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Citation: 2007TCC94
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Date: 20070221
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Dockets: 2001-2301(IT)G, 2001-2302(IT)G,
2001-2303(IT)G, 2001-2304(IT)G,
2001-2305(IT)G, 2001-2307(IT)G,
2001-2308(IT)G, 2001-2309(IT)G,
2001-2318(IT)G, 2001-2319(IT)G,
2001-2320(IT)G, 2001-2321(IT)G.
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BETWEEN:
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JOHN MacKAY, DEREK ROSS LEE,
ROBERT MACDONALD, ROBERT LEE LTD.,
AEBAG HOLDINGS LTD., BEACH AVENUE HOLDINGS COMPANY LTD.,
JOHN CASSILS, JOHN ZAYTSOFF,
TIMOTHY WALLACE, MARIA WONG,
ROBERT GLASS, BRIAN McGAVIN,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
CampbellJ.
I. INTRODUCTION
[1] These appeals arise as a result of a series of transactions and events that took place between August and December 31, 1993, and resulted in the reassessment of the Appellants for various taxation years. The appeals were heard together on common evidence.
[2] The Appellants are involved in some manner in the business of investing in, developing and selling real estate. In August 1993, several of the Appellants were presented with the opportunity to purchase the Northills Shopping Centre (the "Shopping Centre") located in Kamloops, British Columbia. At this time, the National Bank of Canada (the "Bank") had possession of the Shopping Centre as a result of foreclosure proceedings pursuant to a mortgage that the Bank held on the Shopping Centre (the "Receivable"). The Bank's cost base for the Receivable was $16,072,865.
[3] The Appellants negotiated the sale of the Shopping Centre with the Bank for a price of $10,000,000. The sale resulted in a non-capital loss, equal to the difference between the cost base of the Receivable ($16,072,865) and the fair market value ($10,000,000), being transferred to a partnership and eventually allocated to each Appellant based on their proportionate share in the partnership. The basic series of transactions that allowed this loss to be transferred can be summarized as follows:
i. The Bank incorporated a wholly owned subsidiary;
ii. The Bank formed a partnership with this new company;
iii. The Bank assigned its interest in the mortgage Receivable to the partnership; and
iv. The Appellants purchased their partnership units in the partnership.
[4] After the transfer of the Shopping Centre to the partnership, in which the Appellants owned partnership units, they wrote-down the cost of the Shopping Centre and realized a loss of $5,820,875. The Appellants then utilized their proportionate share of the loss to offset income from other sources. The transfer and subsequent write down of the value of the Shopping Centre were in accordance with subsections 18(13) and 10(1) of the Income Tax Act (the "Act").
[5] The Appellants were reassessed on the basis that section 245 of the Act, the General Anti-Avoidance Rule ("GAAR"), applied to deny the claimed losses respecting the mortgage. The Respondent submits that the transaction or transactions that gave rise to the tax benefit were avoidance transaction(s) within the meaning of subsection 245(3) of the Act because they were completed in this manner to obtain a tax benefit of the transfer of the non-capital losses, resulting in the eventual reduction of income tax payable by each Appellant based on their proportionate share in the Partnership.
[6] The Appellants submit that "the primary purpose of each of the transactions, and the series of transactions as a whole, was to enable the vendor of the Shopping Centre (the Bank), the purchaser (the Partnership in which the Appellants were members) and each of the Appellants to complete the acquisition of the Shopping Centre" [Appellants' Submissions, paragraph 3]. The Appellants further state that "obtaining tax losses was not the primary purpose of any of the transactions" [Appellants' Submissions, paragraph 3].
II. ISSUES
[7] The Appellants abandoned the argument that section 245 of the Act violated section 7 of the Canadian Charter of Rights and Freedoms.
[8] At paragraph 4 of the Appellants' written opening statement it was conceded that:
(a) The transactions in question gave rise to a "tax benefit" (as defined in subsection 245(1) of the Act); and
(b) In the circumstances, there is no need for thisHonourable Court to engage in any review of the defence found in subsection 245(4) of the Act.
[9] The sole issue in these appeals is whether, in considering the application of section 245 of the Act, there was an avoidance transaction as contemplated by subsection 245(3) of the Act.
III. FACTS
[10] The facts in these appeals are quite lengthy. Over the course of seven days of hearings, a total of 14 witnesses testified. Those witnesses included 11 of the Appellants; Bill Kennedy, the representative of the Bank; Tony Letvinchuk, the Property Manager of the Shopping Centre; and Gilbert Lee, an Appeals Officer with the Canada Revenue Agency. In addition, 226 documents were presented in a Joint Book of Documents.
[11] The parties entered an Agreed Statement of Facts, which is attached to my Reasons as Schedule "A". I have also attached, as Schedule "B", a brief summary of the evidence of each of the Appellants, or nominee in the case of a corporate Appellant. Both Schedules are relevant to and referred to in my Reasons. A brief summary of the essential facts will suffice as background to my discussion and analysis of the issue.
[12] Prospero International Realty Inc. ("Prospero") is owned by Robert Lee (who is the principal of the Appellant, Robert Lee Ltd.) and his family (the "Lee Family") including his son, the Appellant, Derek Lee. Prospero was hired in 1991 to be the Property Manager of the Shopping Centre.
[13] The Lee Family had prior knowledge of the Shopping Centre as they had briefly owned it before selling it back to the original owners, York-Hannover Developments Ltd. ("York-Hannover"), in 1992 for approximately the same price that they had paid for it. In Derek Lee's opinion, the investment was neither good nor bad; it was merely a non-event.
[14] Prospero employed Tony Letvinchuk as its property manager. He first became acquainted with the Shopping Centre at the time of Prospero's purchase from York-Hannover. Tony Letvinchuk became the official Property Manager at the end of 1992.
[15] During the period from 1990 to 1992, the Shopping Centre operated at a deficit. By December 1992, the Bank filed a petition (the "Foreclosure Proceedings") in the British Columbia Supreme Court against York-Hannover to foreclose on their interest in the Shopping Centre.
[16] In February 1993, the Court issued an order giving the exclusive conduct of the sale of the Shopping Centre to the Bank. As of February 3, 1993, $16,072,865 was owing to the Bank. On February 9, 1993, the Bank and Prospero entered into an Exclusive Agency Agreement to sell the Shopping Centre at a sale price of $12,500,000.
[17] Derek Lee, the primary person at Prospero who was responsible for the marketing and sale of the Shopping Centre, prepared a sales brochure [Joint Book of Documents, Vol. 2, Tab 38]. Several offers were made to purchase the Shopping Centre but none were completed. In an attempt to sell the property, Prospero contacted other business contacts and clients who might be interested in the property. One of those individuals was the Appellant, Robert Macdonald, the principal of Macdonald Development Corporation.
[18] Robert Macdonald testified that he first became aware of the Shopping Centre in the spring of 1993 through the Bank. He was later contacted by Derek Lee and given a copy of Prospero's sales brochure. Initially, Robert Macdonald was not overly enthusiastic about the deal since he was already involved with the Bank on other transactions and felt that he could not "hammer" out as low a price concerning the property [Transcript page 530]. However, Derek Lee and Tony Letvinchuk convinced him that it was an attractive deal.
[19] Robert Macdonald testified, and his diary [Joint Book of Documents, Vol. 6 Tab 208] indicates, that he visited the Shopping Centre in May 1993. At this time, the Shopping Centre was described as "shabby" and lacking in "curb appeal". It needed modernization and many of the tenants were on month-to-month leases. However, Robert Macdonald did not believe that the financial and physical condition of the Shopping Centre would be a detriment and based on his business experience, and discussions with Tony Letvinchuk, he considered the Shopping Centre to have a significant upside potential.
[20] Robert Macdonald testified that he was interested in purchasing this property only if the Lee Family became involved because he felt it would be beneficial if the property manager, Prospero, had an ownership stake in the Shopping Centre. At this time, he did not discuss the purchase with any other potential partners.
[21] Robert Macdonald testified that his plan was to see if he could acquire the Shopping Centre at a base price based on a "bricks and mortar basis and on a cash flow basis". He stated that "if we could get it for 10 [million], ... we would spend some money to undertake improvements, bring in some new tenants, get the income up and then in some time frame hopefully resell the shopping centre for a profit" [Transcript page 557]. He stated that he did not have any discussions about tax or tax losses with either Derek Lee or Tony Letvinchuk at this time.
[22] It was during these discussions that Derek Lee and Robert Macdonald, with the assistance of Tony Letvinchuk, created a business plan (the "Business Plan") for the Shopping Centre. The Business Plan consisted of the following steps:
(a) Purchase the Shopping Centre for a price of $10,000,000 (a price which reflected a capitalization rate of 11.5 percent);
(b) Physically improve and update the Shopping Centre to make it more physically attractive to a potential purchaser;
(c) Lease up and stabilize the tenants at the Shopping Centre, to make it more economically attractive to a potential purchaser;
(d) Increase the value of the Shopping Centre through the physical and financial improvements;
(e) Achieve an annual net operating income from the Shopping Centre of approximately $1,400,000; and
(f) Profit from the resale of the Shopping Centre for a sale price of $14,000,000 (based on a 10 percent capitalization rate) at the earliest and most optimum time.
[23] Before meeting with the Bank on August 5, 1993, Robert Macdonald prepared for the meeting by familiarizing himself with the sales brochure for the Shopping Centre and also pursued discussions with Tony Letvinchuk. These discussions centred around the determination of a potential purchase price for the Shopping Centre together with a cost for improvements. Tony Letvinchuk prepared notes on the Shopping Centre [Joint Book of Documents, Vol. 2 Tab 41] which outlined a potential purchase price of $10 million, the amount of required financing, the amount required for improvements, and the cash flow that would be expected "out of the gate". The notes also included a reference to the importance of obtaining Tim-BR Mart as a tenant. Barrie Sali was the President of Tim-BR Mart, a chain of lumber and hardware stores. Because of tenant vacancies at the Shopping Centre, it was Robert Macdonald's hope that Barrie Sali would become a partner in the Shopping Centre and move Tim-BR Mart into the location.
[24] On August 5, 1993, Robert Macdonald and Derek Lee met with Bill Kennedy, Peter Brennan, and Jim Dysart, the Bank representatives. Bill Kennedy and Peter Brennan were in the special loans section, and Jim Dysart was responsible for North American real estate held by the Bank. Robert Macdonald described the meeting as a "negotiating session" respecting the purchase price and financing terms for the Shopping Centre.
