Natural Retreats of Nova Scotia LTD v. Minister of National Revenue, [1979] CTC 2481, 79 DTC 391

Guy Tremblay:—This case was heard in Halifax, Nova Scotia, on June 16, 1978. The written submissions were received by the Board in September 1978.

1. Point at Issue

The point is whether the respondent is correct in applying subsection 245(1) of the new Income Tax Act to include in the appellant’s income for the 1973 and 1974 taxation years

(a) the commissions ($119,250 for 1973; and $35,063 for 1974) paid by the appellant to Vacatia Limited, a wholly-owned subsidiary corporation located in Bermuda. Those commissions were paid following completed negotiations of recreational properties located in Nova Scotia;

(b) the interests ($2,451 for 1973; and $3,782 for 1974) earned by Vacatia Limited.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof results especially from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.01 The appellant is a body corporate incorporated under the laws of the Province of Nova Scotia in 1969. The appellant primarily carries on the business of buying and selling recreational (waterfront) real property and of providing tourist services. It has done so in Nova Scotia since it was incorporated. The head office of the appellant is in Bridgewater, Nova Scotia. There is another office in Halifax.

3.02 In the early 1970’s, the appellant had accumulated a substantial inventory of rural property in Nova Scotia that had recreational potential. The appellant also had ready access to more property of the same kind.

3.03 The appellant decided to incorporate a wholly-owned subsidiary Vacatia Limited in Bermuda.

3.04 In his testimony, Mr Tustian explained the fundamental reasons for the incorporation of Vacatia Limited (pp 12 and 13 of the transcript):

Q. When did you conceive the idea of forming Vacatia Ltd?

A. It was a natural development. I guess, of conversations internationally with brokers in the States and clients being referred more and more from outside of Canada and the United States. The actual time that I recall was 1972, some part of 1972, the summer maybe, I’m not too sure.

Q. What was your concept of the function of Vacatia, the function Vacatia Ltd could perform?

A. I knew that there was a great deal of investment capital in Bermuda, or through Bermuda, particularly that client (sic) of climate was—I mean atmosphere was the kind of vacation atmosphere that had people in a good frame of mind for investing in recreation. Bermudian real estate was unbelievably high, and the general feeling among brokers in Bermuda was that property of our quality and our prices was not known in the world, and it appeared to be a market through which we could get higher prices for our property.

Q. What was your source of this information of the potentialities of using Bermuda as a base?

A. Well, I talked to Mr Merrill, who was handling our investor sales at that time in New England. He had had a large inquiry from residents and businesses in Bermuda who had investments in other countries and so on, and he felt strongly that the larger packages of property, the over-$100,000 type of investments, were more practical to be sold through that climate than in the United States where he was selling at the time thirty and fourty-thousand-dollar transactions.

3.05 In 1972, Mr Tustian went to Bermuda. He met, among others, with a firm of lawyers to find out some information (p 14 of the transcript):

Q. What kind of information did you find from them? Was it encouraging to your plan or otherwise?

A. Yes, they felt that I was exactly right, the kind of climate with the number of American and European tourists coming there, and the kind of attitude for recreation they had, that they would be very favourable to offerings of quality waterfront properties, even if they were from Nova Scotia. They too confirmed that there was not such real estate for sale in Bermuda.

Q. Did they offer you any advice as to how to set up your operation there?

A. Well, the first meeting was sort of a general, you know, I was relatively uninformed about the whole problem, so the first meeting was sort of a genearl information meeting. I came back to Nova Scotia and talked it over with the people here, accountants and so on, then I went back to Bermuda where we decided to form a wholly owned subsidiary of a Canadian company. That also related to some other factors over who should, had the money to do it.

3.06 In his letter dated November 22, 1973, to the tax office (Exhibit A-3) in which he was seeking advice on taxation, Mr Owen Tustian, the main witness of the appellant, explained the reasons of Vacatia Limited:

Bermuda has been chosen as the country best suited for our international marketing operations because:

(a) We need a high class international location outside the United States to independently attract European investment in such fast growth currencies as the German mark and Japanese yen.

