Ledoux v. R., [1998] 1 CTC 3154, 98 DTC 1034

Archambault T.C.J.:

André Ledoux is challenging notices of assessment issued by the Minister of National Revenue (“the Minister”) for the 1987 and 1988 taxation years. For the 1987 taxation year the Minister treated as business income Mr. Ledoux’s earnings which the latter and persons related to him had reported as capital gains.

For the 1988 taxation year the Minister disallowed the deduction of an expenditure of $37,500 for fees claimed by Douxel, a limited partnership (“Douxel”), which resulted in interest income of $19,805 for the latter. As Mr. Ledoux held one-third of the shares in Douxel, the Minister increased Mr. Ledoux’s income for 1988 by $6,601.50. Pursuant to s. 74.1(2) of the Income Tax Act (“the Act”), [1] the Minister also allocated to him another third of this interest income, the share from a trust (“Fiducie Catherine”) set up for the benefit of Catherine Ledoux, Mr. Ledoux’s minor daughter.

In making these assessments the Minister relied among other things on the facts set out in Paragraph 19 of the Reply to the Notice of Appeal. That paragraph reads as follows:

[TRANSLATION]

19. In making the reassessments for the appellant’s 1987 and 1988 taxation years the Minister of National Revenue assumed among other things the following facts:

(a) since the start of the 1980s the appellant has worked in the real estate field full time;

(b) on March 2, 1987 the appellant by himself made an offer, accepted the same day, to purchase immovable property located at 190 Dorchester sud in Quebec for $2,850,000;

(c) the financing obtained by the appellant to purchase the said immovable property came entirely from external sources;

(d) on March 18, 1987 the appellant by himself accepted an offer made on the same day by Réal Faucher and a group of people, in which he agreed to resell 190 Dorchester sud in Québec for $3,450,000;

(e) in order to evade the obligation to pay tax on the substantial profit he had made in barely two weeks on the disposal of his right in the immovable property located at 190 Dorchester sud the appellant worked out an elaborate series of transactions involving the purchase and resale of the property in question through a limited partnership;

(f) the purpose of this series of transactions was to enable the appellant, first, to transform a profit which was actually business income into a capital gain (through the purchase and resale of shares in a limited partnership), and secondly, to split this income with people with whom he was not dealing at arm’s length (here, trusts in the names of his wife and two children as well as a limited partnership in which the partners were himself and the trusts for his two children);

(g) the appellant acquired a right in the immovable property located at 190 Dorchester sud in Québec for the purpose of reselling it at a profit, or at the very least the opportunity of reselling at a profit was one of the chief factors leading the appellant to purchase this right;

(h) the appellant did not show that he had acquired a right in this property for long-term investment purposes;

(i) further, it was the appellant by himself who purchased and resold his rights in the immovable property on March 2 and 18, 1987, only involving the other entities, consisting of members of his family, on April 29, 1987, once the gist of the transaction was complete;

(j) the profit made by the appellant on disposing of his right in the aforementioned immovable property, totalling $535,000,000 [sic], was therefore entirely allocatable and taxable in full into his hands for the 1987 taxation year;

(k) for the 1988 taxation year Douxel, a limited partnership (in which the partners were the appellant, Fiducie Catherine Ledoux and Fiducie Jean-Sébastien Ledoux, with one-third each), claimed a deduction of $37,500 as professional fees;

(l) despite the requests made to the appellant by the Minister he did not file appropriate documents that supported the existence and reasonableness of this expenditure;

(m) the refusal to allow this expenditure had the effect of increasing the income of Douxel, a limited partnership, for its 1988 taxation year by $19,805, two-thirds of which, $13,203, was allocated to the appellant (his share plus that of Fiducie Catherine Ledoux, the beneficiary of this trust being at that time the appellant’s minor daughter).

Facts

Mr. Ledoux is a mathematician who retired as a CEGEP teacher in the early 19805. He apparently wished to spend more time with his children. In order to provide for their financial security he set up a trust on October 22, 1982 for each of them: Fiducie Catherine for his daughter Catherine, born on April 24, 1976, and another (“Fiducie Jean-Sébastien”) for his son Jean- Sébastien, born on March 20, 1970. Under the terms of Fiducie Catherine the trustee was entirely free to accumulate or distribute the income of the trust until the date the trust was liquidated, which was to be the year 2003 at the latest. Furthermore, the trustee was not required to elect a “preferred beneficiary” as specified in s. 104(14) et seq. of the Act.

Mr. Ledoux’s main activity between 1980 and 1987 appears to have been connected with real estate. First, he transformed and improved the family home. Having sold it at a profit, he bought another. In 1982 Mr. Ledoux purchased an eight-apartment building which he renovated and resold six or eight months later, thus making a profit of some $20,000. In 1983 he did the same thing again, but this time purchased the property in the names of the two trusts for his children, Fiducie Catherine and Fiducie Jean-Sébastien (“the children’s trusts”). The latter resold the property a short time afterwards and also made a profit of some $20,000. In 1985 Mr. Ledoux purchased a small six-apartment building which he resold about 18 months later, making a profit of some $24,000.

In early 1987 Mr. Ledoux became interested in purchasing a building known as Édifice du Parc (“Édifice du Parc”) located at 190-192 Rue Dorchester sud in Québec and owned by Enrico Inc. (“Enrico”). This building contained 26 apartments as well as premises leased to merchants and the federal government. On February 24, 1987, through the real estate broker Century 21 - Citadelle Limitée (“Century 21”), Mr. Ledoux made a written offer of $2,900,000 to purchase Édifice du Parc. On this offer Mr. Ledoux’s name was followed by the notation “in trust”. The offer specified a selling price balance of $200,000.

