised premises by the sublessee, Norma Shaw, to Jack Shaw or Jack Shaw Enterprises.

By a subsequent termination agreement, the date of which is uncertain, BP and Jack Shaw, as customer, purported to terminate effective as of December 31, 1975 an equipment lease dated February 1,1975 and the earlier cross-leases and dealership agreement dated January 1, 1973, without prejudice to the customer's obligation to pay all amounts owing to BP at the date of termination and to perform all obligations incurred prior thereto. This termination agreement was probably redundant in the sense that the new agreement and cross-leases would have replaced the earlier ones by operation of law, but it is further evidence that the parties regarded their interrelated business arrangement as a complete package.

I accept Mr. Shaw's evidence that BP continued to pay the gallonage payments to his wife because she was the registered owner of the real estate. Incidentally, this was the view taken by Mr. Martynuk in his report. While no evidence was forthcoming from BP, I consider the inference can be drawn that the dealership agreement and cross-lease arrangement were expressly designed to provide the incentive of volume price discounts in the form of additional or variable rent as a means of circumventing the prohibitions of the Combines Investigation Act, following the standard practice of the oil industry.

Without elaborating on the objects for which Jack Shaw Enterprises Limited was incorporated, it can be taken as being undisputed that the principal purpose underlying the creation of the corporate entity was the acquisition and operation of the service station business.

The basic question is simply this: To whom did the gallonage payments belong?

Harris, Canadian Income Taxation, 4th ed., makes the following statement regarding the principle of beneficial receipt at page 399:

Whose Income?

The principle of “beneficial receipt" is a part of the concept of income as developed by the courts. It is thge principle by which revenue is attributed to the person who is beneficially entitled to it because he earned it. Therefore if revenue is received by an agent or nominee on behalf of the person who earned it, the revenue will be included in computing the income of the latter person and not in computing the income of the agent or nominee.

M.N.R. v. Cameron, [1972] C.T.C. 380; 72 D.T.C. 6325 (S.C.C.), was an appeal from a judgment of the Exchequer Court [[1971] C.T.C. 87; 71 D.T.C. 506], which had allowed the respondent taxpayer's appeal from reassessments taxing in his hands fees received by a management company. The latter company had been incorporated to provide management services to a contracting company for which the respondent and two associate district managers worked, and to serve as a vehicle whereby they and other senior employees of the contracting company could purchase common shares held by the president and sole shareholder. The contracting company paid the management company 15 per cent of its profits as well as certain expenses of the management company, including salaries. The management fees were to be used for the purchase of the shares. In 1965 and 1966 the management company received management fees from the contracting company and paid tax thereon. In his returns for those years, the respondent reported as income the salary and bonuses he had received from the management company. By reassessment, the Minister added to the income reported by the respondent (and by his two associates) one-third of the fees (less a certain adjustment) received by the management company. The Exchequer Court found on the evidence that the management company was not "a mere sham, simulacrum or cloak", that the management company was a separate corporate entity from the contracting company, and that the primary purpose was to carry out the retirement objective of the president and sole shareholder of the contracting company. The Supreme Court upheld the trial judge's finding of fact as to the primary purpose of the overall plan. Martland, J. said at page 38 (D.T.C. 6329):

In light of this finding, I am not prepared to find that the agreement between Campbell Limited and Independent was a sham. The legal rights and obligations which it created were exactly those which the parties intended.

In Robertson Ltd. v. M.N.R., [1944] C.T.C. 75; 2 D.T.C. 655 (Ex. Ct.) Thorson J. propounded the following important test for determining whether an amount received by a taxpayer had the quality of income, stating at page 91 (D.T.C. 661):

Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it another way, can an amount in a taxpayer's hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue?

This test received the express approval of the Supreme Court of Canada in Sura v. M.N.R., [1962] C.T.C. 1; 62 D.T.C. 1005, Taschereau, J. paraphrasing it even more succinctly at page 5 (D.T.C. 1006):

. . . only he must pay income tax who has absolute enjoyment of the income, unfettered by any restriction on his freedom to dispose of the income as he sees fit.