[25] Initially, Robert Macdonald tabled a price of approximately $9 million and Bill Kennedy countered with a price of $11 million. Eventually, the parties agreed on a $10 million price. The Bank offered to carry a mortgage of up to 75 percent of the sale price, but Robert Macdonald was seeking a greater degree of leverage. The parties negotiated a mortgage of $8.6 million, provided that personal guarantees were given by Robert Macdonald and Robert Lee in respect of the amount of financing beyond 75 percent of the purchase price.[1] The parties also discussed additional financing for capital improvements to the Shopping Centre, the mortgage rate, and other terms of the mortgage. Tax losses or tax benefits were never discussed at this meeting.
[26] Robert Macdonald was aware there could be an issue as the Bank held the mortgage but did not yet have legal title to the property. He stated "[w]e just kind of knew where we wanted to end up [...] which was owning the property so we could carry out [the] business plan" [Transcript page 568]. It is noteworthy that the terms established at this meeting substantially represent the essential terms of the agreement that were eventually settled upon by the Appellants and the Bank.
[27] In the days following this meeting, Robert Macdonald met with the Appellants, Maria Wong and John Zaytsoff, to discuss the structuring of the prospective purchase of the Shopping Centre. At that time, Maria Wong was the Vice President of Finance at Macdonald Development Corporation and was responsible for coordinating legal and accounting structuring advice. John Zaytsoff, a Chartered Accountant and partner at the accounting firm KPMG, was the external accountant for Macdonald Development Corporation. Mr. Zaytsoff worked in the areas of corporate finance, real estate and taxation and his role was to create investment structures to meet his clients' business objectives and tax needs.
[28] It was Robert Macdonald's normal practice to consult with John Zaytsoff after he had "tied-up" a property. In this case, Mr. Zaytsoff advised that the Shopping Centre could be structured using a partnership. He testified that every deal he worked on with Robert Macdonald was different, but that a partnership was a common acquisition vehicle used in Mr. Macdonald's property transactions. The fact that the Shopping Centre was the Bank's mortgage receivable also had to be factored into structuring the transaction. After stating that this was his first time that he had assisted Robert Macdonald with the purchase of a mortgage receivable, John Zaytsoff was asked the following question in his examination in chief.
Q. And what challenges did that present to you for purposes of structuring?
A. When you say challenges, you know, the challenges were that this was a mortgage that was receivable by the bank. The bank had conduct of sale, my understanding was, of the property. My understanding also was that the bank had ... non-performing loan and that the bank wanted to get it off its books ... and our client wanted to buy real estate, that they wanted to enhance value by renovating and solidifying the tenancies. And ... those were the challenges and ... the facts that we were working with in creating a structure for the acquisition of the real estate. [Transcript page 985]
[29] After the meeting with John Zaytsoff, Maria Wong prepared a draft letter of intent addressed to Bill Kennedy of the Bank [Joint Book of Documents, Vol. 2, Tab 42] and faxed a copy of the letter, dated August 9, 1993, to John Zaytsoff for his review. The third page of the letter outlines the structure of the transaction and states:
We understand that NBC is transferring substantially (99.999%) all its interest in the mortgage secured by First Hill [sic] Shopping Centre to a newly created B.C. partnership for realization purposes and that we will be purchasing NBC's interest in this partnership. We further understand that the partnership will obtain beneficial ownership of the Shopping Centre before or upon the Completion date. Legal ownership will be held by a shell company and the shares of this company will be transferred to us.
[30] Although this letter was drafted by Maria Wong, it was completed pursuant to John Zaytsoff's advice. John Zaytsoff was asked in examination in chief why this structure was suggested. He responded that:
... there's a number of reasons. Firstly, a partnership is the most efficient way of owning real estate where you have a number of partners or a number of persons involved that have diverse backgrounds and diverse requirements. Each of the individuals has more flexibility ... in structuring their own affairs so that they don't interfere with anybody else's, whether it be from an estate-planning viewpoint or a tax-planning viewpoint or a financing viewpoint.
It is just the most flexible structure to use in an acquisition of real estate, particularly where you have other partners and particularly where the objectives are you buy real estate, refurbish it and sell it within a very short period of time.
[...]
The bank had a receivable, and that's the only thing that the bank had. My client wanted to buy real estate. It was our view that, and the receivable was under foreclosure proceedings and it was our view that if the bank was to transfer the receivable into a partnership and then foreclose and have the partnership foreclose on the property, that was just a much more efficient and effective way of having the property acquired by the partnership, as opposed to, you know, the bank going under a conduct of sale or first foreclosing on the property and then selling it. So that was another objective, another reason. [Transcript pages 988-989]
[31] Around the same time, Maria Wong drafted another document outlining the proposed steps of the transactions (the "Steps Document") [Joint Book of Documents, Vol. 2 Tab 43] which was faxed to Bill Kennedy. The Steps Document contained the following five steps:
1. National Bank ("NBC") transfers mortgage into a newly created General Partnership, the North Hills Partnership for a 99.999% interest. NBC sets up a new # Co. to hold remaining .001%. Pursuant to Sec.18(13) of ITA, NBC will be denied the loss on transfer and the denied loss will be added to the adjusted cost base of the mortgage. The resulting adjusted cost base of the mortgage will be the principal plus interest of the mortgage. North Hills Partnership shall be formed for the purpose of acquiring the problem mortgage to turn around and realize maximum proceeds therefrom.
2. North Hills Partnership then forecloses on mortgage and obtains title to Shopping Centre. Cost base of Shopping Centre will be the principal plus interest of the mortgage plus foreclosure expense.
3. NCB sells 99.999% of interest in North Hills Partnership to Macdonald Development Corporation ("MDC") and Prospero International Realty Inc. ("Prospero") for negotiated price. Which may include cash, 1st mortgage debt or other security. NBC realizes a loss on the sale of North Hills interest.
4. Pursuant to Sec. 10(1) of ITA, North Hills Partnership writes down the Shopping Centre to its FMV at the end of its first fiscal year and allocates the loss to its partners.
5. North Hills Partnership will carry out it [sic] business plan.
The second page of the Steps Document entitled "North Hills Shopping Centre Summary of Tax Structure" contained a diagram outlining these proposed steps.
[32] On cross examination, Maria Wong was adamant that the Steps Document did not disclose the reason for those steps, but merely listed the steps. She indicated that the Steps Document served to provide a complete picture of the structure of the transaction for the benefit of the Bank and that the only reason each transaction was proposed was to complete the acquisition of the Shopping Centre.
[33] On August 19, 1993, a draft letter of intent [Joint Book of Documents, Vol. 2 Tab 45A] was provided to Bill Kennedy for his review prior to a meeting later that same day with Robert Macdonald. The terms contained in this letter of intent were consistent with the terms discussed at the initial meeting on August 5, 1993. Robert Macdonald testified that the purpose of the meeting on August 19, 1993, was to determine if the Bank was amenable to implementing the structure proposed in the August 19, 1993 letter of intent and the Steps Document. Although Robert Macdonald could not recall whether there were any detailed questions regarding the proposed structure, he indicated that the discussion focused on the ability of the proposed steps to reach the "goal line" of owning the Shopping Centre while also achieving some tax benefits [Transcript page 627].
[34] As a result of this meeting, the Bank and Robert Macdonald reached a tentative agreement regarding the terms for the sale of the Shopping Centre to a group consisting of Robert Macdonald, Prospero and, potentially, Barrie Sali. A letter of intent was sent to the Bank's law firm, Fraser & Beatty on August 24, 1993 [Joint Book of Documents, Vol. 2 Tab 46], accompanied by a deposit of $50,000. The Completion Date contained in this letter of intent was November 15, 1993, reflecting the Bank's intention to close the transaction as soon as possible.
[35] In September 1993, Barrie Sali declined to participate in the Shopping Centre acquisition. Robert Macdonald began seeking alternative investors, including the other Appellants. As Robert Macdonald was heavily invested in other projects, he actively sought other investors to meet the project's capital requirements. Throughout September and October of 1993, Robert Macdonald was still in the process of creating a list of potential partners to raise the necessary capital. In his examination-in-chief, Robert Macdonald was asked whether he had concerns about the Bank forming the Partnership given the fact that the list of potential partners was changing over the period leading up to the establishment of the Partnership. He indicated that this was just part of the closing procedure and that the deal was proceeding according to plan.
[36] On November 5, 1993, the Northills Shopping Centre Limited Partnership (the "Partnership") was established. Northills Shopping Centre Ltd. ("NSCL") was the general partner and the Bank was the initial limited partner in accordance with the Partnership Agreement [Joint Book of Documents, Vol. 2 Tab 73].
[37] The original Completion Date contained in the August 24, 1993, letter of intent was pushed back. Robert Macdonald indicated that this was not an uncommon practice in his real estate acquisitions.
[38] On November 19, 1993, several of the Appellants were invited to a business meeting to review the Business Plan, the structure of the transaction and tax issues related to the acquisition of the Shopping Centre. The meeting was scheduled for two hours. Much of the first half-hour was occupied with social discussions. Discussions regarding the Business Plan occupied approximately an hour. The remaining portion was spent discussing the structure and tax consequences arising from the structure. For this meeting, Maria Wong prepared an Acquisition Synopsis [Joint Book of Documents, Vol. 4 Tab 154] that outlined the tax consequences arising from the structure, including the potential losses that would be allocated to each investor based on their investment in the Partnership.
[39] Also on November 19, 1993, the Bank formally authorized the sale of the Shopping Centre to a group headed by Robert Lee and Robert Macdonald.
[40] On November 23, 1993, the Bank and the Partnership entered into an assignment agreement (the "Assignment Agreement") [Joint Book of Documents Vol. 3 Tab 90], which provided that the Bank would assign its interest in the Receivable and the Foreclosure Proceedings to the Partnership in exchange for 10,000 limited partnership units. On this same date, the Bank actually assigned its interest and acquired the 10,000 limited partnership units.
[41] On December 9, 1993, the Bank offered to provide financing totalling $9,715,000.
[42] On December 23, 1993, the terms of the Bank's offer of financing were accepted by the Partnership and NSCL. Also on this date, Robert Macdonald, Derek Lee, Tony Letvinchuk, Maria Wong and others met to discuss the Shopping Centre and the implementation of the Business Plan. This meeting was held in order to ensure that the Business Plan was implemented efficiently and effectively.
[43] On December 29, 1993, the Appellants became general partners of the Partnership. In total, the General Partners purchased 2,000 general partnership units of the Partnership for a total of $2,000,000. On this same date, NSCL, the Partnership and the Bank entered into the Loan Agreement and Security Agreement [Agreed Statement of Facts, paragraphs 25 and 26].
