Date: 19980331
Docket: 95-2833-IT-G
BETWEEN:
JOHN S. WALTON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bonner, J.T.C.C.
[1]
This is an appeal from assessments of income tax for the 1986 and
1988 taxation years. On assessment the Minister of National
Revenue included in the Appellant's income amounts
calculated under section 94.1 of the Income Tax Act in
respect of "offshore investment fund property" held
by the Appellant.
[2]
Section 94.1 was added to the Income Tax Act in 1984.
It is an anti-avoidance provision which may require an
inclusion in income when a taxpayer acquires or holds offshore
investment fund property. Inclusion is required if it may
reasonably be concluded that one of the taxpayer's main
reasons for acquiring or holding such property is to derive a
benefit from underlying investments held by the fund in a manner
that reduces or defers the tax that would have been exigible
under Part I of the Act had those underlying investments
been held by the taxpayer directly. The section was enacted as a
measure designed to thwart the use of offshore investment funds
which permitted taxpayers resident in Canada a complete escape
from or indefinite deferral of tax on passive income.[1]
[3]
Subsection 94.1(1) reads in part:
94.1 (1) Where in a taxation year a taxpayer, other than a
non-resident-owned investment corporation, holds or has an
interest in property (in this section referred to as an
"offshore investment fund property")
(a)
that is a share of the capital stock of, an interest in, or a
debt of, a non-resident entity (other than a controlled foreign
affiliate of the taxpayer or a prescribed non-resident entity) or
an interest in or a right or option to acquire such a share,
interest or debt, and
(b)
that may reasonably be considered to derive its value, directly
or indirectly, primarily from portfolio investments of that or
any other non-resident entity in
(i) shares of the capital stock of one or more corporations,
(ii) indebtedness or annuities,
(iii) interests in one or more corporations, trusts,
partnerships, organizations, funds or entities,
(iv) commodities,
(v) real estate,
(vi) Canadian or foreign resource properties,
(vii) currency of a country other than Canada,
(viii) rights or options to acquire or dispose of any of the
foregoing, or
(ix) any combination of the foregoing,
and it may reasonably be concluded, having regard to all the
circumstances, including
(c)
the nature, organization and operation of any non-resident entity
and the form of, and the terms and conditions governing, the
taxpayer's interest in, or connection with, any non-resident
entity,
(d)
the extent to which any income, profits and gains that may
reasonably be considered to be earned or accrued, whether
directly or indirectly, for the benefit of any non-resident
entity are subject to an income or profits tax that is
significantly less than the income tax that would be applicable
to such income, profits and gains if they were earned directly by
the taxpayer, and
(e)
the extent to which the income, profits and gains of any
non-resident entity for any fiscal period are distributed in that
or the immediately following fiscal period,
that one of the main reasons for the taxpayer acquiring,
holding or having the interest in such property was to derive a
benefit from portfolio investments in assets described in any of
subparagraphs (b)(i) to (ix) in such manner that the
taxes, if any, on the income, profits and gains from such assets
for any particular year are significantly less than the tax that
would have been applicable under this Part if such income,
profits and gains had been earned directly by the taxpayer,
...
[4]
The assessments in issue were based on the holding by the
Appellant during the taxation years in question of shares of a
corporation resident in Bermuda, Santa Maria Enterprises
Limited ("Santa Maria"). It was not suggested
that the Appellant's Santa Maria shares did not constitute
property described in paragraph 94.1(1)(a) of the
Act. As well, paragraph 94.1(1)(b) did not give
rise to any dispute. The shares of Santa Maria derived their
value from shares in two incorporated funds operated by the Bank
of Bermuda. Virtually all of the capital of Santa Maria was
invested in the two funds and Santa Maria did not carry on any
other business activity. It was not argued that the shares of the
two funds were not "portfolio investments" within the
meaning of paragraph (b).
[5]
Section 94.1 is based on a "one of the main reasons"
test. The sole issue in this appeal is whether it may reasonably
be concluded in accordance with subsection 94.1(1) that none of
the main reasons for the holding by the Appellant of the Santa
Maria shares during the years in question was to derive a benefit
from Santa Maria's portfolio investments in the manner
contemplated by the concluding part of the subsection. It was the
position of the Appellant that his main reasons for investing in
and continuing to hold the Santa Maria shares were to
preserve his capital and to have a fund available for investment
in a business which he hoped to undertake in association with a
colleague named Samuel Hannan. The tax advantages of the
arrangement were, the Appellant said, "number three, a
pleasant result".