I am satisfied on the evidence that the whole operation of the service station business was dependent, as a matter of practical business necessity, on the rights and obligations arising from the dealership agreements and cross-leases between the plaintiffs and BP Oil Limited. In my view, the purposive intent of the 1975 sale agreement was to sell and convey these selfsame rights and obligations to the corporation for valuable consideration, as further manifested by the conduct of the parties in giving effect to the terms of such agreement. Having regard to the contractual linkage between the new dealership agreement and cross-leases executed on January 1,1976 and the parties' consistent course of conduct throughout, it is my opinion that the directors' resolution of January 2, 1976 was effective in vesting in the corporation all the benefits and obligations flowing not only from the new sales and equipment loan agreement but also the integrated head lease and sublease, all of which were essential to the operation of the service station business. I therefore conclude that the new dealership agreement and head lease and sublease were part and parcel of the service station business sold by the partnership to the corporation. Taking all these factors into account, I find that the corporation is beneficially entitled to the BP gallonage payments as the party who earned the income represented thereby and that Mrs. Shaw received the cheque for such gallonage payments merely as agent or nominee of the corporation.

That being so, the question remains whether subsection 56(4) of the Act applies to tax the gallonage payments as income in the hands of the plaintiffs because the property from which the right to these amounts derived had not been transferred or assigned to the corporation. It is the Crown's position that the underlying realty or the head lease giving rise to the gallonage payments would have had to have been transferred or conveyed to the corporation in order to avail the plaintiffs of the benefit of the exception contained in the concluding words of subsection 56(4).

Counsel were diligent in citing a number of cases where taxpayers' income was diverted to a corporation owned or controlled by them as a means of obtaining a tax benefit. For the defendant, see: Simson-Maxwell Ltd. v. M.N.R., [1962] 29 Tax A.B.C. 169; 62 D.T.C. 262 (T.A.B.); The Queen v. Canadian-American Loan and Investment Corp. Ltd., [1974] C.T.C. 101; 74 D.T.C. 6104 (F.C.T.D.); Goldblatt v. M.N.R., [1964] C.T.C. 185; 64 D.T.C. 5118 (Ex. C.R.); and The Queen v. Charles Guay, [1973] C.T.C. 148; 73 D.T.C. 5108 (F.C.T.D.). For the plaintiffs, see: The Queen v. Campbell, [1980] C.T.C. 319; 80 D.T.C. 6239 (S.C.C.); Sazio v. M.N.R., [1968] C.T.C. 579; 69 D.T.C. 5001 (Ex. C.R.); West Fraser Timber Co. Ltd. v. M.N.R., [1965] 38 Tax A.B.C. 44; 65

D. T.C. 246 (T.A.B.); and M.N.R. v. Cameron, supra. It is unnecessary to recount these cases in detail. In my view, they illustrate the tendency of the courts to emphasize the substance of the particular transaction over its mere form and, in most instances, turn on the point of who really earned the income in question or the fact of whether the corporation was a "mere sham, simulacrum or cloak" for the diversion of income.

In The Queen v. Campbell, supra, the issue was whether fees for surgical services performed by the respondent doctor were income properly assessable to him rather than to the licensed private hospital to which he assigned those fees pursuant to an employment contract with the hospital. The respondent had incorporated the hospital and was the beneficial owner of all the issues shares of stock. He agreed to an employment salary at less than his earning capacity with the view that the surplus from his assigned fees would enure to the financial benefit of the hospital. The regulations to the Ontario Hospital Insurance Plan required that billings for medical services be billed separately in the name of the doctor performing those services. The court took the view that nothing turned on this fact. The Crown had conceded that the corporation was not a sham and that the respondent was not engaged in an improper scheme of tax avoidance. The basis of the Crown's appeal was that the hospital was improperly practising surgery contrary to the regulations whereby the respondent's contract of employment was invalid, with the result that the respondent was properly assessable for income tax on the fees generated by his surgical services.

Laskin, C.J.C. was not impressed with this proposition, stating at page 322 (D.T.C. 6242):

This, in itself, does not assist the Crown's position as to taxability of the respondent on the fees he assigned to his wholly-owned hospital. It was, of course, the respondent personally who performed the particular surgical services and if he is to be assessed for tax in respect of the fees for those services, fees which he assigned to the hospital, it would be because under the taxing statute the fees are properly part of his income and not the income of the hospital to which they were assigned pursuant to his contract with the hospital.