[44] According to the Loan Agreement, the Bank agreed to loan $8,600,000 ("Facility A") to NSCL and the Partnership for the purpose of redeeming limited partnership units of the Partnership held by the Bank, $850,000 ("Facility B") for the purpose of financing future capital improvements to the Shopping Centre and $265,000 ("Facility C") for the purpose of financing future tenant and sundry improvements to the Shopping Centre.
[45] Also on December 29, 1993, the Partnership acquired the Shopping Centre pursuant to an order that:
(a) Substituted NSCL as the petitioner in the Foreclosure Proceedings;
(b) Assigned the Receivable to NSCL;
(c) Granted an Order Absolute of Foreclosure which terminated the rights of the previous owners and charge holders of the Shopping Centre; and
(d) Discharged Deloitte & Touche Inc. as the Receiver Manager.
[46] On December 30, 1993, guarantees and postponement claims were given to the Bank by Robert Macdonald, Macdonald Development Corporation and Robert Lee. On the same date, the General Partners agreed to be bound by the terms of the Loan Agreement and Security Agreement. [Agreed Statement of Facts, paragraph 25]
[47] On December 31, 1993, the General Partners wholly owned the Shopping Centre, either directly or through NSCL.
[48] At the Partnership's December 31, 1993 year-end, the Partnership wrote down the value of the Shopping Centre to its fair market value. The Partnership then allocated among the General Partners a non-capital loss of $5,820,875 in accordance with the provisions of the Act.
IV. ANALYSIS
[49] The Respondent submits that the Court must look at the primary purpose of each transaction in the series independently to determine whether there is an avoidance transaction. Further, the Respondent asserts that the Appellants' economic reality of ultimately acquiring the Shopping Centre cannot be the focus of the inquiry. The Respondent relies on Singleton v. Canada, 2001 SCC 61, 2001 DTC 5533, to support the proposition that it would be incorrect to treat this as one simultaneous transaction.
[50] The Respondent relies on the words of subsection 245(3) and the Supreme Court's statements in paragraph 34 of Her Majesty the Queen v. Canada Trustco Mortgage Co., 2005 SCC 54, 2005 DTC 5523 ("Canada Trustco"). According to the Respondent, determining the primary purpose of a transaction is an objective test that must focus on the relevant facts and circumstances at the time the transactions were undertaken, and not the taxpayer's statements of intention.
[51] It is the Respondent's position that having the Bank create a partnership with a newly incorporated subsidiary and then having the Bank transfer the Receivable into that partnership cries out for an explanation. This explanation, in the Respondent's view, is that the transactions were primarily undertaken to transfer the losses and obtain the tax benefit.
[52] The Appellants submit that the correct characterization of the relationships and transactions at issue is that the parties reached an agreement in principle without any discussion of tax benefits at the meeting of August 5, 1993. This agreement embodied a commercial purpose: acquiring the Shopping Centre in order to improve the net operating revenue and to then sell it at a profit. This approach had been employed in prior acquisitions. As this commercial purpose was established prior to engaging in any tax planning, the Appellants submit that the losses arose as a consequence of a particular series of transactions that are inextricably linked to the transfer of the Shopping Centre and were, therefore, undertaken for a commercial purpose. As such, the Appellants argue that "the primary purpose of each of the transactions, and the series of transactions as a whole, was to enable the vendor of the Shopping Centre (the Bank), the purchaser (the Partnership in which the Appellants were members) and each of the Appellants to complete the acquisition of the Shopping Centre" [Appellants' Opening Statement, paragraph 7].
[53] The Respondent has characterized the Appellants' position as treating the acquisition as one simultaneous transaction. As a result, for the GAAR to apply each and every transaction in a series must be found to be an avoidance transaction. However, the Respondent argued that this position is contrary to the statements of the Supreme Court and the wording of subsection 245(3). While I agree that requiring each and every transaction in a series to be an avoidance transaction would be contrary to the words of the Act and the pronouncements of the Supreme Court, I do not agree with the Respondent's argument that the Appellant's position necessitates such a requirement. [emphasis added]
[54] The authoritative approach to the GAAR is set out at paragraph 66 of Canada Trustco, supra, where the Supreme Court of Canada established the three requirements necessary for the application of the GAAR as follows:
The approach to s. 245 of the Income Tax Act may be summarized as follows:
1. Three requirements must be established to permit application of the GAAR:
(1) A tax benefit resulting from a transaction or part of a series of transactions (s. 245(1) and
(2) that the transaction is an avoidance transaction in the sense that it cannot be said to have been reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain a tax benefit; and
(3) that there was abusive tax avoidance in the sense that it cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.
2. The burden is on the taxpayer to refute (1) and (2), and on the Minister to establish (3).
[...]
This same approach was applied by the Supreme Court in Mathew v. Canada, 2005 SCC 55, 2005 DTC 5538 (referred to as "Kaulius").
[55] Because of the Appellants' concessions, my analysis will address only the second requirement: whether the series of transactions, or any transaction within that series, was an avoidance transaction. This involves canvassing and answering the question: may they reasonably be considered to have been undertaken or arranged primarily for a bona fide purpose other than to obtain the tax benefit. This is essentially a factual determination.
[56] During the taxation years in question, the relevant portions of subsection 245(3) of the Act read as follows:
(3) Avoidance transaction - An avoidance transaction means any transaction
(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or
(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.
[57] In Canada Trustco at paragraphs 27 to 35, the Supreme Court provided guidance for determining whether a transaction is an avoidance transaction, with emphasis at paragraphs 30 to 33 on the underlying importance of a taxpayer's right to arrange his or her affairs so as to attract the least amount of tax. Those paragraphs read:
5.4.2. Primarily for Bona Fide Purposes
[27] According to s. 245(3), the GAAR does not apply to a transaction that "may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit". If there are both tax and non-tax purposes to a transaction, it must be determined whether it was reasonable to conclude that the non-tax purpose was primary. If so, the GAAR cannot be applied to deny the tax benefit.
[28] While the inquiry proceeds on the premise that both tax and non-tax purposes can be identified, these can be intertwined in the particular circumstances of the transaction at issue. It is not helpful to speak of the threshold imposed by s. 245(3) as high or low. The words of the section simply contemplate an objective assessment of the relative importance of the driving forces of the transaction.
[29] Again, this is a factual inquiry. The taxpayer cannot avoid the application of the GAAR by merely stating that the transaction was undertaken or arranged primarily for a non-tax purpose. The Tax Court judge must weigh the evidence to determine whether it is reasonable to conclude that the transaction was not undertaken or arranged primarily for a non-tax purpose. The determination invokes reasonableness, suggesting that the possibility of different interpretations of the events must be objectively considered.
[30] The courts must examine the relationships between the parties and the actual transactions that were executed between them. The facts of the transactions are central to determining whether there was an avoidance transaction. It is useful to consider what will not suffice to establish an avoidance transaction under s. 245(3). The Explanatory Notes state, at p. 464:
Subsection 245(3) does not permit the "recharacterization" of a transaction for the purposes of determining whether or not it is an avoidance transaction. In other words, it does not permit a transaction to be considered to be an avoidance transaction because some alternative transaction that might have achieved an equivalent result would have resulted in higher taxes.
[31] According to the Explanatory Notes, Parliament recognized the Duke of Westminster principle "that tax planning -- arranging one's affairs so as to attract the least amount of tax -- is a legitimate and accepted part of Canadian tax law" (p. 464). Despite Parliament's intention to address abusive tax avoidance by enacting the GAAR, Parliament nonetheless intended to preserve predictability, certainty and fairness in Canadian tax law. Parliament intends taxpayers to take full advantage of the provisions of the Income Tax Act that confer tax benefits. Indeed, achieving the various policies that the Income Tax Act seeks to promote is dependent on taxpayers doing so.
[32] Section 245(3) merely removes from the ambit of the GAAR transactions that may reasonably be considered to have been undertaken or arranged primarily for a non-tax purpose. Parliament did not intend s. 245(3) to operate simply as a business purpose test, which would have considered transactions that lacked an independent bona fide business purpose to be invalid.
[33] The expression "non-tax purpose" has a broader scope than the expression "business purpose". For example, transactions that may reasonably be considered to have been undertaken or arranged primarily for family or investment purposes would be immune from the GAAR under s. 245(3). Section 245(3) does not purport to protect only transactions that have a real business purpose. Parliament wanted many schemes that do not have any business purpose to endure. Registered Retirement Savings Plans (RRSPs) are one example. Parliament recognized that many provisions of the Act confer legitimate tax benefits notwithstanding the lack of a real business purpose. This is apparent from the general language used throughout s. 245, as opposed to language which would have adopted a broad anti-avoidance test subject to exemptions for specific schemes like RRSP transactions.
[34] If at least one transaction in a series of transactions is an "avoidance transaction", then the tax benefit that results from the series may be denied under the GAAR. This is apparent from the wording of s. 245(3). Conversely, if each transaction in a series was carried out primarily for bona fide non-tax purposes, the GAAR cannot be applied to deny a tax benefit.
[35] Even if an avoidance transaction is established under the s. 245(3) inquiry, the GAAR will not apply to deny the tax benefit if it may be reasonable to consider that it did not result from abusive tax avoidance under s. 245(4), as discussed more fully below. [emphasis added]
[58] These passages underscore that the facts in each case will be central to a determination with respect to avoidance transactions and echo Justice Rothstein's comments in OSFC Holdings Ltd. v. Her Majesty the Queen, 2001 FCA 260, 2001 DTC 5471 ("OSFC Holdings") at paragraph 46:
The words "may reasonably be considered to have been undertaken or arranged" in subsection 245(3) indicate that the primary purpose test is an objective one. Therefore the focus will be on the relevant facts and circumstances and not on statements of intention. It is also apparent that the primary purpose is to be determined at the time the transactions in question were undertaken. It is not a hindsight assessment, taking into account facts and circumstances that took place after the transactions were undertaken.
[59] To answer the query, "whether it can reasonably be said that the purpose is primarily a non-tax purpose", the Supreme Court noted that the determination should be a factual inquiry by the Court which invokes reasonableness, suggesting "that the possibility of different interpretations of the events must be objectively considered" [Canada Trustco, paragraph 29]. This emphasizes the Supreme Court's departure from the more specific criteria used by the Federal Court of Appeal in OSFC Holdings, supra, and implicitly suggests that the Courts will have more flexibility in making such a determination.