(b) We needed a high pitched vacation oriented atmosphere all year round to successfully operate such a company.

(c) A yachtsman’s paradise where substantial people of means form the majority, places us in a strong promotional position.

(d) Bermuda is not too far to control property showing and not too costly to manage by air. Its climate is akin to Nova Scotia and many of its professional people, are already trained in Nova Scotia and familiar with our type of business problems.

(e) Yet it is an independent colony from both the United States and Canada and is not affected by the yet undefined tax problems in the US and Canada as tax law especially in Canada continues to jostle.

3.07 As that letter, which is part of Mr Tustian’s testimony, describes the appellant’s point of view, the Board thinks it is necessary to quote the rest of it:

1.1 wish to confirm to you that our marketing company in Bermuda called Vacatia Ltd, had its offices in the Argus Building, Wesley Street, Hamilton, Bermuda. Its address is PC Box 1549 (all business in Bermuda have box numbers), its telephone number is 2-7979 and is answered 2-7979 rather than the company name as is common with secretaries in Bermuda. Vacatia Ltd is inscribed on the main office directory panel of the building as well as lettered on the door of the office floor along with other companies who have adjoining offices.

2. The Treasurer and General Manager for Vacatia Ltd is a Bermudian with chartered accounting background. His name is Mike Collins. He hires staff as needed and has full signing power at the Bermuda National Bank where Vacatia Ltd keeps two bank accounts, one for Canadian dollars dealing with its parent here in Nova Scotia and another in US dollars in which many foreign clients are instructed to pay depending on exchange rates.

3. Owen Tustian being President of the Nova Scotia parent is also President of Vacatia Ltd. Vice President of Marketing is Ned Merrill, who handles many property transactions in many countries but does reside in the United States. He is as real estate broker handling business for independent clients as well as acting as an independent agent selling for Land/Vest in Boston. His role as an officer in Vacatia Ltd is independent from his other activities and as you have directed I’ve instructed Bermuda that Ned Merrill as an officer is not to have signing authority to accept purchase and sale agreements for Vacatia Ltd because of his US residency and the possibility of his activity being confused under US trade or business law.

4. Ned is paid by commission for the activities he performs for Vacatia Ltd. He is not paid a salary as an officer. There are no offices or bank account for Vacatia Ltd in the US. Funds are sent to Vacatia by bank draft from the purchaser. Mike Collins and his staff are paid salaries from the Bermuda accounts and apart from the fact that they are responsible for all commissions and promotional costs in the act of sales abroad, including payment of salary to Owen Tustian for a portion of his time devoted to Vacatia’s activities, the routine business in Bermuda we consider not a part of the affairs of Natural Retreats here in Nova Scotia.

5. We have an exclusive marketing arrangement with Vacatia Ltd that is not a legal document yet a commitment in correspondence. Natural Retreats acquires and holds the property. It prepares a description and instructs the required net dollars it must receive from the sale. The Bermuda Company depending on the size of the property marks it up around 45% needed to handle the kind of expenses incurred in marketing to purchasers capable of investing up to $300,000. (Having done what limited research we could in Florida and Bahama land sales budgets, this seems to be a reasonable budget for a total lands performance).

6. Purchase and sale agreements taken by Ned Merrill, myself or other agents disclose the seller as Natural Retreats of Nova Scotia Ltd and are accepted by Vacatia Ltd, Mike Collins, Treasurer. Natural Retreats provides a warranty deed to the purchaser’s lawyers whether they be in Nova Scotia or elsewhere and payment for the property is made in Bermuda to Vacatia Ltd. In turn, Vacatia Ltd pays its outside commissions and forwards the net proceeds of the sale to Natural Retreats of Nova Scotia Ltd, in Bridgewater.

7. As Vacatia gains momentum and does from time to time have more liquid capital, than Natural Retreats because of Natural Retreats’ agressive development program in Queens County, Vacatia often is requested by its parent to help out with interest free loans, periodically during the year. If Vacatia Ltd annually declares a dividend, the loans are repaid and the dividend accepted by Natural Retreats who owns Vacatia’s common stock in its entirety.