The learned Chief Justice proceeded to draw the following conclusion at page 323 (D.T.C. 6243):

In my view, the Federal Court of Appeal correctly held, on the particular facts here, that it was the respondent and not the hospital who was practising or endeavouring to practise medicine. Moreover, that did not inevitably require the conclusion that, in assigning his fees to the hospital, the respondent was assigning his own money rather than carrying out an arrangement under which the fees belonged to the hospital. The billing procedure was required by provincial regulations and cannot be the controlling element in determining to whom the fees belong when there was a valid arrangement for the provision of a salary to the respondent and for the accounting of fees to the hospital as employer.

In my view, the underlying rationale of the Campbell case was simply that the assigned fees were not income of the respondent doctor but rather were income to his hospital pursuant to a bona fide contractual arrangement between the doctor and the hospital.

In West Fraser Timber Co. Ltd. v. M.N.R., supra, the Minister relied on section 23 of the Act [now subsection 56(4)] to tax as income to the appellant profits realized on the resale of its lumber through two affiliated companies with which it was not dealing at arm's length and it was held that the profits so realized were not properly taxable as income of the appellant.

Mr. W.O. Davis, Q.C., stated the ratio of the case at page 55 (D.T.C. 253):

Consideration of the evidence heard leads to a finding that Swetnam Lumber Limited and William J. Swetnam Limited did in fact buy lumber from the appellant at the relevant times, and that any part of the sale price of lumber attributed to either of these companies by the appellant was in fact the profit accruing to the said companies from the resale of the said lumber and, as such, was not a receipt of the appellant on revenue account within the meaning and intent of section 23 of the Income Tax Act, and cannot be taxed as such. There was no transfer or assignment by the appellant to either of the Swetnam companies of the right to any amount that would have been included in the computation of its income for the taxation years in question within the meaning of the said s. 23.

In my view, the West Fraser case is but another illustration of the principle of beneficial receipt to which I have already alluded in making the finding that the corporation was beneficially entitled to the gallonage amounts as the person who had really earned them by virtue of a valid sale arrangement. As a matter of fact, it seems to me that this is the key focal point of the whole case. I quite agree with the characterization made by the Board member in West Fraser as to the applicability of the former section 23. Moreover, I consider that the result obtained by Chief Justice Laskin in the Campbell case flowed directly from his penetrating analysis of the controlling elements for determining to whom the fees belonged, which essentially resolved into the principle of beneficial receipt.

Notwithstanding that the corporation was beneficially entitled to the gallonage payments, as I have found, the question remains whether subsection 56(4) of the Income Tax Act requires that these payments be included in the plaintiffs' incomes. The Crown's position is that the subsection clearly does because the gallonage payments are quantifiable as additional or variable rent derivable from the head lease or the underlying realty itself, neither of which were transferred or assigned to the corporation. As such, they are rental payments running with the land.

Subsection 56(4) relates to the transfer or assignment of rights to income between persons not dealing at arm's length. What is actually contemplated is an amount representing income which, if the right thereto had not been transferred or assigned, would have to be included in computing the taxpayer's income “because the amount would have been received or receiv- able by him”. In my opinion, the quoted words import as an express condition of taxability the concept of beneficial receipt, with the result that subsection 56(4) does not apply to tax the gallonage payments in the hands of the plaintiffs because they were not beneficially entitled to them. This result, as it seems to me, is actually the converse of the one obtained in The Queen v. Canadian-American Loan and Investment Corp. Ltd., supra, where the taxpayer argued that the amount taxed was income from property transferred by sublease to its dormant corporation so as to come within the exclusion and the court held that it was income generated from a business.