[60] The Court in Canada Trustco recognized that the "inquiry proceeds on the premise that both tax and non-tax purposes can be identified" and these "can be intertwined in the particular circumstances of the transaction at issue". The Court stated at paragraph 28:
It is not helpful to speak of the threshold imposed by s. 245(3) as high or low. The words of the section simply contemplate an objective assessment of the relative importance of the driving forces of the transaction. [emphasis added]
This establishes the test to be employed by this Court. The Supreme Court then elaborated on this test and stated at paragraph 30:
The courts must examine the relationships between the parties and the actual transactions that were executed between them. The facts of the transactions are central to determining whether there was an avoidance transaction. [emphasis added]
The above passage indicates that it is the facts and circumstances surrounding the "transactions" that are central in determining objectively whether any individual transaction is an avoidance transaction. The Supreme Court does not indicate that the facts of an individual "transaction", independent from the other transactions in a series, should stand alone in determining whether an avoidance transaction exists. I do not believe that the Supreme Court intended that one part of a series of transactions would be separated and dissected to determine the primary purpose in isolation from, and to the exclusion of, the rest of the activities going on in that series. This would unnecessarily narrow the focus of the test to such an extent that not only economic realities would be offended but indeed such exclusions would alter what is at the very heart of the Supreme Court's test, which is "reasonableness". As the Supreme Court stated, this includes "an objective assessment of the relative importance of the driving forces of the transaction". Underlying all of this is the business premise that taxpayers must be free to arrange their affairs to minimize tax. It is of paramount importance in cases such as this that courts remain sensitive to the individual facts in each appeal in determining what constitutes the primary purpose of the impugned transactions.
[61] I agree with the Respondent that subsection 245(3) requires the Court to determine the purpose of each transaction within a series to ascertain if the non-tax purpose was primary. If the non-tax purpose was primary for each transaction in the series, the GAAR cannot be applied to deny the tax benefit. However, I do not agree that every transaction must be assessed independently without regard to the overall purpose of the series. To do so would clearly frustrate the purpose of subsection 245(3). As paragraph 245(3)(b) explicitly considers that a series of transactions may result in a tax benefit, it is appropriate for this Court to consider the overall purpose of the series and it would be inappropriate to consider each transaction in a series in isolation from the overall purpose.
[62] There is nothing in subsection 245(3) itself or in the Canada Trustco decision that requires that the transactions be assessed independently. The Respondent relied on Singleton, supra, for the proposition that transactions must be assessed independently. However, Singleton did not involve the application of GAAR and does not support such an interpretation of subsection 245(3).
[63] Determining the driving forces for undertaking a particular transaction within a series cannot be undertaken in isolation from the overall purpose of the series. While the overall purpose of the series will not be determinative, it remains one of the pertinent facts which this Court must consider in a determination of avoidance because the Court must determine if the overall purpose was the primary purpose of each transaction. Therefore while a transaction may initially present itself as one which the taxpayer has undertaken for the sole purpose of obtaining a tax benefit, its primary purpose may still be a non-tax purpose when assessed with reference to the overall series where the facts support that the dominant aim is to achieve a commercially reasonable deal in a tax effective manner.
[64] Since the Supreme Court's decisions in Canada Trustco and Kaulius, this Court has dealt with the application of the subsection 245(3) test in several decisions.
[65] Univar Canada Ltd. v. Her Majesty the Queen, 2005 DTC 1478 ("Univar") was the first decision released by this Court after Canada Trustco which considered the GAAR. Justice Bell considered the undue reliance that the Respondent placed on the term "tax strategy" that was found in some of the documentary evidence. He stated at paragraph 61:
In both written and oral submissions, Respondent's counsel stressed the importance of what was contained in multitudes of documents accepting little, if any, of the oral evidence given in Court. For example, undue reliance was placed on the oft used term "tax strategy" in those documents, being used by counsel to establish that the primary purpose of the transaction(s) was the reduction, avoidance or deferral of tax. [...]
[66] At paragraph 65, Justice Bell rejected the Respondent counsel's attempt to recharacterize the transactions in order to support the existence of an avoidance transaction:
Respecting the undue emphasis on "tax strategy", all business transactions, if properly analyzed, planned and implemented, must involve an acute awareness of the tax effect of every aspect thereof. The failure to exercise great care in dealing with that one aspect of a business transaction simply cannot exist in the complicated modern business world.
[67] In Evans v. The Queen, 2005 DTC 1762 ("Evans"), Chief Justice Bowman concluded that the purpose of the series of transactions was to put corporate funds in Dr. Evans' hands with the chosen method or structure of the transactions enabling Dr. Evans to do so with the least tax cost. At paragraphs 22 and 23 he states:
[22] I find as a matter of fact that the primary purpose of the series of transactions with which we are concerned here was to put the corporate funds in Dr. Evans' hands. The method chosen was one designed to enable him to do so at the least tax cost. I emphasize the words from the Explanatory Notes adopted by the Supreme Court of Canada in paragraph 30 of Canada Trustco:
Subsection 245(3) does not permit the "recharacterization" of a transaction for the purposes of determining whether or not it is an avoidance transaction. In other words, it does not permit a transaction to be considered to be an avoidance transaction because some alternative transaction that might have achieved an equivalent result would have resulted in higher taxes.
[23] This is what I think the Crown is doing here. Also, I rely upon the words in paragraph 31:
... Despite Parliament's intention to address abusive tax avoidance by enacting the GAAR, Parliament nonetheless intended to preserve predictability, certainty and fairness in Canadian tax law. Parliament intends taxpayers to take full advantage of the provisions of the Income Tax Act that confer benefits. Indeed, achieving the various policies that the Income Tax Act seeks to promote is dependent on taxpayers doing so.
[68] In Desmarais v. Her Majesty the Queen, [2006] 3 C.T.C. 2304, 2006 DTC 2376 ("Desmarais"), Justice Archambault determined, after referring to paragraphs 28 and 29 of Canada Trustco, that an avoidance transaction had occurred. Justice Archambault stated at paragraph 23:
Here, I have no hesitation in concluding that several of the transactions concluded by Mr. Desmarais were primarily for non-tax purposes, ... However, the transaction in which Mr. Desmarais transferred only 41 of his shares of Comsercom, amounting to 9.78% of this company's shares, cannot be considered to have been concluded primarily for bona fide purposes, other than non-tax purposes. In my judgment, this transfer was completed primarily to make it possible to obtain a tax benefit, that of distributing to Mr. Desmarais a sum of $123,000 from Gestion free of tax. This finding is all the more necessary since Mr. Desmarais' goal of combining all his shares in one basket was not achieved by this transaction. ... [emphasis added, references omitted]
[69] Both Evans and Desmarais involved surplus stripping; however, the facts in each case were considerably different. Although the conclusions reached in Evans and Desmarais differed, both decisions had regard to the overall purpose of the series of transactions. In Evans, the "method" and the aim of each transaction was consistent with the overall purpose. In Desmarais, Justice Archambault looked at each transaction individually but also compared the purpose of each individual transaction to the overall purpose. The "method" chosen in Desmarais by the taxpayer was not consistent with the overall purpose of putting all the shares in one basket and, therefore, the purpose of that transaction was not primarily for non-tax reasons. The fact that there was an inconsistency between the overall commercial purpose and the purpose of the individual transaction is extremely relevant in explaining the different conclusions in the two decisions. As the subsection 245(3) determination is a factual inquiry, the different conclusions are based on the individual facts of each case, although both applied the Canada Trustco test.
[70] MIL Investments v. Her Majesty the Queen, 2006 DTC 3307 ("MIL") dealt with the application of the GAAR to international tax treaties. In discussing the issue of whether there was an avoidance transaction, Justice Bell stated at paragraph 53:
I find it clear that, despite the possibility of the DFR shares already being exempt under the Treaty, one of the "driving forces" of the transactions was the Appellant's desire to ensure the sale of its shares in a tax effective manner. I conclude, however, that the "how" is subordinate to the "why" of the sale. [Emphasis added]
[71] At paragraph 57, Justice Bell stated:
In light of the foregoing, the Appellant having had a bona fide commercial reason for selling, it was open to it to seek tax advice respecting the appropriate structure for concluding that Sale.
[72] In Canada Trustco, the Supreme Court stated that Parliament did not intend subsection 245(3) to be a business purpose test, but rather the subsection is meant to immunize transactions that may reasonably be considered to have been undertaken or arranged primarily for family or investment purposes from the application of the GAAR. The Supreme Court cited Registered Retirement Savings Plans (RRSPs) as an example of a provision of the Act that confers a legitimate tax benefit notwithstanding the lack of a real business purpose. The choice of RRSPs is an interesting example because the primary purpose, if not the sole purpose, for investing in an RRSP in many cases will be to obtain a tax benefit, rather than utilizing an alternative investment vehicle. The fact that this example was employed in the discussion of the appropriate test under subsection 245(3) is indicative that the determination of primary purpose must have regard to the overall purpose.
[73] Although the tax benefits provided by investing in an RRSP are unlikely to be considered abusive under section 245, the example does illustrate the potential to obfuscate the primary purpose of a transaction if the determination is conducted in isolation from a consideration of the entire series. This may be illustrated by the following analogy: if each cell of the human body was examined under a microscope, its purpose might invariably differ from the overall primary purpose of the human body functioning as a whole or as the sum of all its parts. Engaging in this level of introspection would conceal the true purpose of that one cell within the complex overall structure that must, by its very essence, be inter-related and inter-dependant to the functioning of the whole entity.
[74] A similar scenario may be transposed to a business setting where the potential exists for the application of the GAAR. If each step of a series of transactions is analyzed in isolation and without any reference to the overall purpose of the entire series of steps, it ignores the possibility that each step, although separate in function, must necessarily remain mutually dependant upon the purposive intent of all the steps viewed as a unit. Of course, after such an analysis, the particular outcome will be dependant on those findings of fact specific to each appeal.
[75] The same result is apparent in the business context. If advice is received from a tax professional and the parties take these tax considerations into account in structuring the transactions, an otherwise legitimate transaction would be considered an avoidance transaction and, therefore, subject to the abuse analysis under section 245 if a tax benefit resulted. This would be the case even though the transactions were simply the method of achieving the legitimate business purposes. The Supreme Court was insistent in Canada Trustco that Parliament intended to preserve predictability, certainty and fairness in Canadian tax law. This cannot be achieved if every business deal or arrangement undertaken with the benefit of tax advice is subject to the abuse analysis in section 245. The inquiry to determine whether a transaction is an avoidance transaction is not a results-based test. The ability of taxpayers to organize their affairs in a tax efficient manner must be preserved. A transaction cannot be recharacterized as an avoidance transaction merely because tax advice is sought and implemented and then a resulting tax benefit associated with that transaction or series arises.
[76] The Supreme Court also indicated in Canada Trustco that the Duke of Westminster principle is preserved. The principle arises from the seminal case of IRC v. Duke of Westminster, [1935] All E.R. 259, where Lord Tomlin said:
... Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioner of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. ...