8. All mortgages and notes that become a part of any sale transaction are usually held by Natural Retreats because of its ability to deal with such legal matters easily her on Nova Scotia soil. If financing is very high such that Vacatia and Natural Retreats both must participate to make the sale, Vacatia in such cases may hold the shortest term second mortgage. Natural Retreats would have the first call and longest term form of security in a 1st mortgage.

9. Relating to this we do understand from your memo that Natural Retreats is taxable in Nova Scotia only on this amount of principal and interest paid on such mortgages it holds in any one year and that the balances unpaid are not taxable within the year of sale transaction, thereby often deferring tax on major portions of sale profits if such financing is provided by Natural Retreats.

3.08 Concerning the incorporation of Vacatia Limited on October 12, 1972, Mr Merrill, then real estate broker and living in Boston, USA, first said “I don’t recall I had any decision to form it” (p 135 of the transcript). However, because of his experience with Bermuda buyers and his contacts with persons in real estate, Mr Tustian “approached the posssibility of my becoming their sales manager and actually coming into his company with the belief both on his part and my part that there was ‘through’ Bermuda a valid source of dollars and buyers for some of the larger parcels that we had reviewed or that we knew of” (p 135 of the transcript). He also said that in Bermuda it was possible to have “certainly a higher, a more qualified, more sophisticated type of buyer”.

There was a possibility for Mr Merrill to move to Bermuda. For personal reasons, however, he refused to move.

3.09 Vacatia Limited had sales representatives in Bermuda: first, Mrs Burns, later Mr Collins; in the USA Mr Merrill; in Europe, Troy Associates and Mr Brandenberger (son) in Germany.

3.10 Even if many clients showed interest in properties (Molega Lake, Exhibit A-1), however, only five transactions were completed.

3.11 The respondent assessed the appellant by adding to its income in the 1973 taxation year commissions and fees reportedly earned by Vacatia Limited in the amount of $119,250.72 and interest income purportedly Earned by Vacatia Limited in the amount of $2,451.

3.12 The respondent assessed the appellant’s income tax liability for its 1974 taxation year by adding commissions and fees purportedly earned by Vacatia Limited in the amount of $35,063 and interest income purportedly earned by Vacatia Limited in the amount of $3,782.

3.13 The respondent’s assessment was based inter alia on the following assumptions of facts which were confirmed by the evidence adduced and which were not in dispute. These assumptions of facts are described in subparagraph (a) to (h) of paragraph 5 of the reply to notice appeal:

(a) the appellant’s director, Owen Tustian, caused to be incorporated in Bermuda a company called Vacatia Limited which was a wholly owned subsidiary of the appellant;

(b) in its 1972 taxation year the appellant sold a property located in Nova Scotia commonly known as Tumblin Head, receiving total proceeds of $52,500 of which it showed a reserve in reporting its income of $20,250 for a study contract. In its 1973 taxation year the appellant reported as gross income from the study contract the amount of $6,750. Vacatia Limited recorded as part of its income an amount arising from this study contract;

(c) in its 1973 taxation year the appellant sold a property located in Nova Scotia commonly known as Indian Falls for total proceeds of $15,500 of which it reported as gross income the amount of $9,000. Part of the proceeds from the sale of the property were recorded by Vacatia Limited as its income;

(d) in its 1973 taxation year the appellant sold a property located in Nova Scotia commonly known as Evans Island for total proceeds of $215,000 of which it reported as gross income the amount of $115,850. Part of the proceeds from the sale of the property were recorded by Vacatia Limited as its income;

(e) in its 1974 taxation year the appellant sold a property located in Nova Scotia known as Whitehead for total proceeds of $75,000 of which the appellant reported as gross income the amount of $47,250. Part of the proceeds from the sale of the property were recorded by Vacatia Limited as part of its income;

(f) in its 1974 taxation year the appellant sold a property located in Nova Scotia known as Gull Island for a sale price of $13,500 of which the appellant reported as gross income the amount of $6,000. Part of the proceeds of the sale of the property were recorded by Vacatia Limited as part of its income;

(g) Real Estate agents having offices in the United States of America were directly involved in the sale of the properties referred to in paragraphs 5(c), 5(d), 5(e) and 5(f);

(h) Vacatia Limited paid to the appellant the monies it received in respect of the sale of Nova Scotia properties less certain amounts including commissions paid to selling agents, in the form of loans which were repaid by the declaration of dividends by Vacatia Limited.