On March 2, 1987 Mr. Ledoux made a new purchase offer in writing through Gisèle Darveau, a Century 21 salesperson-agent (“the March 2 offer”) for $2,850,000, without any selling price balance, and Enrico accepted it the same day. The same notation “in trust” appeared. The date for possession and occupancy was set at March 20, 1987. Among the conditions for this offer one had to do with obtaining financing in the order of $2,422,500. The offer stipulated that if Mr. Ledoux was unable to obtain such financing his purchase offer [TRANSLATION] “will become null and void”. In that event Enrico would repay the $10,000 downpayment accompanying the offer. In an addendum dated March 2, 1987 it was also stipulated that the purchase offer was conditional on a visit to the premises and that Enrico was released from its obligations to Les Investissements James Inc. and the company 2413-9941 Québec Inc. On a copy of the addendum, Mr. Ledoux stated he had visited the premises and was entirely satisfied with them.

By a further addendum dated March 12, 1987 the seller stated that it was released from its obligations to Les Investissements James Inc. and/or the company 2413-9941 Québec Inc. The date of possession and occupancy was put off to April 1, 1987. A notary, Gilles Naud, was instructed to draw up the purchase contract. It was the same notary who had drawn up the children’s trust deeds.

On March 18, 1987 Mr. Ledoux accepted a purchase offer of $3,450,000 for Édifice du Parc (“the March 18 offer”) made by Réal Faucher on behalf of a group of investors (the “Groupe Faucher”). During his examination Mr. Naud, who said he was a financial consultant, admitted he had put Réal Faucher in touch with Mr. Ledoux. At the time Mr. Faucher was an employee of the Minister, and was thinking about leaving his job and getting into business. He also had interests in a company, Gest-O-Blocs Inc., operating a real estate management business. In early 1987 Mr. Faucher was looking for a large building whose income could support the cost of Gest- O-Blocs fees. According to Mr. Faucher, Mr. Naud told him he knew someone who had such a building for sale. He assumed it was Mr. Ledoux. He confirmed that he met with Mr. Ledoux in February 1987 during the Québec Carnival period. At that meeting Mr. Faucher indicated his interest in purchasing a large building; however, Mr. Ledoux did not specify what building he might be able to sell him.

According to Mr. Ledoux’s version, this meeting actually took place after the acceptance of his purchase offer of March 2, 1987, and further, he said he told Mr. Faucher that Édifice du Parc was not for sale. At the meeting with Mr. Faucher it was very cold but Mr. Ledoux did not recall whether it was Carnival time. Mr. Naud was somewhat evasive as to the date he introduced Mr. Faucher to Mr. Ledoux. The meeting might have taken place before or after March 2, 1987. However, Mr. Faucher’s and Mr. Ledoux’s testimony agreed on the fact that Mr. Ledoux went to Montréal on March 18 to meet with Mr. Faucher, who then made him the offer of March 18.

This offer was made by Messrs. Marcel Champagne, Réal Faucher et al. It contained the usual clause subjecting the offer to financing being obtained in this case in the amount of $2,700,000. The said offer stipulated a selling price balance of $650,000, $350,000 of which was payable on May 25, 1987 and $300,000 payable over a five-year period at an interest rate of 10 percent. The offer was also conditional on a visit to the premises, examination of leases and review of financial statements. The deed of sale was to be signed before the notary Naud on April 1, 1987 at the latest, the same date, according to the terms of the offer of March 2, as that on which Mr. Ledoux was to take possession of Édifice du Parc. Mr. Ledoux accepted this offer by Messrs. Faucher and Champagne without any notation that he was acting “in trust”.

Mr. Ledoux asked Mr. Naud to plan the purchase and sale of the immovable property. He suggested a complicated arrangement which Mr. Ledoux described in his own words as [TRANSLATION] “a series of tax stratagems”. A document titled [TRANSLATION] “sequence of actions” (“the sequence”) described the series of transactions (Exhibit A-3).

When Mr. Faucher showed up to sign Édifice du Parc purchase deed, the arrangement worked out by Mr. Naud with the help of a colleague of his, a tax expert, was explained to Mr. Fauther for the first time. When this meeting ended in the early hours of the morning, the parties were still without an agreement. Mr. Faucher felt ill at ease with this arrangement, which he considered presented him with ethical problems. He did not want his involvement in this series of transactions to embarrass his employer and cause him problems. Other members of his group also held positions with the federal Public Service and Mr. Faucher did not want to expose them to the same type of problem. Shortly after this meeting, Mr. Faucher obtained the opinion of a tax lawyer in Montréal and this apparently reassured him. That opinion was not filed at the hearing.

Although the evidence as to this series of transactions undertaken to carry out the sale was unfortunately limited, the testimony and the documents filed at the hearing disclosed the following. On April 10, 1987 three limited partnerships were formed when their declarations were filed in the Superior Court of Quebec. They were Douxel, in which Gestion immobilière André Ledoux Inc. was the general partner, “Les Investissements du Parc, société en commandite” (“Investissements SEC”), in which the general partner was 2431-8206 Québec Inc. (“8206”), a limited company created on April 7, 1987, and “Édifice le 190, Dorchester sud, société en commandite” (“Édifice SEC”), in which the general partner was also 8206.