The Supreme Court noted that arranging one's affairs so as to attract the least amount of tax is a legitimate and accepted part of Canadian tax law. While this principle may be attenuated by the GAAR to the extent that a transaction is undertaken primarily to obtain a tax benefit, taxpayers must be able to organize their affairs in a tax efficient and effective manner.
[77] In summary, the analysis to determine whether any transaction is an avoidance transaction under subsection 245(3) is a factual inquiry to determine the primary purpose of the transaction. This inquiry is not a results-based analysis that focuses on the tax benefit, but rather it is a primary purpose analysis of each individual transaction. The inquiry proceeds on the assumption that both tax and non-tax purposes may be identified and may be co-mingled. In determining the primary purpose of the individual transaction, the overall purpose of the series of transactions is relevant but not determinative. The test to be employed by this Court is an objective assessment of the relative importance of the driving forces of the transaction to be achieved through the weighing of evidence to determine whether it is reasonable to conclude that the transaction was not undertaken or arranged primarily for a non-tax purpose.
V. Application to the Facts
[78] The Appellants argued that certain criteria have been used in the prior cases to make an objective assessment of the primary purpose of the transactions. They submit the following criteria should be applied in these appeals:
(a) Did the parties start out with a business plan or with a tax plan?
(b) Was the product of the transactions integral to the appellant's business and, where relevant, did the appellant acquire property which it was in the normal course of the appellant's business to acquire?
(c)What was the quality and extent of any due diligence carried out by the parties with respect to the commercial benefits of the transactions?
(d) What quantity of the documentary evidence relates to commercial benefits and what quantity relates to the tax benefits?
(e) Is the subjective evidence of the witnesses regarding the alleged business purpose consistent with the "objective backdrop" of the documents?
(f) Has the appellant called all key witnesses to explain the purpose of the transactions or has the appellant refrained from calling key witnesses?
(g)What is the subjective evidence of the party or parties on the other side of the relevant transactions? Were those parties negotiating a business deal or marketing tax benefits?
(h)Does the evidence of what transpired subsequent to the closing of the transactions support the stated business purpose?
(i) What was the end result when comparing the value of the commercial benefits with the value of the tax benefits? Was there a "significant disparity" between the tax benefits and the commercial return?
[Appellants' Submissions, paragraph 10]
[79] The inquiry to determine the primary purpose is a factual inquiry, and the above criteria provide a useful structure to analyze the facts and circumstances of these appeals. The list is not exhaustive and no one factor is determinative. It is open for this Court to employ whatever criteria is appropriate given the circumstances of each case in order to make an objective assessment of the primary purpose of the transactions and those criteria may vary from case to case. In addition, the Court must still assess each individual transaction in a series to ascertain the purpose of each.
(a) Did the Appellants start out with a business plan or a tax plan?
[80] The Appellants struck a deal with the Bank based on a business plan formulated with a view to acquiring the property, improving it, stabilizing the tenancies, and selling it for a profit. It was Derek Lee that approached Robert Macdonald with the opportunity to acquire the Shopping Centre. The Lee Family and Prospero had extensive knowledge and history associated with the Shopping Centre. Robert Macdonald was of the view that it was potentially a good investment, but he was prepared to enter into negotiations with the Bank only if the Lee Family became involved.
[81] Prior to meeting with the Bank, Robert Macdonald viewed the property to assess its potential. He then met with Prospero's property manager, Tony Letvinchuk, to produce a basic synopsis. Robert Macdonald viewed the acquisition as a potential business opportunity if improvements and tenant stabilization could be accomplished. He felt the Shopping Centre could then be sold for a profit within a relatively short period of time. Tax considerations never factored into the decision to negotiate with the Bank for the acquisition of the Shopping Centre.
[82] When Robert Macdonald and Derek Lee met with the Bank's representatives on August 5, 1993, the discussions focused on the purchase price for the Shopping Centre. After agreeing on a price of $10 million, the parties discussed the potential for financing from the Bank. Tax considerations were not discussed nor was the eventual structuring of the proposed acquisition.
[83] According to the testimony of the Bank's representative, the Bank did not approach Robert Macdonald with a view to selling tax losses. Rather, the Bank had a non-performing loan that it wanted to get off its books as quickly as possible. The Bank's aim was to sell the Shopping Centre as quickly as possible for the best possible price.
[84] Although no binding and formal agreement was concluded at the meeting on August 5, 1993, the parties did reach an understanding on the essential terms of the acquisition. The $10 million price for the Shopping Centre discussed in August, was the same price that the Bank received when the transaction closed. No additional or contingent amounts were included in the purchase price for consideration for the transfer of the losses. The focus was the acquisition of the Shopping Centre in accordance with the initial Business Plan.
[85] It was only after this understanding was reached that Robert Macdonald consulted with Maria Wong and John Zaytsoff for advice on structuring the acquisition. At this time, Robert Macdonald considered the property to be "tied up".
[86] The Appellants' initial approach to the acquisition of the Shopping Centre possessed all the earmarks of a commercial deal without anyone at the initial bargaining sessions ever turning their mind to tax losses.
(b) Was the product of the transactions integral to the Appellants' business and did the Appellants acquire property which would be in the normal course of their business to acquire?
[87] The Appellants were not strangers to one another, but were part of a close knit business network built upon reputation and success. They all had previous involvement with some of the others in numerous commercial property transactions, which had utilized this basic Business Plan created by Robert Macdonald.
[88] It was Robert Macdonald's philosophy to acquire properties with an upside potential, improve the properties both physically and financially by adding value to the properties and resell them for a profit. It is apparent that every investment opportunity was different, but the common thread was the upside potential of the properties. The acquisition of the Shopping Centre was in accordance with the business philosophy of the Appellants and consistent with their previous real estate investments.
[89] The purchase of receivables and the use of a partnership vehicle had been utilized in previous transactions. Prior to the acquisition of the Shopping Centre, Robert Macdonald had acquired receivables from financial institutions and foreclosed on the underlying real property, rather than acquiring the property directly. From the outset of the negotiations, the Appellants intended to own the Shopping Centre in a partnership.
(c) What was the quality and extent of any due diligence carried out by the Appellants with respect to the commercial benefits of the transaction?
[90] The Lee Family were involved with the Shopping Centre in the early 1990's when they owned the property. As a result they had familiarity not only with the Shopping Centre itself, but also with the Kamloops market. The fact that Robert Macdonald was prepared to acquire the Shopping Centre only if the Lee Family was involved is indicative of the importance of the Lee Family's knowledge of this property. However, he independently conducted his own investigation of the property. He personally visited the Shopping Centre and other local shopping centres in the Kamloops area. Around this same time, he discussed the property's potential with the Prospero management team of Tony Letvinchuk and Derek Lee.
[91] Robert Macdonald also engaged Robert Forest, an experienced shopping centre property manager, to review and evaluate the Shopping Centre in early November 1993. He reported his findings to Robert Macdonald and Maria Wong on November 26, 1993 [Joint Book of Documents, Vol. 3 Tab 119].
[92] Robert Macdonald indicated that he personally viewed a successful business plan as a simple one and that if it could not be figured out in his head it was simply not worth pursuing. [Transcript page 700]. The extensive prior dealings among these Appellants never included the production of market forecasts, reports and detailed written business plans even though their acquisitions involved substantial investments. Robert Macdonald and the other Appellants are all experienced real estate investors and entrepreneurs who worked together on prior deals. In their circumstances, detailed reports and written business plans were not common practice. There was a level of comfort, supported by the evidence of all of the Appellants, that if Robert Macdonald and the Lee Family were promoting the acquisition of a property, they were prepared to get involved as investors based on their recommendation alone. The manner in which the Appellants approached prior acquisitions did not vary substantially from the present circumstances except as to the specific structure employed to achieve the acquisition. The approach was consistent with their prior investing history and practice.
(d) What quantity of the documentary evidence relates to commercial benefits and what quantity relates to the tax benefits?
[93] As expected, this acquisition created a great deal of documentation, some relating to the expected commercial benefits and some relating to the tax consequences of the acquisition. One of the central documents is the Steps Document, produced by Maria Wong. Although the Steps Document bears the title "Summary of Tax Structure", it must be assessed within the context of the Business Plan. In fact, at the end of the paragraph in Step One, it was stated that "North Hills Partnership shall be formed for the purpose of acquiring the problem mortgage to turn around and realize maximum proceeds therefrom". The final paragraph, Step Five, states that the Partnership will carry out the Business Plan. The presence of such documents does not necessarily indicate that the non-tax purpose was not the primary purpose of any of the transactions. The Steps Document simply discusses the structure and tax consequences. Assessed within the entire context of the commercial deal, it cannot be said to be determinative of the purpose of the transactions in question. When I look at the documentation in its entirety, supported by the overwhelming oral evidence before me, the direction and flow of the documentary evidence relates to commercial benefits.
[94] It is important to note that there is nothing in any of the documentation that indicates that any part of the $10,000,000 purchase price was in respect to tax losses, that the purchase price was affected by the availability of tax losses, or that the Bank received additional amounts for any tax losses.
(e) Is the subjective evidence of the witnesses regarding the alleged business purpose consistent with the "objective backdrop" of the documents?
[95] The subjective evidence of all the Appellants is consistent with both the Bank's stated business purpose of selling and transferring the Shopping Centre and the Appellants' stated business purpose of acquiring, operating and eventually selling the Shopping Centre. Further, the evidence of Tony Letvinchuk and Bill Kennedy, who were disinterested third party witnesses, is consistent with the business purpose of both the Bank and the Appellants, and this evidence remained largely unchallenged.
[96] The testimony of Robert Glass, John Cassils, Jack Poole and Timothy Wallace indicates that they were unaware of any tax benefits flowing from the acquisition of the Shopping Centre when they committed to investing. It was only after the meeting on November 19, 1993, that these Appellants became aware of the tax benefits. The testimony of all the Appellants indicates that the tax benefits played no role in their decision to participate in the investment. [See Schedule B]
(f) Have the Appellants called all key witnesses to explain the purposes of the transactions or have the Appellants refrained from calling key witnesses?
[97] All key witnesses were called and gave evidence explaining the background and purpose of the transactions. The evidence of each of the Appellants corroborates the testimony of Robert Macdonald that obtaining tax losses was not the primary purpose of their business venture and in fact when the deal was struck, these losses were never discussed. The evidence of Tony Letvinchuk and Bill Kennedy also confirms this.
(g) What is the subjective evidence of the party on the other side of the relevant transactions? Was that party negotiating a business deal or marketing tax benefits?
