Date: 19990624
Docket: 98-827-IT-G
BETWEEN:
JABS CONSTRUCTION LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Bowman, J.T.C.C.
[1] These appeals are from assessments for the appellant's
taxation years which ended May 31, 1993, 1994 and 1995. The
central issue is whether a transfer to a charitable foundation,
Felsen Foundation, ("Felsen") on October 31, 1992 by
the appellant of 13 properties was legally effective.
[2] The appellant's position is that:
(a) it transferred by way of gift 13 properties to Felsen in
its 1993 taxation year and designated its proceeds of disposition
to be the adjusted cost base ("ACB") of the
properties;
(b) the subsequent sale of the properties to Callahan
Construction Company Ltd. ("Callahan") by Felsen
resulted in the realization by Felsen of a capital gain that was
not taxable in Felsen's hands because it was a charitable
foundation;
(c) Felsen loaned a portion of the proceeds of disposition of
the properties to the appellant and the interest that the
appellant paid on the loan is deductible in computing its
income.
[3] The respondent's position is that the transfer of the
13 properties to Felsen was legally ineffective, that accordingly
Callahan had beneficial ownership before the purported transfer
to Felsen, that the proceeds of disposition of the properties
belonged to the appellant and therefore the capital gain was
realized by the appellant. On this basis Felsen had nothing to
loan to the appellant and the appellant is precluded from
deducting the interest paid to Felsen because it was seeking to
deduct interest on its own money.
[4] In the alternative, the respondent alleges that if the
transfer to Felsen was legally effective it was an avoidance
transaction within the meaning of section 245, thereby
permitting the Minister of National Revenue to reallocate the
capital gain from Felsen to the appellant.
[5] The facts as established in the evidence are as follows.
The appellant is a successful owner of commercial real estate. It
is controlled by Mr. Eric Jabs. Mr. Jabs and his wife, Toni
Alwine F. Jabs, are committed Christians. They have devoted
substantial amounts of their time and considerable wealth to
charitable causes and have made substantial contributions to
charities carrying on activities in Canada and throughout the
world.
[6] In 1991, they incorporated Felsen and it was registered as
a private charitable foundation. The purpose of creating Felsen
was to allow the accumulation of capital in the foundation as an
endowment so that amounts could be distributed for charitable
purposes without eroding the capital. Mr. Jabs' target was
$1,000,000 per year and this would have required a capital fund
of $10,000,000. Mr. and Mrs. Jabs and their two adult children
are the directors of Felsen.
[7] In 1967, the appellant went into business with Callahan.
Their relationship was described as a joint venture. The
association was successful and over the years the joint venture
prospered and acquired a large portfolio of real estate,
including apartment buildings, development sites and commercial
buildings.
[8] Differences developed between the appellant and Callahan
in 1988 and an acrimonious dispute ensued, leading to a decision
to terminate the joint venture and divide the properties. The
parties could not agree on a method of doing so and litigation in
the Supreme Court of British Columbia followed. That litigation
was settled in 1992 pursuant to a settlement agreement, a copy of
which the respondent appended to the reply to the notice of
appeal.
[9] By the time of the settlement agreement made "as
of" April 30, 1992, the litigation had reached a certain
stage, including orders for the filing of sealed bids, an action
for partition and an order relating to the shares of Argus
Industries Ltd.
[10] The settlement agreement was evidently intended to bring
the litigation to an end and to supersede any orders made in the
course of that litigation.
[11] The settlement agreement was complex ("unnecessarily
complex" according to Mr. Jabs as the result of the acrimony
between the parties). It provided for a process for the division
of the properties. The properties were to be divided into four
packages and Mr. Jabs and Mr. Callahan were to assess the fair
market value of the properties. A bidding process was established
under which each of the parties could bid on the properties. If
the bid was not accepted the other party would purchase the
property at that price. Simply put, the settlement agreement was
a somewhat unwieldy shotgun arrangement.
[12] Nonetheless, the bidding proceeded between May and
October 1992 and at its conclusion it was determined that the 50%
interest of the appellant in the 13 properties in issue here
would be sold by the appellant to Callahan. It was further
determined that they had an aggregate fair market value of
$17,745,000, and an ACB of $8,335,751 and were encumbered by
mortgages totalling $4,833,709.