In my view, the question posed by the second issue regarding the applicability of subsection 56(4) has been sufficiently answered to dispose of the case on its merits. Irrespective of that, I feel constrained to state my opinion regarding the defendant's alternative submission that the right to an amount of income referred to in subsection 56(4) must necessarily be characterized as relating to income from a "property"with the inevitable consequence that the escape loophole provided by the subsection does not avail where the property itself is not transferred. This constituted the alternative support basis for the reassessments under attack and was the central point of the decision in the Tax Court of Canada: Re Shaw et al. v. M.N.R., [1985] 1 C.T.C. 2232; 85 D.T.C. 154. There, the court found that the actual source of the income was the underlying realty of which the plaintiffs retained ownership, thus bringing them squarely within the provisions of subsection 56(4), notwithstanding any assignment of rentals or even the head lease itself. As I have already indicated, the same theme featured prominently in the argument of defendant's counsel and was countered by the alternative submission of plaintiffs’ counsel to the effect that the gallonage rentals and the head lease itself were "property" within the meaning of the Act.

The words "property" and "transfer" are both terms of wide import. Subsection 248(1) of the Income Tax Act defines the word "property" in part as follows:

"property" means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

(a) a right of any kind whatever, a share or a chose in action,

(b) unless a contrary intention is evident, money,

In Fasken v. M.N.R., [1948] C.T.C. 265; 49 D.T.C. 491 (Ex. Ct.), Thorson, P., confronted with the question of what constituted a transfer of property, was of the opinion that the word "transfer" was not a term of art having a technical meaning and that all that was required to effectuate the transfer of property from one person to another was to pass the property to that other. The means by which that result is accomplished, "whether direct or circuitous, may properly be called a transfer”.

In Wertman v. M.N.R., [1964] C.T.C. 252; 64 D.T.C. 5158 (Ex. Ct.), Thurlow, J. said at page 266 (D.T.C. 5166-67):

Under the Canadian statute what is taxed as income from a property or a business is the “profit therefrom" for a taxation year, and this poses the question "what is the profit from the property or business"? In the great majority of cases it is quite immaterial whether the profit is regarded as arising from a business or from property, but when the question does arise, it is in my opinion simply one that must be resolved on the facts of the particular case and I know of no single criterion on which it may be determined.

Rent is the recompense payable by the tenant to the landlord for the possession and use of the demised premises. A covenant to pay rent runs with the land, the benefit of which passes to the assignee of the lessee. The fact that the oral lease from the plaintiffs to their corporation was not by deed is not, in my opinion, fatal to its efficacy. A parol lease, followed by possession and payment of rent, operates by implication of law to create a yearly tenancy. See generally Anger and Honsberger, Canadian Law of Real Property (Canada Law Book Company, 1959 Edition) pp. 927, 933, 941, 944-45; 27 Halsbury's Laws of England, 4th ed., para. 102; Martin v. Smith (1874), Law Rep. 9 Ex. 50; Walsh v. Lonsdale (1882), 21 Ch. D. 9; and Rogers v. National Drug & Chemical Co. (1911), 24 O.L.R. 486 at p. 488 (Ont. C.A.).

In my opinion, rent payable for the use and enjoyment of property and a lease stipulating payment of the same are both comprehended by the broad definition of property in subsection 248(1) of the Income Tax Act. I have already found that the 1975 sale agreement and the director's resolution of January 2, 1976 and the plaintiffs' consistent course of conduct, viewed from a practical business prospective as a matter of substance and not of form, combined to vest in Jack Shaw Enterprises Limited the benefits and obligations of the service station business, including, as part and parcel thereof, the head lease and the additional rent payable thereunder. Moreover, I consider that the oral sublease between the plaintiffs and Jack Shaw Enterprises Limited eliminates any element of doubt that the net effect of the whole transaction was to transfer the head lease and the gallonage payment rentals to the corporation, notwithstanding that there was not express formal assignment of the head lease itself. I am therefore of the opinion that the plaintiffs are entitled to the benefit of the exclusion contained in subsection 56(4) of the Income Tax Act.

Based on the facts of the present case, I find that the Minister's reassessments of the plaintiffs’ incomes for the 1979, 1980 and 1981 taxation years are wrong in law. In the result, the plaintiffs’ appeals are allowed and the subject assessments are referred back to the Minister for reconsideration and reassessment in accordance with these reasons. The plaintiffs are entitled to their costs of the action, taxed on the basis of one set of costs only.

Appeals allowed.