It was Marcel Champagne who signed Édifice SEC limited partnership declaration for 8206. That declaration stated that the initial special partner was Mr. Ledoux, who made a contribution of $100 [TRANSLATION] “on or about February 1, 1987” (Exhibit A-4). As indicated in a notarial deed (Exhibit A-7) of June 17, 1987 (“the June 17 deed”) drawn up by Josée Perreault of the same firm as Mr. Naud, Mr. Ledoux subscribed to 100 Class B shares in Édifice SEC on April 10, 1987 and paid for them on or about April 21, 1987. The agreement for this limited partnership was notarized before the notary Mr. Naud on April 28, 1987. The sequence described Mr. Ledoux’s subscription and the signature of the agreement for this limited partnership as being stage 1.

According to the facts assumed in the amended Reply to the Notice of Appeal, which were not contradicted, the three special partners in Douxel with equal shares were Mr. Ledoux (who according to the sequence subscribed for his shares in stage 2), Fiducie Catherine and Fiducie Jean-Sébastien (who allegedly subscribed for theirs in stage 4).

The Investissements SEC limited partnership agreement was signed on April 15 and 17, 1987 by 8206 and 22 special partners, namely the members of Groupe Faucher, including Marcel Champagne, Réal Faucher and the initial special partner, Claude Fortin.

On April 29, 1987 Fiducie Geneviève, a trust set up on April 6, 1987 for the benefit of Mr. Ledoux’s wife, the children’s trusts and Douxel each acquired 100 Class B shares in Édifice SEC for $100 (stage 3 of the sequence).

Eighteen members of Groupe Faucher subscribed for shares in Investissements SEC in the amount of $360,000 (stage 5 of the sequence). Investissements SEC subscribed for shares in Édifice SEC in the amount of $360,000 (stage 6 of the sequence). Twenty-two members of Groupe Faucher borrowed the sum of $2,000,000 from the National Bank to finance in part the subscription by Investissements SEC for additional shares in Édifice SEC (stages 8, 9, 10, 11 and 16). Mr. Naud explained why this loan was made by the members of Groupe Faucher and not by Édifice SEC, which would be purchasing Édifice du Parc. This arrangement meant that the interest would be deductible by them, so that Édifice SEC would have more income and thus would maximize the amount of the capital cost allowance which the company could claim. At stage 12 of the sequence, Gisèle Darveau also subscribed $100 for shares in Édifice SEC.

By a notarial deed (“the deed of sale”) dated May 2, 1987 Enrico sold Édifice du Parc to Édifice SEC for $3,454,414, paid by 3,454,414 Class B shares in Édifice SEC, having a paid-up capital of $1 each (stage 17 of the sequence). According to the deed of sale this amount represented the fair market value of this property “on or about March 18, 1987”, the same date as that of the offer of March 18, and the parties agreed to make a tax election with an “agreed amount” corresponding to this value.

At stage 18 of the sequence, Édifice SEC distributed $100,100 to each of Fiducie Geneviève, Fiducie Catherine and Fiducie Jean-Sébastien, $80,100 to Mr. Ledoux and $55,100 to Gisèle Darveau. At stage 19 these three trusts each loaned Douxel $100,000. At stage 24 of the sequence, Édifice SEC distributed $1,955,700 to Douxel and at stage 29 $1,000,000. These distributions were described in the sequence as [TRANSLATION] “deductions”.

On May 4, 1987 Enrico sold to Douxel, represented by its general partner, Gestion Immobilière André Ledoux Inc., the 3,454,414 Class B shares in Édifice SEC for $2,800,000, an amount which Enrico admitted receiving through the trust account of the notary Naud (stages 31 and 32 of the sequence).

According to the deed of June 17 Fiducie Geneviève, Fiducie Catherine, Fiducie Jean-Sébastien and Mr. Ledoux each had on June 17, 1987 100 Class B shares in Édifice SEC, while Douxel had 3,454,714. [2] Under that deed all these holders (“Groupe Ledoux”) sold all their shares to 2170-1495 Québec Inc. (“2170”), represented by Claude Fortin [3] , for a total consideration of $5, that is $1 each. These operations appear in stages 38 to 42; however, the purchaser is described there as “Investissements [SEC]”.

The Minister’s auditor explained the basis of his assessment in his testimony. Fiducie Catherine, Fiducie Jean-Sébastien and Fiducie Geneviève had each reported a capital gain of $100,001. This gain was made on the sale to 2170 for $1. All of the gain (except for $1) resulted from the fact that at the time of this sale there was a negative adjusted cost base (“ACB”) of $100,000 resulting from the distribution made by Édifice SEC. In Mr. Ledoux’s case, the amount of the distribution was $80,000 and he reported a capital gain of $80,001. Finally, Douxel reported a capital gain of $155,601. This figure represented the total of two amounts, namely the gain of $1 made on the sale of 3,454,714 shares to 2170 and the negative ACB of $155,600 [100 - 1,955,700 - 1,000,000 + 2,800,000] [4] on these shares. The total capital gains reported by members of Groupe Ledoux thus represents the sum of $535,605 [(3 x 100,001) + 80,001 + 155,601] and the auditor added this amount as actually being business income made by Mr. Ledoux when the latter disposed of his rights in Edifice du Parc to Groupe Faucher on March 18, 1987.

