Lamarre Proulx, T.C.J. [Translation]:—This is an appeal against reassessments by the respondent, the Minister of National Revenue, with respect to the appellant's 1985 and 1986 taxation years.
The appellant is a wholly owned subsidiary of Le Groupe Desgagnés (1981) Inc. ("GD"). GD is in the shipping business and is the parent corporation of several subsidiaries, each of which specializes and is known in one of the various aspects of shipping.
The appellant holds 100 per cent of the shares in another corporation, Les Entreprises Maritimes Desgagnés Inc. ("EMD"). These shares were acquired in 1982, when EMD was called Techno Maritime Inc. It had tax losses that could be carried forward and held shares that were of interest to GD.
On May 3, 1984, the appellant obtained a contract from the federal Department of Transport to serve the north. On June 1, 1984, it obtained a northern contract from the Québec Department of Transport, and on May 1, 1985, the appellant again obtained the northern service contract from the federal government.
At issue is which company the income from these contracts belongs to.
The appellant contends that it merely acted as EMD's mandatary with regard to these contracts and that, consequently, the income from these contracts must be included in the calculation of EMD's income. Furthermore, as far as it is concerned, only the income from the commission paid by EMD for the appellants work as a nominee may validly be included in the calculation of its income.
The respondent argues that the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") does not allow the use of a consolidated tax return for a group of associated or related companies. Each company is a separate legal entity; this single or unitary view of each company therefore obliges the respondent to determine, if need be, whether each separate legal entity is following the rules common to any corporate structure. This principle is even more important when two corporations do not deal with each other at arm's length.
The respondent contends that there are insufficient facts, and especially documentary evidence, to establish by a preponderance of evidence that there exists an operation legally complete and entirely effective as to its effects between the appellant and EMD whereby EMD appointed the appellant its nominee in order to obtain the northern service contracts . In this regard, he contends that there was never any clear and operative legal relationship between the appellant and EMD. He further points out that the appellant was always in a better position than EMD to carry out the northern service contracts.
Counsel for the appellant argued that the nominee agreement between EMD and the appellant was not exceptional, given GD's administrative set-up and the administrative capability of each of GD's subsidiaries. In fact, the evidence established that the administrative work was done entirely at GD's level. That was the level at which preparations were made for tenders, the sale of services, the purchase of fuel and other goods, the management of funds, banking letters of endorsement, insurance and accounting; it was at that level that the contracts were allocated. The accounting was done for each project, and GD's various subsidiaries were billed according to the allocation of the contracts. GD's subsidiaries owned assets but did not have the capability to administer themselves; their income was calculated according to the contracts that had been allotted to them.
On this subject, counsel for the appellant argued that the appellant's corporate organization is normal in the shipping business, and referred the Court to F. Paine’s The Financing of Ship Acquisitions 2 and in particular the diagrams on pages 59 and 66, where it can be seen that it seems to be common business practice for subsidiaries to own one or. more ships without having an administrative management function and for these management functions to be grouped together in a single corporation.
Here is what GD's general manager had to say about GD's administrative operation:
The management capabilities are in the Groupe Desgagnés. For example, the shipping sales manager handles the duties for all the companies that are part of the Groupe Desgagnés corporate structure. The fitting-out manager is responsible for ensuring that crews are adequate, ships are in good repair and performance is good for all the ships that are part of the "Groupe," regardless of what company the particular ship belongs to.
And on the matter of the allocation of contracts: "[Translation] . . . the contracts are allocated according to various criteria, including the tax benefits, the type of contract, the type of activity and the region ."
With regard to the preparation of tenders and the execution of contracts:
Q. Under what conditions was the execution as such carried out? [. . .]
A. The role of Groupe Desgagnés is to provide qualified staff to execute the contract. It is to prepare the tender, the requests for tender. The tender is not prepared by Transport Desgagnés, Armateurs St-Laurent or Les Entreprises Maritimes Desgagnés; it's prepared by Groupe Desgagnés.