[98] The Shopping Centre was a viable, commercial operation during the time that it was operated by the Bank and its Receiver Manager. Bill Kennedy testified that the Bank's aim was to sell the Shopping Centre in a commercially reasonable manner in order to get a non-accrual, non-performing asset off its books. This was in accordance with the Bank's regular practice during its 1993-1995 financial periods.
[99] Bill Kennedy testified that it was important to the Bank that the Appellants were successful in implementing their Business Plan because the Bank would be holding the mortgage. This amounted to a large economic stake in the Shopping Centre. The Bank also agreed to lend additional amounts to the Appellants so that improvements could be made to the Shopping Centre in accordance with the Business Plan.
[100] On September 10, 1993, Bill Kennedy sent a memorandum [Joint Book of Documents, Vol. 2 Tab 49] seeking advice from the Bank's Vice-President, Taxation, Richard Barriault, with respect to the proposed structure for the acquisition of the Shopping Centre. In the memorandum, Mr. Kennedy states "We have negotiated a sale of the property to a Vancouver based group for $10,000,000 which we would like to close". The memorandum goes on to state that the proposed sale has been structured to take advantage of the tax losses between the sale price and the original book value and in order for the tax structure to work, the Bank is being requested to do certain things such as entering into a partnership and giving up its loss privileges under the mortgage. On September 15, 1993, Richard Barriault responded to the memorandum [Joint Book of Documents, Vol. 2 Tab 51] and stated:
Considering the value of the tax loss to the purchaser you might consider increasing the sale price and/or requesting that the cash tax recovery be utilized to pay down the loan balance.
Otherwise I do not have a problem with the proposed transaction.
[101] Bill Kennedy's memorandum and the response from Richard Barriault are important for at least two reasons. First, Bill Kennedy indicated that "we have negotiated" the sale of the Shopping Centre. This provides affirmation that the Bank's primary intention was to sell the Shopping Centre and not market tax losses. Second, Bill Kennedy rejected Richard Barriault's suggestion to seek an increased price that reflected the tax losses because he did not want to jeopardize the sale negotiated with Robert Macdonald. Consequently, the sale price remained unchanged. From these actions, it appears that completion of the sale of the Shopping Centre was paramount to the Bank. The issue of tax losses was secondary to the negotiated deal.
[102] Bill Kennedy consulted with other officials at the Bank with respect to the structure of the acquisition of the Shopping Centre. As part of these consultations, Bill Kennedy produced Boardsheets (an internal Bank memorandum that is standard for all loans), which discussed the offer. A Boardsheet, produced on November 15, 1993 [Joint Book of Documents, Vol. 2 Tab 58], presented the following caution at the first page:
PLEASE NOTE THAT $5,546 LOSS CANNOT BE UTILIZED BY THE BANK FOR TAX PURPOSES.
[103] Bill Kennedy indicated that the Boardsheets were intended to provide full disclosure of the tax consequences of the structure. The same Boardsheet also stated that the "attractiveness to the deal is clearly the tax losses and given the limited marketability of the Centre, we feel this offer should be accepted". When asked why this statement was included, Bill Kennedy stated:
... my recollection would be that I'm again simply pointing out to everyone up the line that when this structure is put in place and we sell this asset for the commercial price of $10 million, that we're not going to be able to use the tax losses. I'm reiterating it. I want everyone to know whether it's my boss, whether it's the Credit Committee, whether it's the tax people of the bank. [Transcript page 867]
[104] Bill Kennedy was also asked directly whether any of the Appellants had advised him that the attractiveness of the deal was clearly the tax losses. He did not recall specifically, but from the Bank's perspective the price that the Appellants were paying was a market value and that was what the Bank was seeking. Bill Kennedy indicated that he was prepared to do a commercial deal because when it closed the Bank would have an $8.6 million loan instead of a non-performing, mortgage receivable. As such, the Bank's interests were closely tied to the Appellants' commercial interest of making money from the property.
[105] The Bank was prepared to facilitate the structure because it wanted the asset off its books. In the end, the agreement was consistent with the Bank's mandate of getting the asset sold in a commercially reasonable manner. The Bank was not selling tax losses, nor did the Bank market tax losses.
(h) Does the evidence of what transpired subsequent to the closing of the transaction support the stated business purpose?
[106] In January 1994, the Partnership began to implement its Business Plan. Robert Forrest was hired as a consultant to report to Tony Letvinchuk and Prospero. Richard Brown & Associates was hired to conduct a marketing report.
[107] The Partnership also incurred substantial costs to renovate and upgrade the Shopping Centre. To fund the renovation and upgrade costs, the Partnership invested approximately $500,000 of its own funds, $150,000 from Facility B, $50,000 from Facility C (Facility B and Facility C being the additional financing from the Bank) and leasing income from the Shopping Centre, again, all in accordance with the established Business Plan.
[108] The Shopping Centre was listed for sale on May 2, 1994. The $14 million list price was in line with the Business Plan and although Robert Macdonald testified that the sale listing was premature, this action was again consistent with the Business Plan.
[109] In 1994 and 1995, the Partnership hired Prospero as its leasing agent and entered into leases with current and new tenants of the Shopping Centre. The new leases enhanced the net operating revenue of the Shopping Centre and this was another factor that was consistent with the Business Plan. In fact, by December 31, 1995, the Shopping Centre had achieved a net operating revenue in excess of $1,400,000.
[110] Until November 1996, the Partnership held the Shopping Centre as inventory with the intention to resell it for a profit at the first available opportunity. Unable to sell the property by November 14, 1996, the General Partners changed their view about selling it, as the Shopping Centre had been producing significant cashflow. All of the evidence of the actions taken by the Partnership subsequent to the acquisition of the property are consistent with the Business Plan and the stated commercial purpose.
(i) What was the end result when comparing the value of the commercial benefits with the value of the tax benefits? Was there a "significant disparity" between the tax benefits and the commercial return?
[111] The average net income of the Partnership during the 10-year period between 1994 and 2003 was over $330,000 per year, representing a 16.5 percent annual return on the Appellants' investment in purchasing General Partnership units. If 1994 and 1995 are excluded from the calculation, the average net income is approximately $393,275 per year, representing a 19.5 percent return. During the years 1994 to 2004, the General Partners received distributions from the Partnership totalling $2,750,000.
[112] At the Partnership's December 31, 1993 year end, the Partnership wrote down the value of the Shopping Centre from $15,824,569 to its fair market value of $10,000,000. The Partnership duly allocated among the General Partners, the majority of whom were the Appellants, a non-capital loss of $5,820,875 which had been incurred by the Partnership during its fiscal year ending December 31, 1993.
[113] According to the British Columbia property tax assessment, the taxable value of the Shopping Centre is now $16.5 million. The losses realized by the Appellants are, therefore, a tax deferral as opposed to an absolute tax saving. If the Shopping Centre is sold in the future, the Appellants will probably realize a taxable gain. The value of the tax benefit is therefore the time value of tax savings which resulted from the write-down of the Shopping Centre.
[114] When comparing the value of the commercial benefits, including the expected profit that will be realized upon the sale of the Shopping Centre, to the tax benefit associated with the structuring of the transaction, it is clear that there is no significant disparity. Further, the commercial benefits that have been realized and that can be expected upon the sale support a finding that the primary purpose of the transactions was a non-tax purpose.
Evidence of the Purpose of the Individual Transactions
[115] In argument, the Respondent disagreed with the application of the above criteria and insisted that each factor must be applied to each individual transaction. For example, on the first factor (Did the parties start out with a business plan or a tax plan) the Respondent argued that the question should be "did the parties start out with those three transactions as a business plan or a tax plan?" [Transcript page 1431] The Respondent's argument is similar for each of the remaining factors, arguing that the individual transaction must be assessed and not the transactions as a whole.
[116] Although all the Appellants testified during the hearing, few were able to testify as to the purpose for the structuring of the transactions. In fact, most of the Appellants testified that they were unaware of why the transaction was structured in the manner it was. Many Appellants were also unaware of the tax benefits associated with the structure until November 1993 at which time the deal was otherwise solidified. It was Maria Wong and John Zaytsoff that created and refined the structure for the acquisition of the Shopping Centre after the basic terms were negotiated. In John Zaytsoff's cross-examination, he was asked about the purposes for undertaking each of the particular transactions in the structure. He was insistent that the reason this particular structure was undertaken was to facilitate the business purpose of acquiring, holding and ultimately selling the Shopping Centre. He emphasized that one of the "results" of the transactions was the tax benefit, but this was not the "reason" for undertaking the particular transactions. Objectively, it is clear that one of the purposes for undertaking each of the transactions in question was to obtain a tax benefit, but I conclude that this was not the primary purpose of any of the transactions either together or individually. The evidence fully supports that a sound business plan quickly evolved with commercially viable goals and without any consideration of tax benefits. The Business Plan was conceived in a manner similar to other prior acquisitions involving many of the same Appellants. They eventually received tax planning advice as they generally did. The accountant established a series of steps to accomplish the Appellants' Business Plan. These steps intermingled both tax and non-tax purposes. However, to divorce the purpose of each individual transaction in the series from the overall purpose of the series would, in my opinion, frustrate the intent of subsection 245(3) and would interfere with the commercial realties of the marketplace.
Kaulius and OSFC Holdings are Distinguishable on their Facts
[117] The impugned transactions in this case create a tax benefit because of the structure of the transactions and the operation of subsection 18(13). Kaulius, supra, and OSFC Holdings, supra, involved similar transactions that created a tax benefit. In those cases, the Standard Trust Company incorporated a new company, formed a general partnership between itself and the new company and relied on subsection 18(13) of the Act to transfer various mortgages and properties that had a high cost and low fair market value into the partnership. That partnership was then taken over by various arm's length parties, who claimed the losses resulting from the write-down of the mortgages and properties at the partnership's first year-end. In both decisions, this Court determined that the transactions were avoidance transactions within the meaning of subsection 245(3).
[118] The Respondent submits that the transactions in the present appeals are "virtually identical" to the transactions that were found to be avoidance transactions in OSFC Holdings and Kaulius. I would agree that there are some similarities between these cases and the present appeals; however, the inquiry under subsection 245(3) is a factual inquiry and each case must be considered on its own merits. OSFC Holdings and Kaulius are distinguishable on their facts from the appeals before me.
[119] First, in OSFC Holdings (and Kaulius) the transactions were designed so that the properties and the losses could be marketed as part of an intensive campaign. The partnership served as a "holding tank" and "vehicle" to sell losses to arm's length parties. In the present appeals, there was no marketing of tax losses and the Bank was not involved in devising any of the transactions. In fact, the Appellants and the Bank had agreed in principle to the terms of the acquisition of the Shopping Centre prior to any discussion of tax losses and prior to the structuring of the transactions.