Additionally, the auditor disallowed an expenditure of $37,500 as fees in calculating Douxel’s income, as there was no supporting documentation. As Douxel had income of $175,444, $155,601 of which had already been added to Mr. Ledoux’s income, all that remained was interest income of $19,843 and an expenditure of $38, resulting in a net income of $19,805. The auditor increased Mr. Ledoux’s income by $12,601.50, half of which was his share as holder of one-third of the shares in Douxel and the other half, in accordance with the rule of allocation set out in s. 74.1(2) of the Act, the share of Fiducie Catherine whose beneficiary, Catherine, was a minor at the time. However, the auditor was unable to say at the hearing exactly what the source of the interest reported by Douxel was.

On or about June 17, 1987, by a deed signed before Gilles Naud, Douxel loaned 21 of the members of Groupe Faucher the sum of $250,000, repayable on May 1, 1992, at 10 percent interest, and Édifice SEC apparently stood surety for this loan. On September 30, 1991 Douxel brought an action in the Quebec Superior Court against 16 of these borrowers to obtain repayment of the loan. In that action it was alleged that all the interest had been paid up to the date of the proceeding but that Édifice SEC had allowed a 60- day notice to be registered against it and had turned over administration of Édifice du Parc to the second mortgage creditor. Moreover, Édifice SEC had failed to pay municipal taxes for 1991 on time and five of the 21 borrowers had declared bankruptcy. Mr. Ledoux indicated that Douxel could never have obtained repayment of its $250,000 loan because all the other debtors were also bankrupt.

Analysis

Nature of gain

The first point to be decided is the nature of the gain made by Mr. Ledoux in the series of transactions involving the purchase and sale of Édifice du Parc. I consider that the proposed purchase of this property was part of a business of buying and selling immovable property in which Mr. Ledoux was engaged. Since 1982 he had bought and resold property which he had renovated and resold at a profit in a short time. Between 1982 and 1985 Mr. Ledoux, personally or through the children’s trusts, had bought three rental buildings which he had resold at a profit a few months later. In my opinion, Mr. Ledoux’s activities indicated that he was a businessman who bought, developed and resold immovable property at a profit.

In 1987, when he made the offer to purchase Édifice du Parc, Mr. Ledoux said he had no intention of reselling it: the reason he sold it was the very attractive offer made by Groupe Faucher. In my view, this statement by Mr. Ledoux cannot be reconciled with his conduct both before and after March 2, 1987.

To begin with, there is the testimony of Mr. Faucher, who said he met with Mr. Ledoux in February 1987 at the time of the Québec Carnival. According to this testimony Mr. Ledoux already had a buyer interested even before he made his purchase offer of March 2, 1987. Mr. Naud’s testimony was not specific enough to corroborate Mr. Ledoux’s argument. Furthermore, it was not inconsistent with Mr. Faucher’s testimony, when he said he met with Mr. Ledoux before March 2, 1987. Mr. Faucher’s testimony seems to the Court to be more credible than that of Mr. Ledoux, because the former had no interest in the outcome of the appeal. Additionally, the cross- examination by Mr. Ledoux’s counsel did not weaken the credibility of Mr. Faucher. Finally, there is the statement in Édifice SEC limited partnership declaration which places Mr. Ledoux’s initial investment in that partnership at around February 1, 1987. No explanation as to why this date precedes the offer of March 2, 1987 was given in testimony.

There were other points corroborating the fact that Mr. Ledoux was engaged in a business buying and selling immovable property, or at the very least in an adventure or concern in the nature of trade. First, Mr. Ledoux never held Édifice du Parc which he said he had bought as an investment. Barely two weeks after obtaining Enrico’s promise to sell him this building, Mr. Ledoux went to Montréal (a conduct which was surprising to say the least for someone who claimed he did not want to sell) and agreed to resell at a profit. This was an even shorter period of time than that in which he had made his sales between 1982 and 1987.

Neither did the evidence reveal that Mr. Ledoux had sufficient financial resources to purchase and hold this $2,850,000 property over the long term. In particular, the sum of $417,500 had to be paid in addition to the down payment which he had made and the amount of the loan secured by a first mortgage which he hoped to obtain.

Finally, why did Mr. Ledoux become involved in such a complicated series of operations? Mr. Ledoux himself described these operations as [TRANSLATION] “tax stratagems”. It is clear that their purpose was in part to conceal the business income he apparently made on selling Édifice du Parc. He tried to convert this income into a capital gain by substituting his shares in Édifice SEC for his rights in Edifice du Parc (“right to purchase”) and proceeding by deductions rather than by a straightforward sale.

Even if we were to accept that Mr. Ledoux intended to retain this property, and I am not inclined to do that, the possibility of reselling at a profit was certainly one of the primary factors leading him to purchase it. In making his assessment the Minister assumed that a “secondary intent” existed when the building was purchased and Mr. Ledoux was not able to show on a balance of probabilities that such an intent did not exist at that time. In conclusion, Mr. Ledoux made an offer to purchase Édifice du Parc and transferred his right to purchase this building in the ordinary course of his operations, or at the very least as part of an adventure or concern in the nature of trade.

Sham

The Minister’s auditor found that Mr. Ledoux had made his business income of $535,605 on March 18, 1987 when he accepted Groupe Faucher’s offer of $3,450,000. I do not think that the facts in evidence at the hearing support this determination by the Minister. There was no disposition of property on March 18, 1987. According to the terms of the offer of March 18, on that date all that Mr. Ledoux did was to promise to sell Édifice du Parc to Groupe Faucher for $3,450,000. He undertook to transfer the ownership title on April 1, 1987.

Neither was the purpose of this offer of March 18 to transfer to Groupe Faucher the right to purchase which Mr. Ledoux had acquired from Enrico through the offer of March 2. The evidence disclosed that Mr. Faucher did not know on that date that the sale would be made through Édifice SEC, and in my opinion, Groupe Faucher acquired no right from Mr. Ledoux on that date.