[13] Given Mr. and Mrs. Jabs' decision to fund Felsen with
a capital endowment of $10,000,000, the solution was obvious:
transfer the 13 properties to Felsen at a designated
consideration under subsection 110.1(3) equal to their ACB and
let Felsen sell them to Callahan and realize, tax free, the
capital gain. This, together with the amounts already given to
Felsen by Mr. and Mrs. Jabs, would bring Felsen's capital up
to the targeted figure of about $10,000,000. The alternative
would have been for the appellant to sell the properties to
Callahan, realize the capital gain of approximately $9,000,000,
pay tax of about $3,100,000 and be left with cash of about
$5,900,000 which it could keep or donate to charity, including
Felsen, and obtain a deduction within the limits permitted by the
Income Tax Act. The mortgages to the bank of $4,833,709
would have to be retired and the appellant would also be liable
for tax on the recapture of capital cost allowance of about
$3,000,000. These consequences were inevitable, irrespective of
which alternative was chosen. However what emerges is that from
the appellant's point of view the second alternative, whereby
the appellant would sell the property rather than Felsen was
financially advantageous to the appellant, whereas the first was
far more beneficial to Felsen.
[14] In the result, the appellant on October 31, 1992 executed
a deed of gift of each of the 13 properties in favour of Felsen
and designated under subsection 110.1(3) the proceeds of
disposition to be the ACB of each property[1].
[15] Paragraph 1 of the deed of gift reads as follows:
1. Subject to paragraph 2 hereof, the Company hereby assigns
and transfers by way of gift to the Foundation all of its right,
title and interest in and to the Land for the Foundation's
sole use and benefit absolutely and effective the day and date
first above written, subject to the Foundation subsequently
issuing a Receipt containing prescribed information as well as
the Designated Amount and subject to the Minister of National
Revenue accepting the Receipt as evidence of a charitable gift as
described in paragraph 110.1(1)(a) of the Act made on the date
set out in the Receipt and accepting the Designated Amount as
being the Company's deemed proceeds of disposition of the
Land pursuant to Subsection 110.1(3).
[16] On the same day, the appellant executed a Declaration of
Nominee Status whereby it declared and acknowledged that it held
the legal and registered title to the property as bare trustee
and nominee for the benefit of Felsen.
[17] As noted above, this transfer gave rise to recapture of
capital cost allowance in the appellant's hands.
[18] The following is a list of the steps contemplated and in
fact followed on October 29, 30 and 31, 1992 in accordance with
the advice of Mr. Nicholas P. Smith of Douglas, Symes &
Brissenden, solicitors (this summary is taken from paragraph 15
of the appellant's written submissions):
15. In order to carry out its objective, Jabs Construction did
the following in conjunction with the Felsen Foundation:
(a) The Felsen Foundation would borrow $3 million from the
Bank of Montreal secured by the personal guarantee of Mr.
Jabs;
(b) The Felsen Foundation would then loan the $3 million plus
an additional sum [$293,000] to Jabs Construction. This loan
would be secured by equitable mortgages[[2]] over each
of the 13 properties. The mortgages carried an interest rate of
10% per annum;
(c) Jabs Construction would then gift its 50% interest in each
of the 13 properties to the Felsen Foundation by signing and
delivering 13 Deeds of Gift transferring the ownership of each of
the 13 properties to the Felsen Foundation. The Felsen Foundation
[an obvious error: it should read Jabs Construction] would sign a
Declaration of Nominee Status in which Jabs Construction would
agree to hold the 50% interest in the 13 properties in trust, as
a bare trustee for the Felsen Foundation;
(d) The value designated for the 13 properties for income tax
purposes would be the adjusted cost base of those properties or
$8,335,751.00;
(e) The Felsen Foundation would then have two interests in
each of the 13 properties: the 50% interest and the equitable
mortgage. By operation of the doctrine of merger, the two
interests would merge in the hands of the Felsen Foundation. The
mortgages given by Jabs Construction would then be discharged and
the debt would be extinguished;[[3]]
(f) In order to complete the obligations under the Settlement
Agreement, Jabs Construction would then sell, as bare trustee for
Felsen Foundation, the 13 properties to Callahan Construction for
the amount agreed upon through the bidding process, being
$17,745,000.00 less the Bank mortgages on the 13 properties of
$4,833,709.00;
All of the above steps took place on October 29, 30 and 31,
1992.