3.14 In assessing the appellant, the respondent relied on three other assumptions of facts which are in dispute. These assumptions of facts are described in subparagraphs (i), (j) and (k) of paragraph 5 of the reply to notice of appeal;

(i) Vacatia Limited neither tendered services to the appellant nor carried on any activity for the purpose of earning income for its own benefit, advantgage or account;

(j) all of the amounts which were treated by Vacatia Limited as its income were in fact income of the appellant;

(k) the real purpose and effect of the incorporation of Vacatia Limited was to unduly or artificially reduce income earned by the appellant in the course of its business.

3.15 The evidence showed that in the five transactions (the Board had deed on hand) in the present case (Tumblim Head— Exhibit A-4; Indian Falls—Exhibit A-6; Evans Island—Exhibit A-12; White Head—Exhibit A-18; Gull Island—Exhibit A-23):

(a) three buyers were from USA (two from Massachusetts, one from Connecticut), one from Holland and one from Switzerland;

(b) the seller is the appellant company;

(c) Vacatia Limited is not the owner of the lands sold;

(d) Mr Owen Tustian, president of the appellant company (which in fact is the only shareholder of Vacatia Limited) signed for the appellant except, however, in the case of Evans Island. In the latter case, Mr Edwin K Merrill signed as follows:

Edwin K Merrill (Signature)

Vacatia Ltd (Seller) per Edwin K Merrill,

Vice President, for Natural Retreats of Nova Scotia.

Despite the fact that in the agreement the seller was described as Natural Retreats of Nova Scotia, Vacatia Limited is supposed to be the seller.

3.16 Even if Mr Merrill once signed as Vice President of Vacatia Limited he admitted in cross-examination he never received a share of the company. He also confirmed he has never been an officer or an employee of Vacatia Limited nor of the appellant. No evidence by documents could be made because most of the documents concerning Vacatia Limited were destroyed. In fact, according to Mr Merrill, market conditions changed (oil crisis in the world, wood expropriation of the property in Nova Scotia on November 5,1974) and did not produce the type of buyer which had been anticipated. Consequently, Vacatia Limited was liquidated. The main documents concerning Vacatia Limited are the certificate of incorporation (Exhibit R-1), a non-dated and non-signed minutes of meeting of shareholders (Exhibit R-2) (the name of Mr Merrill does not appear as shareholder); a photocopy of a share of Vacatia Limited issued to Owen Tustian on August 7, 1973. Mr Merrill said he had never invested any money in Vacatia Limited. It appears from Exhibits R-1, R-2 and R-7 that the shareholders of Vacatia Limited were Natural Retreats of Nova Scotia Ltd (11,997), William M Cox, Esq (1), Cleo Janet, secretary (1), and Owen Tustian (1).

3.17 In his testimony, Mr Merrill explained that he received similar commission on sales which took place after the incorporation of Vacatia Limited as he had prior to it. Mr Merrill indeed was an agent for the appellant company before the incorporation of Vacatia Limited. He had been working for 10 years as a broker in Nova Scotia, New Brunswick and Newfoundland. He was associated with Land Vest Ltd (a brokerage service company). Depending on certain conditions, he divided his commission with Land Vest Ltd. 3.18 The evidence showed that commissions were divided, on one hand, between Vacatia Limited (35% to 45% of gross sales) which had to pay the commission to the brokers, the expenses concerning development study, and on the other hand, Natural Retreats of Nova Scotia Ltd (55% to 65% of gross sales) which had to pay the cost of the sole property.