Must the Court therefore conclude that the assessment was ill-founded and allow Mr. Ledoux’s appeal? The appellant maintained that on June 17, 1987 he and the other members of Groupe Ledoux made a capital gain on the disposition of their shares in Édifice SEC to 2170. He contended that this gain should be calculated in accordance with the provisions of s. 100(2) of the Act, which in 1987 read as follows:

100.(2) Gain from disposition of interest in partnership. In computing a taxpayer’s gain for a taxation year from the disposition of an interest in a partnership, there shall be included, in addition to the amount thereof determined under subsection 40(1), the amount, if any, by which

(a) all amounts required by subsection 53(2) to be deducted in computing the adjusted cost base to the taxpayer, immediately before the disposition, of the interest in the partnership,

exceeds

(b) the aggregate of

(i) the cost to the taxpayer of the interest in the partnership determined for the purpose of computing the adjusted cost base to him of that interest at that time, and

(ii) all amounts required by subsection 53(1) to be added to the cost to him of that interest in computing the adjusted cost base to him of that interest at that time.

Before deciding whether this argument is valid, it is worth recalling the approach that must guide the Court in this undertaking. When taxpayers have engaged in transactions the primary purpose of which is to obtain tax benefits, the courts must be especially diligent in ensuring that those transactions correspond to the taxpayer’s true intent and also that they are legally valid and complete transactions. The courts have developed several judicial tools to help them in this undertaking, in particular the concept of the sham, the ineffective operation and the actual nature of a transaction. In Stubart Investments Ltd. v. R., [1984] 1 S.C.R. 536 (S.C.C.), at 545, Estey J. proposed the following definition of a sham:

à transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a facade of reality quite different from the disguised reality.

Application of the second tool is relatively straightforward. The Court must minutely scrutinize whether the transaction used by the taxpayer, such as a contract, is a real transaction from the standpoint of formal as well as substantive conditions. Urie J. gave a good description of the application of this tool in Atinco Paper Products Ltd. v. R. (1978), 78 D.T.C. 6387 (Fed. C.A.), at 6395:

It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is correct inform, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other Court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carrying out its judicial duties, but in its duty to the public at large.

[My emphasis.]

Stubart provides an illustration of this duty of the courts: in that case the taxpayer met the standard. In Atinco, however, the taxpayers were not so successful.

The third tool, the concept of the actual nature of the transactions, has prompted and continues to prompt problems of application. According to that theory, in assessing a transaction the courts must look at the commercial and economic reality of the transaction. In Bronfman Trust v. R., [1987] 1 S.C.R. 32 (S.C.C.), at 53, Dickson C.J. said:

Assessment of taxpayers’ transactions with an eye to commercial and economic realities, rather than juristic classification of form, may help to avoid the inequity of tax liability being dependent upon the taxpayer’s sophistication at manipulating a sequence of events to achieve a patina of compliance with the apparent prerequisites for a tax deduction.

There are those who think, and I agree with them, that this approach does not mean the courts may disregard the legal consequences of a transac- tion. In Continental Bank of Canada v. R. (1994), 94 D.T.C. 1858 (T.C.C.), at 1869, Judge Bowman clarified the meaning of this principle as follows: [5]

So far as the broader question of substance versus form is concerned, we should at least be clear on what we are talking about when we use the elusive expression “substance over form”. Cartwright, J. (as he then was) said in Dominion Taxicab Assn. v. M.N.R., 54 DTC 1020 at p. 1021 :

It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Acts [sic] its substance rather than its form is to be regarded.

His Lordship did not elaborate but in light of other authorities / do not think that his words can be taken to mean that the legal effect of a transaction is irrelevant or that one is entitled to treat substance as synonymous with economic effect. The true meaning of the expression is, I believe, found in the judgment of Christie, A.C.J.T.C.C. in Purdy v. M.N.R., 85 DTC 254 at p. 256, where he said:

It must be borne in mind that in deciding questions pertaining to liability for income tax the manner in which parties to transactions choose to label them does not necessarily govern. What must be done is to determine what on the evidence is the substance or true character of the transaction and render judgment accordingly.

[My emphasis.]

It is quite clear from reading all these comments that at the very least the courts have some room for manoeuvre in assessing the legal consequences of an agreement between two parties.

Let us apply this approach to the facts of this appeal.

Enrico never sold Édifice du Parc to Mr. Ledoux. According to the deed of sale it actually sold the building to Édifice SEC on May 2, 1987. There was nothing in the Reply to the Notice of Appeal or in the evidence submitted at the hearing to indicate that Édifice SEC was not a duly created limited partnership. That partnership appears to have held and operated Édifice du Parc for several years for the benefit of Investissements SEC and ultimately Groupe Faucher. Moreover, nothing allows the Court to conclude that the transfer by Enrico to Édifice SEC was a sham as such.

However, did the $3,454,414 price mentioned in the deed of sale correspond to the actual price agreed on by the parties? Were the moneys distributed to members of Groupe Ledoux actually “deductions”, as Mr. Ledoux claimed? Two days after acquiring the 3,454,414 Class B shares Enrico resold them to Douxel for $2,800,000, that is almost exactly the amount agreed on in the offer of March 2 for the sale of Édifice du Parc. A few days later Douxel in turn resold all its shares to 2270, including the 3,454,414 shares bought for $2,800,000, for the sum of $1! What explanation can there be for the value of these 3,454,414 shares falling so dramatically in the space of a few days: first from $3,454,414 to $2,800,000 and then to less than $1 ? A deduction in favour of Enrico after the sale of May 2, 1987 might have explained the first decrease. However, Enrico received no deduction. Deductions amounting to $2,955,700 in favour of Douxel could have explained the second decrease. However, they occurred before Douxel acquired the 3,454,414 shares from Enrico. There was no other special fact, such as the precarious financial position of Édifice SEC or of the members of Groupe Ledoux to explain why these shares lost their economic value.