(g) Jabs Construction would receive the purchase funds from
Callahan Construction as bare trustee for the Felsen Foundation
(which it did on January 15, 1993) and, pursuant to the
terms of the Declaration of Nominee Status, would be required to
hold these funds for the account of Felsen Foundation;
(h) On November 15, 1992 Jabs Construction loaned to the
Felsen Foundation an amount of $3 million, enabling the Felsen
Foundation to repay its loan with the Bank of Montreal. Out of
the proceeds of disposition received by the Felsen Foundation
from the sale of Jabs Construction's interest in the 13
properties to Callahan Construction, the Felsen Foundation repaid
the $3 million loan to Jabs Construction. This repayment, in
turn, provided Jabs Construction with the necessary funds to pay
its tax liability for recapture.
[19] These steps are substantially in accordance with the
letter of October 30, 1992 from Mr. Nicholas P. Smith to the
appellant's accountants, Doane Raymond Pannell. That letter
reads, in part, as follows (Exhibit R-81):
The transactions should occur in the following order and on
the following dates:
1. The Foundation must borrow $3 million from the bank and
$350,000 from Eric Jabs personally by October 29, 1992. We
confirm your advice that Bank of Montreal (the "Bank")
has already advanced the $3 million to the Foundation and Eric
advanced the $350,000 to the Foundation on October 29, 1992.
2. The Foundation must then advance the $3,350,000 to
Construction on October 29, 1992 and Construction must date the
Promissory Notes October 29, 1992. On the same date, the
mortgages securing the debt owing by Construction to the
Foundation should be dated. We confirm your advice that the
Foundation advanced the $3,350,000 to Construction on October 29,
1992.
3. The Construction director's resolution authorizing the
gift of the Properties to the Foundation should be dated the
following day, October 30, 1992.
4. The Deeds of Gift whereunder Construction will gift the
Properties to the Foundation and the Declarations of Nominee
Status should be dated the next day, October 31, 1992. At that
point in time, the mortgages in favour of the Foundation will
merge with the Foundation's interest in the Properties so
that the debt of $3,350,000 owing by Construction to the
Foundation will disappear. The Foundation will still owe the Bank
$3 million and Eric $350,000. Construction will be left with
$3,350,000 cash and no offsetting obligation. In fact,
Construction may consider lending the Foundation the $3 million
to repay the Bank, so that the Foundation would owe Construction
$3 million and interest accruing to the Bank would cease.
5. The Foundation should sign the Irrevocable Direction on,
say, November 5, 1992 instructing Construction to complete the
transfer of the properties to Callahan Construction on November
10, 1992 (if that is indeed the closing date).
6. On November 10, 1992, the Foundation will sell the
Properties to Callahan Construction and part of the proceeds will
be used to retire the first mortgages over the Properties. The
Foundation will end up with cash in the amount of the purchase
price paid by Callahan Construction less the amounts required to
pay out the first mortgages.
7. Prior to November 10, 1992, the Foundation may wish to
retire the Bank debt to avoid having to pay ongoing interest.
This may be accomplished by having Construction lend funds to the
Foundation prior to November 10 out of the moneys previously lent
to Construction by the Foundation. Alternatively, Eric might
consider reducing his shareholder loan balance with Construction
and lending this money to the Foundation so that it could in part
repay the Bank. We understand Eric's shareholder loan balance
is not large enough to sufficiently fund the Foundation so as to
retire the entire $3 million debt with the Bank. We also
understand that any properties which might be purchased from
Callahan Construction will be purchased by Construction, so
Construction may require liquidity and may not be in a position
to pay out Eric's shareholder loan or lend the Foundation the
money.
The Foundation may, on the other hand, be prepared to pay
interest on the Bank debt accruing until November 10 and then
retire this debt with the proceeds received from Callahan
Construction (after the first mortgages have been paid out).
However, if the closing is delayed until after November 10, the
Foundation will continue to incur interest charges on the Bank
debt.