3.19 In the five transactions involved, the evidence showed clearly that

(a) the five transactions were carried out by the intermediary of the agents of Vacatia Limited—Mr Merrill (4 transactions), Mr Brandenberger (1 transaction—he sold Gull Island to his father);

(b) the participation of Vacatia Limited was a development study contract in Indian Falls transaction (study made in fact by Mr Merrill and employees of the appellant);

(c) only transaction was introduced by the intermediary of Mr Collins with Mr Brandenberger and the four others by the intermediary of Mr Merrill directly with the appellant.

3.20 In September 1975, Mr Tustian decided to liquidate Vacatia Limited. Many reasons were given to explain that decision. In a letter dated September 8, 1975 (Exhibit A-25) addressed to Mr Collins, Mr Tustian explained:

We are running into several problems with respect to Vacatia Ltd that brings us to the final decision to liquidate this company.

1. We are having extreme difficulty with our own ability to borrow proper operating capital in Canada because bankers fear the existence of this foreign subsidiary a potential means of draining off their loan funds to a foreign country.

2. The international financial situation has caused such a burden on investor capital that it is difficult, as you know, for Vacatia Ltd to acquire enough business to keep it alive.

3. The high cost of lawyers fees and government fees make it impractical for us to keep it going.

We do hereby request that you satisfy all accounts, pay up the balance as a dividend prior to Sept 30, 1975 and liquidate Vacatia Ltd so we can take the company off our annual financial statement.

Mr Tustian, in his testimony (confirmed by Mr Merrill) gave two other factors—(p 60, line 18 of the transcript):

First of all, the oil crisis developing began to cause difficulties in the economies of the countries in which we were selling.

Well, inflation occurred and began to develop from the rise in price of oil, and the lack of amount of dollars to invest in such properties or the scare, the concern in the marketplace just wasn’t conducive to get clients any more of any substance to invest in our Nova Scotia property. And the second thing that contributed to it at the same time was an expropriation on land that occurred here in Nova Scotia by the Department of Lands and Forests.

Q. Could you explain a little bit about that expropriation and why it was a factor?

A. Some large, in the order of 5,000 acres as I recall, qualitly ocean-front vacation property in the Liverpool again, which I understand is worth about $2 million, was expropriated by the Nova Scotia government for $75,000, which sent a resounding shock through all the media of the USA for sure, and what chilled any money investing in Nova Scotia was the fear that they would have their property taken away for less money than they paid for it.

3.21 After the market for foreign clients dropped, the appellant company had an argument with Lakeland Sales Ltd, a marketing company of Nova Scotia. Its responsibility was to sell the properties of the appellant. At that time the market in Nova Scotia was stronger for subdivided lots. “We were able to take our properties and subdivide them into cottage lots and develop better business income her in Nova Scotia”.

3.22 Concerning the fiscal aspect of the formation of Vacatia Limited, counsel for respondent, referring to Exhibit R-4, asked Mr Tustian (p 90, line 14 of the transcript):

Q. Now, in the May 18 letter which Mr Doane attached to his October 30 letter, he writes on page 2, under No 2:

If you decide to form such a company it will be necessary to ensure that the new company is more than just a shell and actually operates a business.

Do you remember being warned about that?

A. I remember discussing that. I don’t remember the intent to form an operating company.

3.23 The respondent, on June 10, 1977, issued notices of reassessment for the taxation years 1973 and 1974 increasing the net income as follows, as it appears on form T7WC annexed to the notices:

3.24 On September 6, 1977, the appellant filed a notice of objection. The respondent, on November, 1977, confirmed the notice of reassessment.

3.25 After the appellant had lodged an appeal on January 9, 1978, the respondent issued notices of reassessment. It was on March 6, 1978, that changes appeared as follows on form T7WC annexed to the notices:

4. Law—Doctrine and Jurisprudence—Comments

4.1 Law

The sections of the new Income Tax Act involved in the present case are 3, subsections 4(1), 9(1), paragraphs 12(1)(c), 18(1)(a) and subsection 245(1).