Q. Did Transport Desgagnés have the staff to manage such a contract?
A. No, Transport Desgagnés did not have the staff to manage or even to prepare and file the tender and study everything . .. there is a whole schedule to be followed for the ships, priorities, amount of cargo, different types of cargo . . . for example, you can't load flour at the same time as a hazardous product, so you have to analyse everything, how you are going to set up your voyages, how many voyages it will take, how much time it will take you. Then, from that, you determine your costs, and on the basis of that you make the tender. But all that staff is used, from the president to me and then to the fitting-out manager or the Arctic operations manager.
Q. So, as I understand it, this tender was prepared by employees of Groupe Desgagnés (1981) Inc.?
A. As always.
Q. As always. And the tender for the federal contract was done by Transport Desgagnés Inc. I understand that the reason for this was because of the invitation that had been addressed to your companies?
A. Yes. Desgagnés is the company recognized mainly at the Canadian level. I wouldn't say at the international level, but at the Canadian level, for carrying out shipping contracts in Canada. It was on call, on selected request; the federal government selects certain suppliers and asks them for a quotation.
The evidence suggests that, right from the acquisition of the shares in EMD, a company that was itself involved in shipping, it was planned that EMD would carry out the northern service contracts. However, this decision was not implemented during the first two years after the acquisition because there was a dispute regarding that acquisition. When this problem was settled, two years after the transaction, GD decided that the appellant would bid in place of EMD on the northern service contracts because the appellant was well known in the shipping business and the calls for tender for the federal contract were by invitation and were addressed to the appellant.
Here is what GD's general manager had to say about the allocation of the northern service contracts:
A. [. . .]
So that is why in January 1984 I instructed my staff to proceed by having the federal northern service shipping contract, the Québec northern service shipping, carried out by Les Entreprises Maritimes Desgagnés. [. . .]
Q. So, in fact, Mr, Beaulieu, in 1984 such contracts were awarded to Transport Desgagnés Inc.?
Q. To your knowledge, were your instructions carried out? If so, under what conditions was this contract carried out?
A. Yes, the instructions were definitely carried out by my staff. On several occasions I had meetings and discussions with them because of the problem we had with the accounting systems and in the memory capabilites [. . .].
Here it is necessary to quote exhibit A-13:
January 21, 1985
Mr. Yvan Desgagnés
Mr. Rosaire Desgagnés
Mr. Louis Olivier
Re: 1984 Arctic contract — Federal and provincial
In response to the many questions and objections that have been presented to me, I am attaching a document that explains why I decided in January 1984 to have the 1984 Arctic contract (federal and provincial) carried out by Techno Maritime Inc (now Les Entreprises Maritimes Desgagnés Inc) rather than by some other company.
This document explains the various alternatives that I considered as well as the problem with accounting and customer relations.
My analysis of this file and the decision that I made in January 1984 were based on numerous recommendations that I had received during the previous years, including those by our auditors.
I trust this will clarify the situation and make it possible for you to close the file.
Le Groupe Desgagnés (1981) Inc
I decided that:
A. Transport Desgagnés Inc. should do the tender itself for the federal and provincial Arctic;
B. Transport Desgagnés Inc. should act as a nominee for and in the name of Techno Maritime Ltée;
C. Transport Desgagnés Inc., acting as a nominee, was to bill the clients directly, collect all accounts receivable and pay all invoices and expenses;
D. Transport Desgagnés Inc., dealing directly with the clients and suppliers, was to handle the accounting for all transactions relating to North 84. The system was to be complete, including the vouchers, the list of accounts receivable and payable, and the ledger and pay system;
E. Transport Desgagnés Inc., dealing with suppliers for Techno Maritime Inc., was to sign all contracts, all undertakings, the various bid securities, ship and/or barge rental contracts, stowage contracts . . .
F. At the end, when all the operations were compiled (that is, near the end of November or December), Transport Desgagnés would turn over all the transactions and documents to Techno Maritime Inc. The compilation of the operations by Transport Desgagnés would be transferred to Techno Maritime Ltée. The transfer of the result of the operations would be done with all revenues and all expenses;
G. In consideration of the work done by Transport Desgagnés Inc., Techno Maritime Ltée agreed to let Transport Desgagnés Inc. collect a 2.5% commission on the revenues estimated at approximately $5,000,000.