[20] When the sale to Callahan was completed Felsen loaned the
proceeds to the appellant at a rate of interest higher than it
could have obtained by depositing the money in the bank. The
evidence discloses — indeed it is not disputed — that
the funds were used in the appellant's business. The
appellant paid or accrued interest to Felsen in the following
amounts in the taxation year 1993, 1994 and 1995:
1993 $48,155
1994 $663,893
1995 $771,599
[21] One of the issues in these appeals is the deductibility
of these amounts.
[22] The result of the gift to Felsen was that it was able to
disburse much larger amounts of its funds for the purposes of
carrying on the wide range of charitable activities throughout
the world.
[23] The Minister assessed in the manner set out at the
beginning of these reasons, on the basis that the transfer to
Felsen was ineffective, the capital gain on the sale to Callahan
belonged to the appellant, the interest paid to Felsen was not
deductible and in any event section 245 applied. The Minister
sees the whole series of transactions as an elaborate and
sinister form of tax avoidance. For the reasons that follow, I
see it as no such thing. It is in my view a sensible and
carefully conceived plan carried out within the specific
provisions of the Act designed to achieve the overall
charitable objectives of Mr. and Mrs. Jabs.
Was the transfer to Felsen legally effective?
[24] It is not suggested that any of the discrete steps were
shams. They created genuine legal relationships. The deeds of
gift and the declarations of nominee status were effective to
convey the beneficial interest in the properties to Felsen.
[25] The Minister contends that the settlement agreement, as
well as the subsequent negotiations which identified the 13
properties that would be sold to Callahan, resulted in Callahan
obtaining the beneficial ownership of the 13 properties so
that the appellant had nothing to give to Felsen on October 31,
1992. I do not accept this proposition. The appellant retained
beneficial ownership in the property until it gave it to Felsen.
It would have retained beneficial ownership up to the date of
sale to Callahan had it not disposed of it to Felsen. A vendor
under an agreement of sale retains full ownership of the property
until the conveyance of legal title, subject only to the
obligation to ensure that on closing the purchaser obtain title.
Had the vendor put itself in a position of being unable to do so,
the vendor would be liable in damages. Whether a purchaser has an
equitable interest in the property amounting to beneficial
ownership depends upon the contract being specifically
enforceable. The law, as set out in Semelhago v.
Paramadevan, (1996) 136 D.L.R. (4th) 1 (S.C.C.) at pages 10
and 11, is that specific performance will not lie if an
alternative remedy [e.g. damages] is available. Certainly there
was nothing unique about a group of commercial properties such as
were involved here: Arbutus Garden Homes Ltd. v. Arbutus
Gardens Apartments Corp., (1996) 20 B.C.L.R. (3d)
292.
[26] In that case, Parrett J. said at pages 326 and 327:
The final submission directed solely at the claim for specific
performance is that damages are in this case an adequate remedy
and that, as a result, specific performance should not be
ordered.
The equitable remedy of specific performance is one which in
historical terms was based on a concept which recognized land as
having a unique value. In recent times the law has moved to a
more modern recognition of the fact that where the land in
question is being purchased solely for investment purposes, the
"unique quality" envisioned by the law is absent and
damages are an adequate remedy. McNabb v. Smith (1981), 30
B.C.L.R. 37 at 41, affirmed (1982), 44 B.C.L.R. 295 (C.A.);
Zalaudek v. De Boer (1981), 33 B.C.L.R. 57 at 65 (S.C.);
and Chaulk v. Fairview Construction Ltd. (1977), 3 R.P.R.
116 at 122 (Nfld. C.A.).
Specific performance is a discretionary remedy and the modern
trend appears to be based on the exercise of that discretion to
achieve justice and equity in the circumstances of the particular
case viewed from a more modern and flexible view of the
"unique" nature of land.
In the present case the position advanced by the plaintiff is
traditional in the sense that they submit that the Arbutus
Gardens property is unique and "one of the most desirable
and well located complexes in the City of Vancouver."
While this may be true the submission ignores the reality of
the situation and the position of the plaintiff in the present
litigation. The plaintiff intended to pre-sell units in the
property by the time it was required to close. Their intention,
clearly found in Mr. Skalbania's affidavit material, was to
have it completely sold by the time they were to take title. This
property was never unique to them except in the context of an
investment opportunity. Not only are damages capable of
calculation in this case they have already purported to present
that calculation.
This is precisely the type of case which lies at the root of
the more recent trend in these types of cases. In this case it is
clear, in all of the circumstances that damages are an entirely
adequate remedy.