How are we to explain the fact that shortly before the purchase of May 4, 1987 Douxel received “deductions” from Édifice SEC totalling $2,955,700 after having invested only $100 on April 29, 1987? The same question arises with respect to the “deductions” received by the other members of Groupe Ledoux, who together received $380,400 in a very short time after investing only $400 in Édifice SEC. Like Douxel, they too each resold their Class B shares to 2270 for $1.

How are we to explain the fact that members of Groupe Ledoux received large “deductions” about a week after subscribing for their shares while the largest special partner, Investissements SEC, received nothing? How are we to explain the fact that members of Groupe Ledoux received “deductions” in various amounts though they had each invested $100 in Édifice SEC? — each trust received $100,100, Mr. Ledoux $80,100 and Douxel $2,955,700. How are we to explain the fact that each member of Groupe Ledoux received the same consideration for the sale of its shares to 2170 although none of them held the same number of shares?

It appears from the facts as a whole that the price mentioned in the deed of sale did not represent the actual price of the sale by Enrico of Édifice du Parc and that the distributions made by Édifice SEC to members of Groupe Ledoux were not actually deductions.

As Mr. Ledoux himself admitted, these transactions were [TRANSLATION] “tax stratagems” adopted so he could claim that he was making a capital gain in disposing of his right to purchase. “Artifice” [stratagem] is defined in the Petit Robert as [TRANSLATION] “clever misleading device to disguise the truth, artfulness”. The consideration of 3,454,414 Class B shares with a paid-up capital of $1 each mentioned in the contract of sale was not really the consideration to which Enrico was entitled. The real consideration was the sum of $2,800,000 which it received two days later through Douxel. The real purpose of the payment of this amount by Douxel was not to acquire the 3,454,414 Class B shares, since it transferred them a few days later for less than $1. Instead, it was to pay on behalf of Édifice SEC the price owed to Enrico for Édifice du Parc in accordance with the terms of the offer of March 2.

In the Petit Robert a “prélèvement” [deduction] is described as an [TRANSLATION] “asset which someone who is co-owner of certain possessions takes before division”. Did the money paid to Groupe Ledoux really represent a deduction or was it instead simply a distribution of part of the assets of Édifice SEC? Setting aside the Douxel case, I think we are dealing here with two separate amounts. The first represents the repayment of the investment of $100. The second, the remainder, is nothing more than the consideration given by Édifice SEC to acquire from Mr. Ledoux his purchase option, namely the right to receive from Enrico a transfer of ownership of Édifice du Parc, a right which Mr. Ledoux acquired under the offer of March 2 and which he clearly transferred to Édifice SEC when Édifice SEC was created. For example, the sum of $80,100 paid to Mr. Ledoux represented a repayment of $100 of the subscription made by Mr. Ledoux on April 10, 1987, according to the deed of June 17, and the remainder, $80,000, represented part of the consideration Édifice SEC owed Mr. Ledoux for acquiring the purchase option. The same analysis applies to money paid to the trusts for the children and to Fiducie Geneviève as “deductions”.

In the case of Douxel we are actually dealing with three amounts. Of the sum of $2,955,700 delivered to it by Édifice SEC, $100 represented repayment of the subscription of April 29, 1987, $2,800,000 represented the amount owed by Édifice SEC to Enrico for Édifice du Parc, and the remainder, $155,600, represented the consideration owed to Mr. Ledoux for his purchase option.

If Mr. Ledoux had first purchased Édifice du Parc on May 4, 1987 and later resold it to Édifice SEC, he would have made a profit of $535,685. [6] Instead, Mr. Ledoux, with the assistance of Enrico, Groupe Faucher and Century 21, arranged for the sale to take place directly between Enrico and Édifice SEC. As a matter of form, the purchaser was no longer the same. From an economic standpoint, however, the result remained the same. Once the series of transactions had been completed, Enrico received only $2,800,000.

What is still more important is the fact that, thanks to the distributions made by Édifice SEC, Groupe Ledoux made the same profit as Mr. Ledoux would have made if he had himself resold Édifice du Parc. It was clearly apparent from the evidence as a whole that the deductions paid by Édifice SEC in addition to the paid-up capital and amount owed to Enrico were actually only an indirect means of paying what Édifice SEC owed Mr. Ledoux for acquiring Édifice du Parc.

Mr. Ledoux’s counsel emphasized that the Minister could not base his assessment on the two offers of March 2 and March 18, 1987 because, in his submission, they had no legal validity at the time of the transfer of the property to Édifice SEC on May 2, 1987. As he pointed out, some of the conditions had not been met. I cannot share this view of counsel. There is no evidence that the offers were cancelled through application of certain of the conditions specified. For example, the offer of March 2 stipulated that Enrico would be released from its commitments to Investissements James Inc. and/or the company 2413-9941 Québec Inc. In the addendum of March 12, 1987 Enrico said it was released. The offer stipulated that it was conditional on Mr. Ledoux visiting the immovable property, and in the addendum of March 2, 1987 he said he was satisfied with it. As regards the condition that Mr. Ledoux be able to obtain the necessary financing to complete the transaction, there was no evidence he was unable to do so, that he told Enrico of this, that the contract was cancelled as a result of this failure and that the $10,000 down payment was returned to Mr. Ledoux by Enrico. As to the condition regarding the date of signature of the purchase deed, the offer did not stipulate that this condition would terminate the contract if it was not met.