4.2 Doctrine and Jurisprudence Cited

The Board has studied the following doctrine and jurisprudence:

1. Ralph J Sazio v MNR, [1968] CTC 579; 69 DTC 5001;

2. Dominion Bridge Co Ltd v Her Majesty the Queen, [1975] CTC 263; 75 DTC 5150; [1977] CTC 554; 77 DTC 5367;

3. Massey-Ferguson Ltd v Her Majesty the Queen, [1977] CTC 6; 77 DTC 5013;

4. Leonard Mendels v Her Majesty the Queen, [1978] CTC 404; 78 DTC 6267;

5. Alberta & Southern Gas Co Ltd v Her Majesty the Queen, [1976] CTC 639; 76 DTC 6362; [1977] CTC 388; 77 DTC 5244;

6. Anthony T Leon et al v MNR, [1974] CTC 588; 74 DTC 6443; [1976] CTC 532; 76 DTC 6299;

7. “The Business Purpose Test—Who Needs It?’’: an article written by M J O’Keefe in Canadian Tax Journal, March-April 1977, pp 139-150;

8. “Evasion fiscale”: an article written by Mrs Michelle Rochon, in “Revue générale de droit”, published by the Faculty of Law, Ottawa University, 1978 vol 9, p 438 ss.

4.3 Comments

As the crux of the matter particularly concerns the application of subsection 245(1), it is necessary to quote it:

Artificial transaction.

(1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

4.3.1 The Board finds enlightening the statement of principles and comments made by M J O’Keefe in the article cited above “The Business Purpose Test—Who Needs It?”, at pp 145 and 146, concerning the said section:

Nowhere in the Act are the terms “unduly” or “artificially” defined, and to date the cases have not given any clear-cut definition of the terms. While the scope of section 245(1) is by no means certain, it is possible to deduce some general principles as to the application of the section from the considerable number or relevant cases.

(1) The section would presumably have no application to arm’s-length transactions which are not inspired in whole or in part by a desire to minimize the tax burden.

(2) It is well settled that section 245(1) has no application if the issue before the court is not the deductibility of a disbursement or expense. In other words, no matter how artificial they might be, schemes are outside the scope of section 245(1) if they do not involve the deduction of a disbursement or expense.

(3) Unless the outlay or expense is incurred at least in part for business reasons, the deduction would presumably be prohibited by section 18(1 )(a) of the Act as not being made for the purpose of gaining or producing income and therefore would not involve section 245(1).

(4) Evidence that the transaction was entered into in whole or in part for the purpose of reducing or minimizing tax is not fatal to the taxpayer’s position although evidence of such a motive or lack of a business purpose is a condition precedent to the Crown establishing its case.

(5) If the taxpayer can point to a specific provision in the Act which authorizes the transactions, then in the absence of the transactions being viewed as a sham transaction, the fact that the transaction is motivated by a desire to reduce or avoid tax is of no consequence.

(6) If the taxpayer is unable to point to any specific provision in the Act which authorizes the transaction and instead relies on general accounting principles, then it would appear to be unecessary to establish some significant business purpose for the transaction. Presumably it is necessary to establish the business purpose in order to rebut the argument that the transaction is artificial.

(7) Section 245(1) is designed to catch transactions which on one hand cannot be categorized as shams, but which on the other hand are not caught by some other specific provision in the Act relating to deductibility of expense, such as sections 67 and 17(1).

(8) There appears to be some confusion as to whether the word ‘artificially référés to the transactions or to the arithmetical impact of the deduction on taxable income, although the better view is that it refers to the transaction itself and the arithmetical impact of the transaction is irrelevant.

(9) There appear to be degrees of artificiality, with some artificiality being tolerated before the transaction is struck down as being artificial within the meaning of the section. It is difficult to draw the line between schemes which are not ‘too’ artificial and those which are; but the distinction probably lies in the degree to which the transaction in question differs from the commercial norm for such transactions.

From the foregoing it can be seen that the application of section 245(1) is not all encompassing and that it has been given a narrower interpretation by the courts than presumably was wished for by the Revenue authorities.