[27] It is incorrect to suggest that, as the result of the
complex procedures under the settlement agreement, resulting in
13 properties being identified as those that would be sold to
Callahan, this without more made Callahan the beneficial or
equitable owner of those properties or constituted a legal
impediment to their being given to Felsen.
[28] The respondent relies upon The Queen v. Paxton, 97
DTC 5012 (F.C.A.), where it was held that a pre-existing sale of
shares to a purchaser prevented a "sale" to the
taxpayer's children. That is not the situation here. All we
have is a settlement agreement in which the parties agreed to
negotiate a manner of dividing up a number of properties
comprising a large group held jointly, followed by an
identification of which properties would be sold to whom. It is
in my view quite erroneous to suggest that on October 31, 1992
Callahan had acquired any beneficial interest in the
appellant's one-half interest in the properties that Callahan
ultimately acquired from Felsen. Until the properties that were
to be sold to Callahan were identified, it could not be
determined which ones should be given to Felsen.
[29] By October 31, 1992, the parties had not even reached the
point of having an agreement of purchase and sale. They had
substantially reached the end of a complicated and acrimonious
negotiation under the settlement agreement and had identified the
properties to be sold. However, as Mr. Jabs observed, the
situation was fluid and until the end Mr. Callahan kept coming up
with changes.
[30] The respondent advanced other arguments in support of the
contention that there was no legally effective gift. Counsel
argues, in paragraph 31 of his written submissions, that the
appellant wanted to "transfer only the capital gain from the
13 properties to Felsen Foundation and expected to recover the
appellant's costs of these properties".
[31] The use of the expression "to transfer only the
capital gain ... to Felsen" is, I think, susceptible of
misinterpretation. The term "capital gain" is a tax
concept. It is not something that can be transferred. What is
transferred is property the disposition of which gives rise to a
capital gain. The respondent reads more into the use of a
shorthand expression that is descriptive of the intended economic
result than is warranted. Where the Act permits the
transfer of property at its ACB to another entity and the
property is then sold at a gain, in a sense one might say that
the capital gain is "transferred" to the transferee,
but this is not descriptive of the legal reality.
[32] Counsel then contends that of the net proceeds of
$12,911,291 ($17,745,00 – the mortgages of $4,833,709)
$3,472,042.08 was received as an amount owing to the appellant by
Felsen. This figure appears in an accounting record of the
appellant, headed "Jabs Construction Ltd., A/R-Other"
[A/R means, I assume, accounts receivable]. The figure is arrived
at as follows, according to Exhibit R-67:
Elected amount $8,335,750.68
Less mortgages $4,833,708.60
Donations $30,000.00
$3,472,042.08
[33] The date of the document (Exhibit R-67) is 21-09-93 and
it purports to describe the situation as of 31-05-93. I am not
prepared to treat these accounting entries as reflecting the true
legal relationship between the appellant and Felsen. Accounting
entries are supposed to reflect reality, not create it (Ed
Sinclair Construction & Supplies Ltd. et al. v. M.N.R.,
92 DTC 1163; Gresham Life Society v. Bishop, (1902) 4 T.C.
464 at 476).
[34] The respondent argues that only $9,230,534 was shown as
owing by the appellant to Felsen. This figure is found in Exhibit
R-70, a document called "Comments on Draft Financial
Statements (Draft Copy) January 31, 1993". This document
relates not to the appellant but to Felsen and is dated 28-06-93.
It shows the gross proceeds from the sale of $17,345,000
(excluding the sale of the Cargo property for $400,000 which took
place later) less the mortgages of $4,833,709, for a net
$12,511,291. To this is added a donation of $20,000, interest on
$3,293,000 and $9,192,636, other income of $200,130 and repayment
of cash advances $285,000 and $3,573,000 for a total of
$16,637,576. From this is deducted $7,407,042 a figure made up of
amounts owing to the appellant, including the $3,000,000 that the
appellant loaned Felsen on November 15, 1992. (It could not have
been the $3,000,000 that Felsen loaned to the appellant. That had
disappeared on the merger.) It also included the $3,472,042
discussed above, being the elected amount less the mortgages and
a donation.