There are other points which support my conclusion. If an agreement between Mr. Ledoux and Enrico on the one hand and Mr. Ledoux and Groupe Faucher on the other no longer existed, how did Enrico obtain $2,800,000, virtually the amount specified in the offer of March 2, 1987, how did Groupe Faucher pay the sum of $3,450,000 specified in the offer of March 18, 1987 through Édifice SEC (actually $3,454,414, the difference being due to normal adjustments in a purchase) and how was it that Mr. Ledoux and members of his family received within a few days, by the alleged capital deductions, the profit which Mr. Ledoux would have made if he had purchased the ownership title for Édifice du Parc and had disposed of it to Groupe Faucher? It is worth noting that the deed of sale dated May 2 stipulated that the fair market value of Édifice du Parc was $3,454,414 at “March 18, 1987”, the date of the March 18 offer.

The only conclusion that must inevitably be drawn here is that Mr. Ledoux transferred his purchase option to Édifice SEC and that that company paid the value of that option, namely $535,605, to persons designated by Mr. Ledoux. How does one explain the fact that Édifice SEC distributed such large amounts, for such a small investment, to Fiducie Geneviève and the children’s trusts and to Douxel, controlled by Mr. Ledoux’s family? It must be borne in mind that not all the special partners of Édifice SEC benefited from the deductions.

Another sign that the March 2 offer was still in effect is the fact that the broker through whom Mr. Ledoux was to acquire the immovable property participated in the series of transactions relating to sale of the property to Édifice SEC. The sequence disclosed in stage 33 that the sum of $129,500 was paid to Century 21 in payment of a bill of $139,500, and as I have already mentioned there was a deduction for Gisèle Darveau, who received $55,100 in exchange for a subscription of $100 by her (stages 12.2, 18.5 and 33). As Mr. Ledoux indicated that he had not used the services of a broker to find a purchaser for Édifice du Parc, this commission cannot be due to any obligation on the part of Mr. Ledoux. The evidence also disclosed that, with regard to the March 18 offer, it was Mr. Naud who intro-

duced Groupe Faucher to Mr. Ledoux: there is thus nothing to indicate that Century 21 was entitled to any commission on the transfer by Enrico to Édifice SEC. The most probable explanation is that Century 21 received the commission Enrico would have paid it if Enrico had made the sale directly to Mr. Ledoux.

If Mr. Ledoux had not transferred his purchase option to Édifice SEC, why would the latter have distributed to Groupe Ledoux without compensation the sum of $535,605 over and above that group’s investment, when Édifice SEC was under the control of Groupe Faucher? It was a completely new partnership which had not yet made any profits or surpluses part of which could have belonged to Groupe Ledoux. The most likely explanation is that Mr. Ledoux transferred his purchase option to that partnership.

Splitting of business income

The next question to be answered is whether Mr. Ledoux has to include in his income all the profit made in this series of transactions, namely $535,605, or whether that amount can be distributed between the members of his family in the manner adopted by Mr. Ledoux. In his testimony Mr. Ledoux admitted that when he drew up the March 2 offer with the notation “in trust”, he did so on the advice of Mr. Naud that such a notation should always be included in any offer to purchase immovable property. However, he also admitted that in making this offer he did not know on whose behalf he was acting. This was only determined through a plan made by Mr. Naud. Further, when Mr. Ledoux accepted Groupe Faucher’s offer no mention was made that Mr. Ledoux was acting for other taxpayers. Accordingly, the Court was not persuaded that Mr. Ledoux was acting for the children’s trusts, Fiducie Geneviève and Douxel when he acquired his rights to Édifice du Parc.

In Quebec law, the notation “in trust” does not mean that a person is acting as trustee. In 1987 a trust could only exist if there had been an inter vivos gift or a legacy. [7] This “in trust” notation actually indicates, in my opinion, that a person is acting as the mandatary for a mandator under a mandate. The evidence did not disclose that such a mandate existed when Mr. Ledoux acquired his rights under the March 2 purchase offer. He was therefore acting for himself and the profit made on the sale of his purchase option to Édifice SEC belonged to him. Neither did the evidence disclose that he had transferred part of his purchase option to other members of Groupe Ledoux. If such a transfer had been made, either by a gift or by a sale at a price below the fair market value, Mr. Ledoux would under s. 69 of the Act be deemed to have received an amount equal to the fair market value.

The evidence disclosed that it was Mr. Ledoux who operated the business and that it was due to his own efforts that he was able to make the gain by reselling his purchase option on Édifice du Parc to Groupe Faucher. Here, the Court was not persuaded that Mr. Ledoux was acting for the members of his family when he made the March 2 offer. The fact that part of the amount owed to Mr. Ledoux was paid to members of his family or to Douxel does not alter the fact that the amount was earned by him and that he must include it in his income. There is also, if necessary, s. 56(2) of the Act, to the same effect, which provides:

56.(2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person ... shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

$37,500 expense

In my opinion, Mr. Ledoux did not succeed in showing on a balance of probabilities that Douxel incurred expenditures of $37,500 during its 1988 fiscal year. He was unable to show exactly how this amount was spent or why it was spent. The Minister’s auditor asked him several months before the hearing of these appeals to provide evidence on these points. When he appeared at the hearing, Mr. Ledoux had no more specific information to give the Court. The gross profit he made on the resale of Édifice du Parc was $600,000. [8] It is quite possible that the expenditure in question was taken into account in the amount of moneys distributed to Groupe Ledoux and so in computing the gain of $535,605 reported by that group. By allowing such an expenditure to be deducted, the result might be that Mr. Ledoux would benefit from the same expenditure twice.