[120] Second, the taxpayers in OSFC Holdings were real estate developers and lawyers who resided in British Columbia. They invested in a portfolio of third-rate properties that were located in unfamiliar markets in other provinces. In the present appeals, the Appellants had extensive experience in successfully investing in commercial real estate, including shopping centres situated in British Columbia and throughout Canada and the United States. In fact, not only did the Appellants possess a history with similar investments, the Lee Family had prior associations with the Shopping Centre.
[121] Third, there is no indication that the partners in OSFC Holdings developed a realistic business plan to improve, sell or otherwise deal with the properties that were acquired. Contary to the evidence in the present appeals, there appeared to be little evidence that the partners were knowledgeable about the rehabilitation of distressed mortgages. In the present appeals, the Business Plan was established long before the potential tax benefit was ever identified and that same Business Plan had been successfully utilized in the past in acquiring other commercial properties.
[122] Fourth, in OSFC Holdings the parties negotiated the value of the tax losses to be $5,000,000 and the sale agreement stipulated that $5,000,000 of the purchase price was contingent on the taxpayers being able to deduct the tax losses. There is no evidence in the present case that any portion of the $10 million purchase price was attributable to tax losses. In fact, the evidence supports the opposite conclusion. The price was negotiated at the outset, and despite some suggestion from an official at the Bank that the price should be adjusted to reflect the value of the tax losses, the price remained unchanged.
[123] These are the primary factual differences that allow me to distinguish OSFC Holdings and Kaulius from the present appeals. In the end each case must be decided on its own facts to determine whether any transaction is an avoidance transaction within the meaning of subsection 245(3).
VI. Conclusions
[124] An objective assessment of all of the driving forces of the transactions as a whole, and each individual transaction, supports my conclusion that obtaining tax losses was not the primary purpose of any of the transactions. Each transaction was legally enforceable; valid and binding; and was neither vacuous nor artificial. The Appellants commercial purpose of acquiring the Shopping Centre to carry out its Business Plan was the primary purpose of each transaction. Thus, none of the transactions were avoidance transactions within the meaning of subsection 245(3).
[125] The transactions were undertaken to achieve certain business objectives which were infused at a later date with the tax structuring suggested by Mr. Zaytsoff. The driving force behind these transactions from the outset was the acquisition, improvement, and resale of the Shopping Centre. The evidence was that the knowledge of tax benefits arose subsequent to the initial meetings with the Bank, where the purchase price of 10 million was solidified. The deal struck with the Bank had a purely economic, commercial flavour. The result could certainly have been achieved by other methods but if the Appellants, after striking the deal with the Bank and formulating the Business Plan had ignored the tax advice of the accountant and chose a less complicated method of acquiring the property, they would have done so at their own peril, ignoring the very tax advice in the structuring of the deal for which they had enlisted Mr. Zaytsoff.
[126] In summary, I conclude that the evidence supports my finding that each transaction was undertaken primarily for bona fide purposes other than to obtain a tax benefit. The primary purpose of each transaction and the series as a whole was to successfully complete the acquisition of the Shopping Centre. The evidence of all the Appellants clearly supports this as being their primary objective. Consequently the GARR has no application to the acquisition of the Shopping Centre.
[127] These appeals are allowed. If the parties cannot resolve the question of costs, they may contact the Court with respect to submissions in this regard.
Signed at Ottawa, Canada, this 21st day of February 2007.
Campbell J.
Schedule B
SUMMARY OF THE TESTIMONY OF THE WITNESSES
Robert Macdonald
Robert Macdonald personally invested in the Partnership and was the central figure in creating the Business Plan and negotiating the acquisition of the Shopping Centre. Before starting his own company, Macdonald Development Corporation ("MDC"), Robert Macdonald worked for a number of companies involved in property management and commercial real estate. MDC holds hotels, office buildings, retail and multi-purpose properties across North America. Robert Macdonald explained that he was a "value-type" buyer: the type of property did not matter as much as the price for which the property could be acquired. His practice also included property acquisitions in depressed real estate markets where he considered that the markets would eventually recover. Typically MDC raised capital through the formation of partnerships and the issuance of units to investors.
In 1993, Robert Macdonald traveled across North America seeking opportunities in a depressed real estate market. He first heard of the Shopping Centre through the Bank, but it was Derek Lee that eventually informed him that the property was for sale. Initially, Robert Macdonald was not enthusiastic about the deal because he did not believe that he could obtain the property for a good price as he was involved with the Bank in respect to other deals. However, he became convinced that the property would be a viable acquisition. After the formulation of the Business Plan until the closing of the deal, Robert Macdonald was of the view that the purpose of the overall transaction was to acquire the Shopping Centre and carry out the Business Plan to earn a profit. This Business Plan was the same plan that Mr. Macdonald had successfully used in over 90 percent of his prior acquisitions [Transcript page 482]. The structuring of the transactions was formulated by John Zaytsoff after the Business Plan was created. Robert Macdonald acknowledged that although he was informed that the structure would result in a tax benefit, in his opinion, the structure was simply a reasonable method of acquiring the property. Further, he expected John Zaytsoff to provide professional advice in respect to the acquisition of the Shopping Centre in order to achieve the objective of the Business Plan. The fact that this advice included tax considerations was no surprise because John Zaytsoff provided advice on all of his deals.
Brian McGavin
Brian McGavin is a lawyer with 22 years' experience in the real estate business. He works for MDC. Mr. McGavin invested personally in the Partnership and also invested through his holding company, Aebag Holdings Ltd.
Mr. McGavin met Robert Macdonald while they were both working at Strand Development Corporation ("Strand"). He left Strand in 1990 when Robert Macdonald offered him work at MDC. Mr. McGavin's role at MDC was to raise equity capital to acquire properties. He testified that he normally earned a percentage of the partnership interest in properties which MDC acquired, according to the amount of equity that he was able to raise for that project. He made money only if the project was successful and sold for a profit.
Mr. McGavin testified that he learned of the opportunity to invest in the Partnership and the Shopping Centre through Robert Macdonald. Mr. Macdonald informed Mr. McGavin that he would have to invest personally in the Partnership as opposed to earning an interest through raising equity. He was attracted to the investment because of his knowledge of the Kamloops area and of this property. He understood that the Business Plan was similar to that of other property investments at MDC, that is, take an under-priced property, make improvements, attract good tenants, increase net operating income, and then sell the property for a profit. Mr. McGavin indicated that tax considerations did not play a role in his decision to invest in the partnership.
Timothy Wallace
Timothy Wallace is a real estate developer at MDC who invested personally in the Partnership. His primary responsibilities at MDC included raising equity and negotiating the acquisition of properties throughout the United States, together with the ongoing management of MDC's properties located in the eastern United States. Mr. Wallace indicated that he has invested in over 20 projects with Robert Macdonald and MDC. He became aware of the Shopping Centre in the fall of 1993 during a brief conversation with Robert Macdonald in which Mr. Macdonald explained that the Shopping Centre looked attractive despite being situated in a depressed market. Based on $50 per square foot, the Shopping Centre could be purchased for $10 million. If the net operating income could be increased to $1.4 million, it was projected that the Shopping Centre could then be sold for $14 million, reflecting a 10 percent capitalization rate. He committed to the investment at this time, as it was consistent with the philosophies of other investments in which he had previously participated. Mr. Wallace testified that there was no mention of tax losses or benefits associated with the acquisition of the Shopping Centre and that it was simply a "bricks and mortar real estate deal".
Robert Glass
Robert Glass has worked as a senior property manager with MDC since 1992. He personally invested in the Partnership. He invested in real estate ventures in the form of partnerships prior to 1993 and had also been involved in deals with financial institutions. Mr. Glass first became aware of the Shopping Centre through discussions with Robert Macdonald in the late spring of 1993 when Mr. Macdonald presented it to him as an opportunity to acquire the Shopping Centre at a greatly discounted price. His impression of the deal was that it was an opportunity to acquire a property at less than its replacement cost and later sell it at a profit. He indicated that the deal was attractive because the property could be acquired for $10 million with only "lipstick" improvements required.
Mr. Glass visited the Shopping Centre in the summer of 1993 with Robert Macdonald to discuss potential improvements. In September 1993, Mr. Glass approached Robert Macdonald to participate. Until this point in time, there was no discussion about the tax consequences regarding the purchase of the Shopping Centre.
Mr. Glass attended the November meeting of investors and recalled that a half-hour of that two hour meeting was devoted to John Zaytsoff discussing the structuring of the transactions. At this time he became aware of potential tax consequences, but had already committed to invest and therefore knowledge of the tax benefits did not affect his decision.
Maria Wong
Ms. Wong is the Vice President of Finance at MDC and personally invested in the Partnership. Her primary responsibilities at MDC were to work with Robert Macdonald and the external financial advisor, John Zaytsoff, to determine the optimal structure for the acquisition of properties. She had previously invested in real estate with Robert Macdonald and MDC. These investments frequently took the form of joint ventures or limited partnerships. Prior to 1993 a number of transactions involved the purchase of receivables from financial institutions.
Ms. Wong explained that MDC purchased properties across North America with each project undertaken with a view towards profit. Tax benefits had never played a role in MDC's investment strategy in the projects in which she had previously invested.
Ms. Wong first heard of the investment opportunity in the Shopping Centre on August 9, 1993, after Robert Macdonald returned from a meeting with the Bank in Toronto. At this time, she was informed that he had made a deal to acquire the Shopping Centre from the Bank and that he wanted to meet with both her and John Zaytsoff to discuss the structuring of the deal.
At this meeting, Ms. Wong explained to John Zaytsoff that the Bank did not own the Shopping Centre, but held the Receivable. She also indicated that the Bank was to remain involved in the project by providing $8.6 million in financing for the acquisition..
Ms. Wong testified that it was Mr. Zaytsoff that created the structure for the acquisition but that he did not explain his reasons for the structuring. However, Ms. Wong did understand the tax consequences that resulted from the structure. Despite these tax considerations, she was of the opinion that the structure was suitable for accomplishing the business objective of acquiring the Shopping Centre. Ms. Wong explained that no two deals were the same and, in her opinion, there was nothing unusual about the structuring of this deal. When asked why the Bank set up the Partnership, Ms. Wong testified that she viewed it as being expedient since Robert Macdonald had not confirmed all of the partners.
Throughout cross-examination, Ms. Wong was adamant that the various documents she prepared were to assist Mr. Kennedy and the Bank and facilitate the closing of the deal. She stated that there were never discussions with Bank representatives about payment to the Bank for the tax losses.