[35] It is here that the unreliability of the accounting
records comes into sharp focus. The designated amount for the
purpose of subsection 110.1(3) of the Act has absolutely
nothing to do with the commercial reality of the matter. The
appellant gave Felsen property with a fair market value of
$17,745,000 less the encumbrances of $4,833,709, for a net value
of $12,911,291. That is the commercial value of the gift. The
Act permits a corporate donor to designate a lesser
figure, between the ACB and the fair market value. Somehow the
accountants have mixed up the financial accounting with the
deemed proceeds and the deemed fair market value under the
Act and this has skewed the accounts. It is no wonder that
the accounting entries are incomprehensible, that the accountants
have had to admit to errors (Exhibit R-64, paragraph 15) and that
the respondent has drawn some interesting but unsupported
inferences from the accounts. Moreover, there was according to
the respondent some confusion whether the loan of $3,000,000 to
the appellant was repaid or extinguished. I do not find the
accounting evidence, including the documentary evidence adduced
by the respondent, reliable. I am basing my conclusions of fact
on the other documents filed and the evidence of Mr. Jabs and Mr.
Blake Bromley.
[36] I find that Felsen borrowed $3,000,000 from the bank and
loaned it plus an additional $293,000 to the appellant, secured
by mortgages and that the appellant gave the 13 properties to
Felsen by way of gift, subject to the bank mortgages and to the
equitable mortgages and those equitable mortgages disappeared on
merger. The appellant loaned $3,000,000 to Felsen on November 15,
1992 with which it retired the bank loan. When the properties
were sold by the appellant as nominee and trustee for Felsen,
Felsen became the beneficial owner of the proceeds which were
used in part to retire the mortgages of $4,833,709, and in part
to repay the appellant its loan of $3,000,000. The balance, or a
substantial part of it, was loaned to the appellant at the
greater of 7% or the prescribed rate set by Revenue Canada.
[37] These are the objective facts that the evidence has
established and it is unfortunate that the waters have been
muddied by the accounting entries.
[38] The respondent makes two further submissions. First, it
is contended that there was no gift but rather a transfer for
consideration. The evidence simply does not support this
position. The deeds of gift refer to no consideration and I am
unable to accept that the extinguishment of the debt of
$3,293,000 on the transfer of the properties to Felsen, by reason
of the doctrine of merger, constituted consideration within the
generally accepted meaning of that term[4]. The extinguishment of the debt was
not the price exacted for the gift. It was simply the legal
result of the transfer to Felsen of property that was subject to
the equitable mortgages.
[39] The second contention is that the gift was subject to a
condition that was unfulfilled, by reason of the words in the
deed of gift:
...subject to the Foundation subsequently issuing a
Receipt containing prescribed information as well as the
Designated Amount and subject to the Minister of National Revenue
accepting the Receipt as evidence of a charitable gift as
described in paragraph 110.1(1)(a) of the Actmade on the date set
out in the Receipt and accepting the Designated Amount as being
the Company's deemed proceeds of disposition of the Land
pursuant to Subsection 110.1(3).
[40] I find on the evidence that such receipts were issued. It
is true, however, that the Minister has not accepted anything
about the transaction — including the making of the gift,
the receipts and the designated amounts under
subsection 110.1(3). Without dealing at length with the
somewhat elusive meaning of the words "subject to"
— it has different effects depending on the context —
the short answer is that if I allow this appeal the Minister has
no alternative but to accept the validity of the charitable gift
and the designation under subsection 110.1(3).
[41] Therefore there was a valid gift to Felsen of the
appellant's ownership of the 13 properties.
GAAR
[42] As has been stated before[5], the general anti-avoidance rule (GAAR)
contained in section 245 is a measure of last resort, to be
applied if all else fails. It may only be applied if a tax
avoidance scheme otherwise works. It need not be applied if the
scheme is otherwise defective.
[43] Section 245 reads:
(1) In this section,
"tax benefit" — "tax benefit"
means a reduction, avoidance or deferral of tax or other amount
payable under this Act or an increase in a refund of tax or other
amount under this Act;
"tax consequences" — "tax
consequences" to a person means the amount of income,
taxable income, or taxable income earned in Canada of, tax or
other amount payable by or refundable to the person under this
Act, or any other amount that is relevant for the purposes of
computing that amount;
"transaction" — "transaction"
includes an arrangement or event.