Each year there was a resolution adopted by the directors of the corporations involved in this appeal that read as follows: “ [Translation] It Is Resolved that all by-laws, resolutions and instruments adopted or passed by the directors and officers of the corporation since the last annual shareholders' meeting shall be approved and ratified.”
The books were kept and the financial statements were presented in accordance with the legal situation determined by the general manager.
Exhibit A-9 shows that, although it was the appellant that nominally obtained the federal contracts for 1984 and 1985 and the provincial contract for 1984 for the northern service, its equipment was used to a lesser degree to carry out the contracts. In fact, 100 per cent of the tonnage for the federal contracts was carried by the equipment of another subsidiary of GD, and the appellant's equipment was used for only 33 per cent for the tonnage for the provincial contract.
Counsel for the appellant argues that GD used the company best known in the shipping business, namely, the appellant, to bid on the northern service contracts, even though it was planned that those contracts would be the internal responsibility of EMD so as to give it the best chance to obtain those contracts.
Counsel for the respondent disputes that the nominee agreement was actually made concrete. In his view, the basic problem is to determine who is the real legal owner of the northern service contracts. He claims that it does not solve the problem simply to say that the legal owner of these northern contracts is the company selected by GD to absorb the profit for tax purposes. He argues that the absence of a written contract, express resolution or public announcement is an important fact that counters the appellant's claim that there is a real legal relationship between it and EMD.
It is true, as counsel for the respondent points out, that it is necessary to determine which company is the legal owner of the service contracts, and this must be done with regard to the appellant and EMD. Accordingly, I must determine whether the nominee agreement is valid, and, if so, whether the respondent must take it into account.
A review of legal theory shows that a nominee agreement is a form of agency contract recognized in Article 1716 of the Québec Civil Code 8 , and that it is usually in the nature of a nominee contract not to be made public. The mandate may be written, oral or tacit , and does not have to be in any particular form. Its validity is subject to the general rules for contract validity.
By such an agreement, an individual promises to act on behalf of another, but by hiding under his own personality the real party involved in the proposed operation. This type of agreement is used when the party concerned does not want to appear in the proposed operation and intends to let the third party believe that his agent is dealing for himself. The first question to be asked concerns the validity of such an agreement. When it is valid, a nominee agreement is analysed in a counterletter. As in all cases of sham, its effects will be different in the relations of the parties to the counterletter and in their relations with third parties.
There are various possible reasons for the secrecy sought by the real party concerned: desire to hide himself from the co-contracting party, from his family or from public opinion, impossibility of laying the legal relationship at his doorstep . . . The validity of the operation will depend on this.
The sole requirement for the nominee agreement to be valid is that it may not make it possible to accomplish clandestinely what the law will not allow to be done openly. Case law has never gone beyond this requirement.
Thus, the nominee agreement proposed by the appellant may be valid even if it is not in writing and made public, provided the purpose sought by the nominee agreement is not unlawful. The respondent did not raise this point, and since I do not see on the face of it that the goal pursued is unlawful, I do not have to settle the question. As regards the point raised by counsel for the respondent that such a nominee agreement would require an express resolution by the directors, it would have had to be proved that the annual resolution ratifying all instruments adopted by the officers of the corporation was not sufficient. This was not done. It is true, as counsel for the respondent notes, that the contract allocation plan and the nominee agreement could always have been modified, but as long as the decision was not modified, the whole remained valid. This is true for any resolution and any agreement, which stand as long as they are not modified.
There remains the problem of the evidence. I see two points there: (1) the evidence of the nominee agreement and (2) its enforceability against the respondent.
(1) How can one prove a legal transaction that is private in nature and not set down in writing?
The law, for an essentially pragmatic purpose, also lays down formalities for evidence in order to avoid needless disputes before the courts and to force the parties to draw up beforehand material evidence of their agreement. A merely oral contract remains valid. However, for any civil contract where the amount exceeds a certain amount, the Code requires a document in writing. This means that anyone who invokes a right based on such an undertaking cannot succeed unless he produces written evidence of the contract. However, the contract remains valid, since the parties can still prove it by the adverse party's admission and, in certain limited cases, by testimonial evidence supported by prima facie documentary evidence.