John Zaytsoff
Mr. Zaytsoff is a chartered accountant and tax partner at the accounting firm KPMG. He provided external advice to MDC in regard to tax and structuring of transactions. In addition, Mr. Zaytsoff personally invested in the Partnership as he had previously done in a number of other projects with MDC and the Strand Group. He characterized himself as a cautious real estate investor, weighing the risks and benefits of each particular investment. He had invested with Robert Macdonald on at least five occasions. Mr. Zaytsoff indicated that all of these investments were through partnerships or co-ventures.
Ms. Wong informed Mr. Zaytsoff about the property in early August 1993. After the meeting, he understood that the property was subject to foreclosure proceedings. He also understood that the deal required investors to come on board. Mr. Zaytsoff understood that, after the acquisition, the property would be refurbished and renovated, the tenancies improved and the property sold eventually for a profit.
Mr. Zaytsoff indicated that this deal created some structuring challenges for him as it was his first experience in the purchase of a mortgage receivable. He recommended using a partnership because it was easier for the Partnership to achieve its business objectives if the Bank set up the partnership and transferred the Receivable into a partnership that the Bank controlled. He indicated that this method would allow the Bank to maintain control over the property until it could be transferred to the purchasing partners.
Mr. Zaytsoff recognized that there would be some tax benefits resulting from the proposed structure of the transactions, but he insisted that the reason he recommended the structure was to enable the property to be acquired in a manner that was consistent with the Business Plan. His view was that the tax benefits played a very insignificant role in the overall scheme.
Mr. Zaytsoff testified that there were no discussions with the Bank or their representatives with respect to the pricing of the tax losses. The deal was to acquire the Shopping Centre, not the losses. The losses were a consequence flowing from the transactions but not the purpose of those transactions.
Further, he questioned the value of the tax losses to the partners. He explained that the value of the tax benefit to each partner was the amount of their personal tax rate times their proportionate share of the loss. In his opinion, because of the intention to resell the Shopping Centre, the tax benefit was a tax deferral and not a permanent saving of tax. On cross-examination, Mr. Zaytsoff indicated that his understanding was that if the property was ultimately sold for $14 million, the $4 million profit would be taxable as income in the hands of the partners.
Derek Ross Lee
Derek Lee was directly involved in the acquisition of the Shopping Centre. He is currently the President of Prospero. Prospero's business is to manage large commercial properties, such as shopping centres, apartment and office buildings, and industrial properties. Prospero's investment philosophy was to buy real estate and hold it long term. It would look for properties in under-performing markets where the property could be improved and sold for a profit.
The Lee Family had an extensive history with the Shopping Centre beginning in the late 1980's. Derek Lee thought that the Shopping Centre had the potential of increasing in value if improvements were made. With that goal in mind, Derek Lee began working with Robert Macdonald to develop the Business Plan.
Derek Lee attended the meeting with the Bank on August 5, 1993, to discuss the acquisition of the property. He explained that they were able to work out certain terms including the price, the commission to be paid to Prospero, the amount of deposit, financing and the requirement of personal guarantees. Derek Lee did not recall any discussions relating to tax structuring or any tax benefits of the purchase. He also indicated that there was always an intention to form a partnership to purchase the property, but he left all the details of the structuring and closing with Robert Macdonald and Maria Wong.
In 1996, the partners revisited their holding strategy for the property and concluded that it was better to continue to hold the property because it could be sold for $11 million only instead of the expected $14 million.
Robert Lee
Robert Lee invested in the Partnership through his company, Robert Lee Ltd. He has over 47 years' experience in the real estate business. He has invested in other shopping centres in British Columbia, some of which his family still owns. His investment strategy involves finding properties that have a good value based on cash flows and price per square foot. In his experience, tax consequences had never played a part in any of his investment decisions because financial institutions consider good value and good cash flow when providing financing to a borrower.
Although Robert Lee was very familiar with the Shopping Centre, he had given his son, Derek Lee, many responsibilities in managing and dealing with the property. Robert Lee was informed by his son that he and Robert Macdonald were in active negotiations with the Bank for the purchase of the Shopping Centre. He was interested in acquiring an interest in the Shopping Centre because it had good value. In 1989, the Lee Family had purchased the Shopping Centre for $20 million and held it for a short period of time before reselling it for a slight profit. At that time, the price worked out to be approximately $100 per square foot. Later in 1993 when the price dropped to $10 million, or $50 per square foot, he thought it offered a great value although he recognized that improvements were required.
Robert Lee, along with Robert Macdonald, was asked to provide a personal guarantee because the Bank had agreed to provide additional financing to make improvements beyond the amount required to acquire the property. Guarantees were provided by both Robert Lee and Robert Lee Ltd.
Robert Lee was not involved in any of the negotiations and he left most of the details of the closing to his son.
John MacKay
John MacKay is the President, Director, and a shareholder of the Strand Group of companies (the "Strand Group") which is involved generally in real estate investments. The philosophy of the Strand Group was to purchase properties where they could add or create value. Usually this was accomplished by improving cash flows and then selling the property within three to seven years. He also noted that tax implications were not a factor in the Strand Group's investment decisions. Mr. MacKay noted that partnerships were the preferred vehicle for Strand's real estate investments.
Mr. MacKay first met Robert Macdonald in 1984 or 1985 when Robert Macdonald worked at the Strand Group as an acquisition officer. Robert Macdonald eventually left to form his own company, but Mr. MacKay indicated that he made several investments with him after his departure from Strand and he made money on these investments.
Mr. MacKay first heard about the Shopping Centre in 1993 from Robert Macdonald. Mr. MacKay explained that it was typical practice for Robert Macdonald to call, give some basic information and say "I've got a great deal, do you want to invest?" [Transcript page 923]. Although details were usually sketchy, over the last eight to nine years Mr. MacKay always invested in deals that Robert Macdonald recommended based on Mr. Macdonald's reputation.
Mr. MacKay understood the Business Plan for the Shopping Centre was based on its turnaround potential. He testified that tax losses played no part in his decision to invest and that he had no role in the structuring of the transactions.
John Cassils
John Cassils has approximately 30 years' experience in real estate activities as a former owner of the Strand Group with John MacKay. He personally invested in the Partnership. Mr. Cassils stopped practicing medicine to work in the real estate business full-time until his retirement four or five years ago. At the Strand Group, Mr. Cassils worked on the acquisition side of the business' real estate investments, which entailed researching real estate markets across North America.
Mr. Cassils was attracted to the Shopping Centre investment based on the projected returns, which he considered quite attractive. He explained that his investment decisions were often based on the person doing the deal and not just the deal itself. Mr. Cassils stated that he had a lot of confidence in Robert Macdonald and although he had not previously invested with him, he had a high regard for his abilities. Mr. Cassils had completed business deals with many of the other Appellants previously and knew many of the others on a social basis. Mr. Cassils had a lot of confidence in participating in the Partnership based on the involvement of the other investors whom he considered to be "pretty smart real estate people" [Transcript page 433]. Mr. Cassils explained that he had never been a tax motivated investor since those types of investments are "rarely profitable". His feeling was that deals for tax purposes were not normally solid investments.
John (Jack) Wilson Poole
John Poole invested in the Partnership through his company, Beach Avenue Holding Company Ltd. Mr. Poole has also been very active in the real estate business since 1964. He decided to participate in the acquisition of the Shopping Centre because of his close friendship with Robert Lee. Derek Lee presented him with the offer to participate. He was interested in the investment because it was an opportunity to acquire an income property at substantially less than the replacement cost.
Mr. Poole was offered a 10 percent share, although he was interested in a larger investment since he considered 10 percent to be a minimal investment. He indicated that the investment was an easy decision for him to make because it was a relatively small investment by his standards, the cost was considerably lower than the replacement value, and because he knew most of the partners it gave him a level of comfort. The issue of tax losses or benefits never arose.
Tony Letvinchuk
Tony Letvinchuk was employed as a senior property manager with Prospero from 1981 until 1998. He became acquainted with the Shopping Centre in 1989 when York-Hannover was interested in having Prospero manage the property. From this time until the Bank started the foreclosure proceedings, Mr. Letvinchuk became more familiar with the property. In 1992 he became the official property manager. In 1993, he helped Derek Lee prepare the property for sale and in June 1993 he authored a report that was eventually given to Robert Macdonald to assist in formulating the Business Plan and negotiating with the Bank.
He declined to become involved in this deal because he was occupied with other investments.
Bill Kennedy
Bill Kennedy is the Vice President of the Special Loans Group with the Bank. He is the only Bank employee, who had any involvement with the acquisition of the Shopping Centre, that is still employed by the Bank. He was under subpoena to testify at the hearing.
In 1993, Mr. Kennedy was responsible for dealing with real estate projects that were presenting difficulties to the Bank. During the 1990's the Bank held a large real estate portfolio. At this time a recession was causing hardship within the real estate market. He testified that non-accrual, non-performing loans had a negative impact on the Bank because of the significant costs to carry such loans in addition to the actual loss on the loans. The mandate of the Special Loans Group was to deal with these problem loans as quickly as possible in a commercially reasonable manner. This was usually accomplished by selling the asset or getting the loan back to performing status to minimize the loss.
The mortgage to York-Hannover, in respect to the Shopping Centre, became a non-performing loan in November 1992. Mr. Kennedy explained that the Bank's plan was to get control of the property and then to develop a strategy to maximize its value. Since it was a significant loan, there was pressure to get this asset on performing status and maximize its value. Eventually Prospero was given the exclusive listing agreement and the task of finding a buyer.
The original listing price for the Shopping Centre was $12.5 million based on an appraisal value of $11.9 million. The Bank was concerned that it would not get its asking price and therefore its focus was on obtaining the best price possible. Although he believed that Prospero was capable of selling the property, he was concerned about the general lack of liquidity in the real estate market. At the time of the listing, Mr. Kennedy did not have any discussions with Prospero or Derek Lee about tax losses. He simply wanted to sell the property as quickly as possible for the best possible price.
At the initial meeting of August 5, 1993, Mr. Kennedy did not recall any discussions about tax losses. Eventually, when the structure was proposed for the acquisition of the property, he still considered that the purpose of the steps in the structure was to facilitate the sale pursuant to Robert Macdonald's initial Business Plan. Mr. Kennedy stated that he would never recommend a sale involving a vendor take-back mortgage, as he did in this case, where the purchaser was only interested in tax losses. The Bank wanted to sell the property to experienced individuals if it was providing financing to them as that tied the Bank's future interest directly to a purchaser's interest, in this case the Appellants. He stated that the deal fit perfectly with the Bank's mandate of dealing with non-accrual loans.
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