(2) Where a transaction is an avoidance transaction, the tax
consequences to a person shall be determined as is reasonable in
the circumstances in order to deny a tax benefit that, but for
this section, would result, directly or indirectly, from that
transaction or from a series of transactions that includes that
transaction.
(3) 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.
(4) For greater certainty, subsection (2) does not apply to a
transaction where it may reasonably be considered that the
transaction would not result directly or indirectly in a misuse
of the provisions of the Act or an abuse having regard to the
provisions of this Act, other than this section, read as a
whole.
(5) Without restricting the generality of subsection (2),
(a) any deduction in computing income, taxable income,
taxable income earned in Canada or tax payable or any part
thereof may be allowed or disallowed in whole or in part,
(b) any such deduction, any income, loss or other
amount or part thereof may be allocated to any person,
(c) the nature of any payment or other amount may be
recharacterized, and
(d) the tax effects that would otherwise result from
the application of other provisions of this Act may be
ignored,
in determining the tax consequences to a person as is
reasonable in the circumstances in order to deny a tax benefit
that would, but for this section, result, directly or indirectly,
from an avoidance transaction.
(6) Where with respect to a transaction
(a) a notice of assessment, reassessment or additional
assessment involving the application of subsection (2) with
respect to the transaction has been sent to a person, or
(b) a notice of determination pursuant to
subsection 152(1.11) has been sent to a person with respect
to the transaction,
any person (other than a person referred to in paragraph
(a) or (b)) shall be entitled, within 180 days
after the day of mailing of the notice, to request in writing
that the Minister make an assessment, reassessment or additional
assessment applying subsection (2) or make a determination
applying subsection 152(1.11) with respect to that
transaction.
(7) Notwithstanding any other provision of this Act, the tax
consequences to any person, following the application of this
section, shall only be determined through a notice of assessment,
reassessment, additional assessment or determination pursuant to
subsection 152(1.11) involving the application of this
section.
(8) On receipt of a request by a person under subsection (6),
the Minister shall, with all due dispatch, consider the request
and, notwithstanding subsection 152(4), assess, reassess or make
an additional assessment or determination pursuant to
subsection 152(1.11) with respect to that person, except
that an assessment, reassessment, additional assessment or
determination may be made under this subsection only to the
extent that it may reasonably be regarded as relating to the
transaction referred to in subsection (6).
[44] The reasoning that lay behind the application of section
245 to the appellant's transactions is found in a memorandum
dated June 5, 1995 to the Head Office, Tax Avoidance and
Legislative Recommendation Division from the Southern Interior
B.C. TSO, Tax Avoidance Section.
[45] The concluding paragraphs read as follows:
Issues:
The real property was transferred in such a way that the
resulting capital gains were reflected in the income and tax
return of a non-taxable entity rather than in the
corporation's income and return. The cash from these capital
gains, though, was available to the corporation anyway under loan
terms that are very imprecise and generous.
Further, the taxable corporation now incurs significant
interest expense on the funds to offset its current and future
taxable income.
General Anti-Avoidance Consideration
It is evident that this arrangement is a version of a loanback
scheme mentioned in Claire Nelson's bulletin dated
November 22, 1994 in which she recommended that any such
schemes be referred to Avoidance Services for consideration of
the General Anti-avoidance Rules.
Tax Benefit and the Avoidance Transaction
The tax benefit derived by this arrangement is the tax savings
to Jabs Construction Ltd by not having to report the taxable
capital gains on the disposition of its interest in the real
property to Callahan Construction Company Ltd. The capital gain
would be the same as the loan from Jabs Construction to the
Felsen Foundation ($10,004,470). This would translate to tax of
approximately $2,885,000.
The "avoidance transaction" would be the series of
transactions whereby Jabs Construction transferred the real
property to the Felsen Foundation below the properties' fair
market value after having agreed with Callahan Construction to
transfer the property to that corporation; Jabs then caused the
Foundation to sell the property to Callahan Construction and then
further caused the Foundation to loan the funds back to Jabs
Construction.
