A Schiel Construction Ltd, H S Holdings LTD v. Minister of National Revenue, [1979] CTC 2426, 79 DTC 366

M J Bonner:—The appellants have each appealed from assessments made pursuant to directions under subsection 247(2) of the Income Tax Act that they be deemed to be associated for the 1973 and 1974 taxation years. The appeals were tried together on common evidence. The issue raised by each appeal is whether none of the main reasons for the separate existence of the two corporations is to reduce the amount of tax otherwise payable under the Income Tax Act. The issue is one of fact. The onus is on the appellants to establish that tax reduction is not one of the main reasons for their separate existence.

The older of the two companies is A Schiel Construction Ltd (hereinafter called “Oldco”). Adolph Schiel is now a land developer and contractor. He came to Canada from Germany in 1958. He worked as an employed painter for two years and then he started his own company. In 1961 he married Hilda Schiel. From the beginning Mrs Schiel assisted her husband in the business. She looked after the office work and accounting. In 1962 Mr Schiel started to build houses. In 1964 Oldco was incorporated. The house building activity continued to 1970. In 1968 Mr Schiel first bought some land. The land was subdivided in 1970. During the period from 1964 to 1971 Mrs Schiel was active in the business of Oldco. She ran the office, did the bookkeeping and assisted with the sale of housing built on speculation by Oldco.

Matrimonial problems developed at least as early as 1964 and became increasingly severe. Mr Schiel was apparently in the habit of assaulting his wife. He did so on a number of occasions over the years and once in 1971 he severely injured her.

In 1969 or 1970 Mr Schiel consulted his accountant, Mr Fee, with respect to the manner in which the matrimonial discord might impinge on his business affairs. Mr and Mrs Schiel each owned half of the shares of Oldco. Mr Schiel was concerned that if a contest over property arose as a result of separation or divorce the affairs of Oldco could be tied up for a lengthly period of time and that the bank, upon which the company was dependent for financing, might become reluctant to advance funds or even call existing loans. Mr Fee recommended that the assets of Mr and Mrs Schiel be separated.

Mrs Schiel’s reaction to the problems was a desire to be independent of her husband. She and her husband discussed separation and divorce as early as 1969. They have, however, remained together for the good of their children. In April of 1971 H S Holdings Ltd (hereinafter called “Newco”) was incorporated. All the issued shares were held by Mrs Schiel. On May 7, 1973, an agreement was executed between Mrs Schiel and Mr Schiel providing for the sale to Mr Schiel of his wife’s share in Oldco for $132,750, payable $12,500 in cash and the remainder by promissory note. This agreement was made sometime early in 1972 but was not formalized until one year later. The agreement was completed and the promissory note was delivered by Mr Schiel to his wife.

Mr and Mrs Schiel testified that they were unaware of any tax advantages flowing from the existence of a separate corporation. Walter Fee, who until the end of 1971 acted as accountant for Oldco, gave evidence which supported that of Mr and Mrs Schiel. He confirmed that Mr Schiel had discussed with him his concern about the difficulties of operating Oldco if a property dispute arose between Mr and Mrs Schiel. He confirmed as well that at the time he ceased to act for Oldco a decision, based on the matrimonial problems, had been made by Mr Schiel to “split up the company and separate the assets of husband and wife”. His evidence was that he did not advise Mr Schiel on details as to how this would be done, but rather left the matter to Mr Schiel’s legal advisors.

Evidence was also given by Alexander MacQuarrie, a solicitor who acted on the incorporation of Newco. He was, I felt, an entirely candid witness. His evidence clearly established that he did not discuss with either of the Schiels or Mr Fee any question of tax savings arising out of the separate existence of Oldco and Newco. He stated that he would not have been able to do so because he was not conversant with tax matters. Although he wrote a letter to Mr Schiel referring to compliance with taxation laws, his attention was directed to gift tax. He stated as well that although the Schiels did not discuss their matrimonial problems with him he had an impression that Mrs Schiel felt insecure and that she sought to have assets in her own name. Mr MacQuarrie never met with Mr Finlay, the man who succeeded Mr Fee as accountant for Oldco and acted in that capacity throughout most of 1972.

It was apparently during the period while Mr Finlay acted as accountant for Oldco that the plan to separate the affairs of Mr and Mrs Schiel assumed the form in which it was finally implemented. Mr Finlay sold his practice and ceased to act for the Schiel interests sometime toward the end of 1972. Mr Finlay subsequently departed from Canada and, unfortunately, he could not be found to give evidence.

It should be noted that the evidence of Mr and Mrs Schiel clearly established that the separate existence of Oldco and Newco had its genesis in their matrimonial problems. The evidence of Mr and Mrs Schiel was not inherently improbable and it was supported in large measure by the evidence of two of their professional advisors, the third being unavailable. On all of the evidence I have concluded that neither Mr nor Mrs Schiel was sufficiently astute in tax matters to select, from the mechanisms available for the separation of their affairs, the mechanism which would have the effect of producing the best tax result.

Although he pointed out that all witnesses called by the appellants could remember the one topic not discussed, tax, counsel for the respondent appeared to have concluded that at least Mr and Mrs Schiel were not aware of a potential tax saving in effecting the separation. In argument he submitted that sometimes agents and professional advisors create a situation for a taxpayer which that taxpayer must contend with. Put another way, it was his position that the mechanism ultimately chosen for the separation of the business interests of Mr and Mrs Schiel must have been chosen on the basis of tax considerations present in the mind of a professional advisor. If that was the case, that advisor could only have been the absent Mr Finlay.

It was suggested that I should draw this inference from certain circumstances which I will now deal with. Oldco and Newco engaged in concert in a number of real estate development operations. Each of them also entered into real estate ventures in which the other did not participate. It was apparent in October of 1973, when Mrs Schiel resigned and severed her connection with Oldco pursuant to the agreement, that one of the joint ventures would be quite profitable.

Counsel for the Minister pointed out that management salaries in both Oldco and Newco were taken only where the result would be to produce profit levels falling below the small business limit fixed by section 125 of the Act.

I have concluded, after carefully reviewing all of the evidence, that the appellants have discharged the onus. Undoubtedly, salary manipulation is a factor of considerable weight in a case such as this*. [1] However, such manipulation as did take place here took place after Oldco and Newco were separated. I do not infer that considerations based on section 125 of the Act had a bearing at the time when the separate structure was formed.

I do not believe that the evidence could properly be regarded as demonstrating the phenomenon of selective recollection. It should be remembered that all witnesses were giving evidence as to events which took place several years ago. Mr MacQuarrie did not clearly recall all that transpired. However, his explanation that he was not conversant with income tax matters was a clear and believable basis for his unequivocal assertion that income tax advantages were not discussed. Similarly, in the case of the evidence of Mr Fee, it is not surprising that he could be certain that tax was not discussed in light of the fact that at the time of his departure from the scene the plan was to “divide the assets” of the company between husband and wife (presumably on winding up). As mentioned previously, I am persuaded that neither Mr nor Mrs Schiel understood the tax situation.

On balance I have concluded that the separate existence of the two companies flowed from the single minded pursuit by Mr and Mrs Schiel of a common objective, namely, the separation of their business interests so that in the event of divorce Mrs Schiel would have property of her own and Mr Schiel would not find his business crippled by a share interest held by his wife.

In the result the appeals will be allowed and the direction vacated. The assessments will be referred back to the Minister for reassessment in accordance with this finding.

Appeals allowed.