[6]
Counsel for the Appellant approached the case as one which must
turn on acceptance or rejection of the Appellant's
testimony regarding his subjective purpose.
[7]
The Appellant was the only witness at the hearing of the appeal.
He was born and raised in Canada. He commenced his career as an
engineer and businessman in this country. In 1977 he ceased to
reside in Canada, took up residence in England and commenced to
work there. In 1979 he moved again, this time to Brazil, where he
took up residence and served as a senior executive of a large
corporation. His second-in-command was Mr. Hannan, a
resident of Brazil . In September 1981 the corporation for which
the Appellant worked was bought out. The Appellant sold his
shares and options to purchase shares in that corporation and
received consideration in the amount of approximately
2.5 million dollars (U.S.). He deposited the money in an
account at the Bank of Bermuda. In mid-1982 the Appellant
terminated his employment in Brazil and decided to return to
Canada. At that time Mr. Hannan was also considering a
career change. He was looking for a business which he could
purchase and manage. The Appellant was interested in
participating as an investor in a venture with Mr. Hannan if
the latter could find an appropriate business opportunity. It is
at this point that the Appellant made the investment arrangements
which continued essentially unchanged until 1989 and ultimately
led to the assessing action now under appeal.
[8]
The Appellant testified that he was concerned with maintaining
the value of his capital and for that reason did not want to
bring it with him to Canada where the dollar was declining in
value and foreign exchange controls were thought to be a
possibility. Moreover, as already noted, he said that he wanted
to keep his funds available for investment if he and Mr. Hannan
could find an appropriate project. He discussed the matter with
investment managers at the Bank of Bermuda who recommended that
he consult John Carson, a Toronto lawyer. The Appellant stated
that he consulted Mr. Carson in order to ascertain what his
Canadian tax position would be for, as he observed, he was about
to return to Canada. He insisted that "corporate
advice" was paramount and income tax advice was a
subsidiary matter only.
[9]
The consultation with Mr. Carson resulted in a lengthy
written report to the Appellant dated September 9, 1982. That
report focused almost exclusively on the foreign accrual property
income (FAPI) rules contained in sections 91 to 95 of the
Income Tax Act. Mr. Carson appears to have taken great
pains to locate the precise boundary between arrangements which
attracted the tax under the FAPI rules and those which did not.
Mr. Carson's reporting letter emphasized that the FAPI
rules which attribute the passive income of a controlled foreign
affiliate to its Canadian shareholder do not apply if the foreign
affiliate is not a "controlled foreign
affiliate".
[10] As a
result of the consultation, Mr. Carson, on behalf of the
Appellant and Mr. Hannan, caused Santa Maria to be incorporated
under the laws of Bermuda on September 29, 1982. The Appellant
invested the 2.5 million dollar proceeds from the sale of his
shares and options in Santa Maria. Mr. Hannan invested
almost 2 million dollars in the company. Each of the two became
owner of 50 percent of the Class "A" voting shares of
Santa Maria. Each also became owner of non-cumulative
redeemable preference shares of Santa Maria although not in equal
proportions. The preference shares were non-voting and thus
neither the Appellant nor Mr. Hannan controlled the company. For
that reason Santa Maria could not be regarded as a controlled
foreign affiliate of the Appellant under paragraph
95(1)(a) of the Act. The Appellant testified that
the voting shares of Santa Maria were equally divided between
himself and Mr. Hannan so that the two would be able to work
together as partners.
[11]
Santa Maria was an "exempt undertaking" under
the laws of Bermuda, that is to say, it was exempt from existing
and future Bermuda tax on its profits and capital assets. The
shares of Santa Maria were held for the Appellant and
Mr. Hannan by a Bermuda firm, Murdoch and Company, which
provided Bermuda-resident directors and managers for
Santa Maria. The directors acted on the instructions of Mr.