Misuse and Abuse of the Act
The Act clearly intends to tax the capital gains on the
disposition of a taxpayer's interest in capital properties in
the year the disposition occurs (sections 38 and 39 and, of
course, subsection 3(b)). The Act also clearly allows
deductions from income of a corporation's donations to a
registered charity in the year (or five prior years) that the
donation is made (reference subparagraph 110.1(1)(a)(i)). The
courts have determined that a gift to such charities must be
"transferred voluntarily and not as a result of a
contractual obligation to transfer it and that no advantage of a
material character was received by the transferor by way of
return" (reference The Queen v. Burns (88 DTC 6101)).
In this particular situation, the taxpayer generated capital
gains on the disposition of the real properties per terms of an
agreement between it and a third party. It legally structured the
dispositions in such a fashion to avoid these resulting gains. In
the real and practical sense, the funds were paid to it, however,
these were now called loan proceeds rather than proceeds of
disposition. The controlling shareholder of Jabs Construction
always controlled the Felsen Foundation. Eric Jabs could
determine when and how these loan funds would be repaid. Further,
the arrangement created a situation where the corporation would
be able to deduct interest expenses on the funds
"borrowed" from the Foundation and evidently used in
its business; at the same time, the recipient of the interest was
tax exempt.
Reasonable Tax Consequences
It is estimated that the scheme saved, or at least deferred
approximately $2,885,000 in federal taxes.
Timing Consideration
All transactions occurred well after 1988; the provisions of
section 245 could be applied.
[46] Essential to the operation of the section is that there
be an avoidance transaction, i.e. a transaction resulting in a
"tax benefit", as defined. It is true, the appellant
did not, as a result of the gift to Felsen, have to pay tax on
the capital gain that it would have realized had it sold the
properties itself to Callahan. If this were the tax benefit upon
which the respondent relies, every gift at a designated amount
less than fair market value to a charity under
subsection 110.1(3) would be an avoidance transaction. Such
gifts are however precisely what subsection 110.1(3)
contemplates. I fail to see how the use of a specific provision
of the Act that allows the tax consequences of a
charitable gift to be mitigated can by any stretch of the
imagination be a misuse of the provisions of the Act or an
abuse within the meaning of subsection 245(4). It is simply a use
of a provision of the Act — not a misuse or abuse
— for the very purpose for which it was designed.
[47] Does the loaning of the proceeds back to the appellant by
Felsen at a favourable interest rate turn what is patently not an
avoidance transaction into one? Once again the loaning of money
by a private foundation to persons with which the foundation does
not deal at arm's length is specifically contemplated by
section 189 of the Act which in essence penalizes a
non-arm's length borrower from a private foundation to the
extent that the interest paid on the debt falls below the
prescribed rate. I accept Mr. Jabs' testimony that he
believed that loaning the money to the appellant was a prudent
investment for Felsen and resulted in a better rate that could
have been achieved elsewhere and was less subject to the vagaries
of the stock market.
[48] I can discern nothing else in the entire series of
transactions that could possibly justify their being avoidance
transactions, either separately or collectively. This transaction
is the last one that would have occurred to me as subject to
attack under section 245. Section 245 is an extreme sanction. It
should not be used routinely every time the Minister gets upset
just because a taxpayer structures a transaction in a tax
effective way, or does not structure it in a manner that
maximizes the tax.
[49] The appeals from assessments for the appellant's
taxation years 1993, 1994 and 1995 are allowed and the
assessments are referred back to the Minister of National Revenue
for reconsideration and reassessment in accordance with these
reasons and specifically on the basis that:
(a) the transfer of the 13 properties to Felsen is a valid and
effective charitable gift and the appellant's proceeds of
disposition are the amounts designated by it;
(b) the sale of the 13 properties to Callahan constituted a
sale by Felsen of its beneficial interest in those properties
giving rise to a capital gain in the hands of Felsen and not in
the hands of the appellant;
(c) the interest paid or accrued by the appellant in the
amounts of $48,155, $663,893 and $711,599 in its taxation years
1993, 1994 and 1995 on the loans made to it by Felsen
respectively is deductible by the appellant in computing its
income pursuant to paragraph 20(1)(c) of the
Act;
(d) the series of transactions in issue in these appeals do
not constitute avoidance transactions within the meaning of
section 245 of the Act.
[50] The appellant is entitled to its costs.
Signed at Ottawa, Canada, this 24th day of June 1999.
"D.G.H. Bowman"
J.T.C.C.
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