There is, however, that rather large body of “schemes” that are not caught by section 245(1) because they do not involve disbursements or expenses, but which are attacked by Revenue nonetheless. There are of course all the transactions considered to be a sham within the meaning of the definition of that term as set out in Snook v London West Riding Investments. But since the Canadian courts, with perhaps one exception, have adopted the relatively narrow definition of sham as set out in the Snook case, viz, that the transaction must be one that neither party ever intended to be acted upon, the Revenue is in a rather awkward position in asserting sham. The very transaction it is seeking to impugn as being a sham is normally a transaction which the parties fully intended to carry out, if for no other reason than to obtain the tax advantage in question.

Even if a transaction is outside the scope of 245(1) because it doesn't involve a disbursement or expense, and it cannot be fairly described as a sham, the taxpayer still may have more hurdles to jump. There is a negative judicial reaction or feeling of repugnance towards blatant tax avoidance schemes which causes the courts to strive mightily to strike down such schemes and protect the fisc against the ingenuity of tax planners if there is no valid business purpose to the transaction. If any trend is discernable it is a shift away from a blind obedience to the rule in the Duke of Westminister case and towards a form of a business purpose rule, although to date the courts—other than in the Leon cases—have stopped short of establishing such a test. As Chief Justice Jackett stated, the fact that the purpose of an arrangement was to obtain a tax advantage, .. does not affect the result actually achieved by what was done, it does, in my view, warrant a very careful appraisal of the evidence when considering whether what was projected with that end in view was actually carried out”.

4.3.2 Résumé of Jurisprudence

Because of the importance of the cases, the Board thinks it is necessary to give a résumé of the cases studied.

4.3.2.1 The case of Ralph J Sazio v MNR, [1968] CTC 579; 69 DTC 5001, is well summarized in the Dominion Tax Cases:

The appellant had been, since 1950, a coach with a professional football club and was also engaged in numerous other business activities. On April 2, 1964, the appellant incorporated a private company of which he became the principal and controlling shareholder. One of the objects of the company’s business was to furnish coaching services. On April 15, 1964 the appellant resigned as coach and on the same day the club engaged the company as a coach for the balance of the term of the original contract between the appellant and the club. On December 8,1964 the appellant was formally engaged as general manager of the company at a fixed salary. This agreement confirmed in writing an alleged oral agreement made in April 1964. Also on December 8, 1964 the club again engaged the company as its coach at a new rate of remuneration. The company received the sums of $20,143 and $22,143 pursuant to the April 15, 1964 and December 8, 1964 agreements respectively and included these amounts in its income for the 1964 and 1965 taxation years. The Minister took the position that the fees received by the company were income receipts of the appellant for coaching services personally rendered by him. The main arguments of the Minister were: (1) the appellant was an employee of the club; (2) the payments by the club to the company were made, with the appellant’s concurrence, for his benefit; (3) the agreements of 1964 were not bona fide business transactions but constituted an attempt to artificially reduce the appellant’s income. The Minister argued also that since neither the appellant nor the club heeded certain of the provisions of the agreements, the agreements should be disregarded:

Held: The appeal was allowed. The amounts involved in the appeal were not income of the appellant. The company formed by him was a properly constituted legal entity and could legitimately carry on the objects described in its charter. Unlike in Kindree v MNR (64 DTC 5248) where the rendering of services was restricted to natural persons under the general tenor of the Medical Act and the code of ethics of the medical profession, there was no such restriction imposed in this case. A company must, from its very nature, act through natural persons. The fact that it may have been formed to serve the interests of a particular person did not necessarily mean that a principal-agent relationship was established between that person and the company. The company in this case was fully competent to engage in football coaching activities, and the agreements entered into in connection with these activities were bona fide commercial transactions. While there may have been a few minor breaches of a technical nature in carrying out the terms of the agreements, these breaches were countenanced by the parties, and the agreements were otherwise scrupulously adhered to. As the company was engaged in a variety of activities other than supplying the football coaching services of the appellant, there was no logical reason for segregating these coaching services from those other activities.