In the present case, neither of the parties to the nominee agreement disputes the existence of the contract. Therefore, in my opinion, we have a judicial, or at least extrajudicial, admission. With regard to the respondent, however, this is not sufficient, since there might have been collusion between the two parties. There is a very important document given the circumstances of this appeal, namely, the internal memorandum from the general manager dated January 21, 1985, already quoted from extensively. As well, there are the accounting entries matching the agreement from the beginning of execution of the contracts, which demonstrate to me a prior agreement between the two companies, as regards both the allocation of the service contracts and the nominee agreement. This constitutes presumption of fact or prima facie documentary evidence which, in my opinion, is acceptable for proving the existence of a real prior agreement.
I consider that the appellant has demonstrated a specific, prior nominee agreement between itself and EMD. I can affirm that there is such an agreement because, on the one hand, the mandate is a contract that does not have to be in writing in order to be valid; and, on the other hand, in addition to the extrajudicial and even judicial admission of the parties to the agreement in question, there is the prima facie documentary evidence based on the written document of January 1985 and on the matching bookkeeping entries dating from the beginning of execution of the contract. I therefore conclude that between the mandator and the mandatary there was a formal agreement prior to execution of the contract and that it was not “some ex post facto arrangement" or a retroactive decision by the directors.
There was some dispute as to whether the mandate was commercial or civil in nature. The question is important as regards the proof to be provided. I did not have to settle this question, since I consider that I had before me the more demanding evidence of a mandate of civil nature. It is possible, however, that the nominee mandate might be commercial in nature, since this mandate was the source of the appellant's income, that is, the commission that EMD paid it for its nominee work.
(2) I now come to the matter of the agreement's enforceability against the respondent. Counsel for the respondent indicates in his written arguments that he is in fundamental disagreement with the appellant's position because a taxpayer may not adopt two versions with regard to the same transaction, namely, one for third parties and the other for income. This assertion results, I believe, from a certain confusion about the third-party status of the respondent with regard to the service contracts and about the interpretation to be given to Article 1212 of the Civil Code.
Article 1212 of the Civil Code affirms that counter-letters do not constitute proof against third parties. According to Mignault, this expression is unfortunate, since, he says, the counter-letter is proof against third parties as well as against the parties of the sham with which the apparent instrument is tainted. However—and this is the meaning of Article 1212—a sham once proved does not have the consequence of destroying the legal effects with regard to third parties that the apparent agreement was supposed to have produced.
. . . when it is a matter of determining whether an insured party has an insurable interest in something, it is the actual situation as revealed in the counter-letter that must prevail. In such a case, the insurer may not claim to be a third party against whom the counter-letter is not enforceable under Article 1212 of the Civil Code.
There is no legal relationship between the mandator and the contracting third party when the mandatary contracts in his own name, since the contract is then formed between the mandatary and the third party. If the respondent was a person who has done business with the appellant by reason of the service contract, such as the Minister of Transport, it is clear that the nominee agreement could not be enforced against him.
However, the respondent has business dealings with the appellant as Minister of Revenue. In a self-assessment system, he verifies whether the taxpayer has filled out his tax returns correctly, taking into account the taxpayer's rights and obligations as they existed at the time the income was earned. In my view, he is, ex officio, a sort of auditor. He is not, here, in the position of one who derives his rights solely from the apparent agreement and for whose protection Article 1212 of the Civil Code exists. He must therefore, in my opinion, take into account the nominee agreement insofar as that agreement is valid and prior to execution of the service contracts, and he must take the service contracts into account.
There is no doubt that the sole aim of this agreement was to secure tax benefits. But this does not render the nominee agreement invalid under tax law, according to Stubart, supra.™ This is clearly acknowledged by counsel for the respondent. Stubart clearly states that there is no consolidated income return for associated companies, but it also says that if there are prior, valid and certain agreements between the companies, such agreements must be followed when the income is calculated, unless specific provisions of the Act prevent their application. In this regard, I wish to note that the respondent has not relied upon subsection 111(5) or section 245 of the Act.
The appeal is allowed with costs.