Hannan and the Appellant given through Mr. Carson. Prior to 1990
all meetings of directors and shareholders of Santa Maria
were held in Bermuda. On the basis of the central management and
control test Santa Maria was resident in Bermuda. Santa Maria
could not be regarded as resident in Canada on the basis of place
of incorporation.
[12] Virtually
all of the money invested by the Appellant and Mr. Hannan in
Santa Maria was in turn invested by it in capital shares of
Bermuda International Bond Fund Limited and managed shares of
Bermuda International Currency Fund Limited. The two funds were
open-ended investment companies incorporated under the laws of
Bermuda. The manager of the funds was a subsidiary of the Bank of
Bermuda. The funds earned income from investments in foreign
currencies and in government bonds, treasury bills and similar
high quality investments yielding fixed income. Each fund held an
undertaking from the Bermuda government exempting it from income,
profits and capital gains taxes until March 2006. The shares in
the two funds did not entitle the holders thereof to cash
dividends. Net profits of the funds were accumulated and were
reflected in the price of the shares which were redeemable at
prices based on the net assets of the funds.
[13] The
venture which the Appellant and Mr. Hannan hoped to find did not
materialize. The Appellant stated that one enterprise which
appeared to have potential was investigated by Mr. Hannan in 1983
but nothing came of it. According to the Appellant other
investments were considered. The timing and extent of those
investigations were not revealed. Ultimately the plans evaporated
when Mr. Hannan was named Chief Executive Officer of a large
Brazilian mining concern. The evidence does not indicate when
this happened. Thus from the outset until 1989 virtually all of
Santa Maria's money remained invested in the two funds
earning interest income, albeit indirectly.
[14] It was
admitted that if the income, profits and gains from the Bond Fund
assets and from Currency Fund assets had been earned directly by
the Appellant, the Appellant's income, net taxable capital
gains and federal tax payable thereon by the Appellant in 1986,
1987 and 1988 would have been, as follows:
|
|
1986
|
1987
|
1988
|
|
Income and taxable capital gain
|
$381,819
|
$223,399
|
$140,208
|
|
Federal tax
|
$136,310
|
$ 78,190
|
$ 41,922
|
[15] In my
view the evidence of the surrounding circumstances supports a
conclusion that one of the main reason for interposing Santa
Maria between the Appellant and the underlying investments was
the avoidance of the tax that would have been imposed on the
Appellant as a resident of Canada if he had held his pro-rata
share of those investments directly. Mr. Carson's role
extended beyond offering advice. He created a structure which
does not appear to have been designed solely to satisfy the
objectives described by the Appellant in his testimony. The
evidence does not identify any compelling reason for the
selection of Bermuda as a jurisdiction for the incorporation of
Santa Maria save for the availability of exempt undertaking
status. No business-driven non tax reason for the use of Murdoch
and Company was suggested. Initially there may have been an
intention to invest the funds of Santa Maria in a business to be
operated by the Appellant and Mr. Hannan if such a business could
be found. There is no suggestion in the evidence however that
such intention continued to exist in the years in question. The
only clearly identifiable reason for the continued holding of
Santa Maria shares by the Appellant during the years in question
was the potential to insulate the Appellant from taxation on
profits from the underlying investments. It is difficult to
imagine how the capacity to accomplish tax savings of the sort
set out above was a less important reason for holding the Santa
Maria shares than the subjective reasons on which the Appellant
relied. In Symes v. The Queen, 94 DTC 6001 Iacobucci J.
stated at 6014:
As in other areas of law where purpose or intention behind
actions is to be ascertained, it must not be supposed that in
responding to this question, courts will be guided only by a
taxpayer's statements, ex post facto or otherwise,
as to the subjective purpose of a particular expenditure. Courts
will, instead, look for objective manifestations of purpose, and
purpose is ultimately a question of fact to be decided with due
regard for all of the circumstances.
In my view the Appellant's recollection of the reasons
which led him to acquire and to continue to hold the Santa Maria
shares is imperfect. The evidence does not support a conclusion
that the Minister of National Revenue erred in applying section
94.1 of the Act in the circumstances of this case.
[16] The
appeals will be dismissed with costs.
Ottawa, Canada, this 31st day of March 1998.
"Michael J. Bonner"
J.T.C.C.
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