Allocation of interest income

There remains the question of the allocation in Mr. Ledoux’s income of the share of Douxel’s interest income accruing to Fiducie Catherine. In his testimony the Minister’s auditor was unable to identify the property from which Douxel had derived its income of $19,843. Moreover, in her Reply to the Notice of Appeal the respondent did not give sufficient facts to support application of s. 74.1(2) of the Act, which provides:

(2) Where an individual has transferred or loaned property, either directly or indirectly, by means of a trust or by any other means whatever, to or for the benefit of a person who was under 18 years of age and who

(a) does not deal with the individual at arm’s length, or

(b) is the niece or nephew of the individual, and

any income or loss, as the case may be, of that person for a taxation year from the property or from property substituted therefor, that relates to the period in the year throughout which the individual is resident in Canada, shall be deemed to be income or a loss, as the case may be, of the individual and not of that person unless that person has, before the end of the year, attained the age of 18 years.

Section 74.3(1 )(«) of the Act is also relevant for the purposes of these appeals:

(1)Where an individual has loaned or transferred property (in this section referred to as “loaned or transferred property”), either directly or indirectly, by means of a trust or by any other means whatever, to a trust in which another individual who is at any time a designated person in respect of the individual is beneficially interested at any time, the following rules apply:

(a) for the purposes of section 74.1, the income of the designated person for a taxation year from the property shall be deemed to be an amount equal to the lesser of

(i) the amount in respect of the trust that was included by virtue of paragraph 12( 1 )(m) in computing the income for the year of the designated person, and

(ii) that proportion of the amount that would be the income of the trust for the year from the property or from property substituted therefor if no deduction were made under subsections 104(6) or (12) that

(A) the amount determined under subparagraph (i) in respect of the designated person for the year

is of

(B) the aggregate of all amounts each of which is an amount determined under subparagraph (i) for the year in respect of the designated person or any other person who is throughout the year a designated person in respect of the individual...

[My emphasis.]

There is a high probability that the Douxel interest came from loans made out of the profit made on sale of the purchase option, and specifically the loan made by Douxel to Groupe Faucher. Moreover, counsel for Mr. Ledoux also recognized in his submissions that these Douxel assets [TRANSLATION] “were purchased from profits made by the three family trusts who made a loan to Douxel and from the profit made by Douxel on the sale of its shares in Édifice [SEC]”.

However, this fact is not sufficient here to support application of the rules of allocation described in ss. 74.1 et seq. For them to apply certain conditions must be met, in particular that the minor must have included in computing his or her income the income that falls under the allocation rule. When an individual transfers or loans property to a minor, s. 74.1(2) allocates to that individual the “income or loss ... of that person”. When an individual transfers or loans property to a trust one of the beneficiaries of which is a “designated person”, the allocated amount is deemed to correspond to the lesser of two amounts, one of which is the amount included in the income of the designated person (s. 74.3(1)(a)(i) of the Act). Accordingly, if no trust income was included in that of the designated person there is no income to allocate. If the trust was inter vivos the trust income would in any case be subject to a higher tax rate (s. 122 of the Act).

The evidence here did not disclose whether Catherine Ledoux included any part of the interest income earned by Douxel in her income. It was Fiducie Catherine, not Catherine, which received the alleged deduction of $100,100, $100,000 of which was loaned to Douxel. It was Fiducie Catherine, not Catherine, who was the Douxel special partner. Fiducie Catherine, holding one-third of the shares in that partnership, should have included in its income one-third of the interest income earned by Douxel. The trust deed stipulated that the trustee had complete freedom to accumulate the income or distribute it. It is thus possible that the Fiducie Catherine trustee did not distribute this income to Catherine. Neither was he required to make the election of a preferred beneficiary contemplated by s. 104(14) of the Act. It is thus possible that Catherine did not include this interest income in her income. On the evidence before the Court, there is no basis for applying the allocation rules.

$250,000 loss

Alternatively, in his Notice of Appeal Mr. Ledoux claimed a $250,000 deduction in computing his tax for 1987 or 1988. The evidence disclosed that Douxel had made a loan to members of Groupe Faucher so they could invest in Édifice SEC through Investissements SEC. It is possible Douxel was entitled to deduct a loss for the fiscal year in which its loan became a bad debt. However, there was nothing in the evidence to indicate that this loan became uncollectible during the 1987 and 1988 taxation years. On the contrary, it appeared that it was still a valid debt at September 30, 1991 since Mr. Ledoux’s counsel brought an action in the Superior Court on that date. It was not until later that Mr. Ledoux found that the debt was uncollectible because his debtors had gone bankrupt. As Mr. Ledoux’s appeals were limited to the 1987 and 1988 taxation years, this Court has no jurisdiction to deal with the loss resulting from that loan.

For these reasons, Mr. Ledoux’s appeal for the 1987 taxation year is dismissed and that for the 1988 taxation year allowed and the notice of assessment referred back to the Minister for reconsideration and reassessment on the basis that the interest income allocation rules do not apply. The respondent will be entitled to her costs.

Appeals allowed in part.