4.3.2.2. The case of Dominion Bridge Company Limited v MNR, [1975] CTC 263; 75 DTC 5150:

(a) Federal Court, Trial Division

This case was heard first before Décary, J of the Federal court, Trial Division. It is well summarized in the Dominion Tax Cases:

The planitiff, a Canadian company engaged in the manufacture of steel, purchased 85% of its steel requirements in the domestic market, ie, Canada and the USA. The balance came from off-shore mills either directly or through commission agents. In April 1966, with the purported objective of establishing a direct offshore steel supplier, the plaintiff caused a wholly-owned subsidiary to be incorporated under the law of the Bahamas. Extreme care was taken to give an appearance of independence to the operations of the subsidiary. Until January 1968, the subsidiary had no employee with any technical knowledge about the purchase and sale of steel. The work was apparently managed by officers of a trust company in Nassau. However, even prior to incorporating the subsidiary, every minute detail of every step of the purchase through the subsidiary was worked out by the plaintiff. Every aspect of the subsidiary’s operations was controlled and approved by plaintiff’s vice-president who became a director of the subsidiary soon after incorporation. He issued all instructions and under his direct control, all documents of the subsidiary were drafted and sent out. The plaintiff also controlled the price at which the subsidiary should purchase and sell off-shore steel. Yet, the plaintiff chose to pay the subsidiary 95% of the price of domestic steel for off-shore steel which had a lower market value. The plaintiff was the subsidiary’s only customer. In January 1968, an employee of the plaintiff’s off-shore purchasing department took up residence in Nassau and became the manager of the subsidiary, but he considered his functions and duties to be quite similar to those he had had in the plaintiff’s purchasing department. From the date of incorporation to the end of October 1967, the subsidiary had an income of $750,000; in 1968 and 1969 it had incomes of $1,100,000 and $1,400,000 respectively; for November and December of 1969 its income was $225,000. The Minister reassessed the plaintiff for the relevant years, adding back to its income the difference in price between domestic steel and off-shore steel, as well as alleged legal, appraisal and audit fees, bad debts, commission, dividends and interest. The Minister contended that the plaintiff was in fact carrying on its own business under the guise of the subsidiary. The plaintiff company appealed, arguing that the subsidiary was a separate legal entity resident in the Bahamas, and was never the agent of the plaintiff.

Held: The appeal was dismissed. The Minister had correctly added back the sham expenses claimed by the plaintiff. The plaintiff was in fact carrying on its own business under the guise of a subsidiary, which had no bona fide operations pertaining to the off-shore steel. The pervasive control of every step of the subsidiary’s activities by plaintiff’s vice-president prevented any freedom of action on the part of the subsidiary. Incorporation and the alleged operations of the subsidiary were a sham. From a formalistic view, the profits were those of the plaintiff because the subsidiary was only a puppet. The relationship between them was so close as to make them a single entity. In reality, the offshore steel purchasing department of the plaintiff was transferred off-shore and incorporated off-shore, but supervision and control remained the same as if there had been no other legal entity involved. What the plaintiff had claimed as expenses was in fact income in its hands. By paying excessive prices for the offshore steel, the plaintiff was intending to keep in a tax-free country a part of its profits which could always be repatriated into Canada taxfree. The paramount object of the exercise was the avoidance of tax.

(b) Federal Court of Appeal

Dominion Bridge Company Limited v MNR, [1976] CTC 554; 77 DTC 5367, appealed before the Federal Court of Appeal. Jackett, CJ, Pratte, J and Ryan, J heard the case and dismissed the appeal.

The decision is summarized in the Dominion Tax Cases:

Held: The appeal was dismissed. The evidence supported the findings of fact of the Trial Judge and there was no ground for interfering with them. The cost of the steel to the taxpayer must be computed by reference to the costs incurred by the subsidiary itself on behalf of the taxpayer and not by reference to amounts shown on the taxpayer’s books as having been paid to the subsidiary.

4.3.2.3. The case of Massey-Ferguson Ltd v MNR, [1973] CTC 2088; [1974] CTC 671; [1977] CTC 6; 73 CTC 66; 74 DTC 6529; 77 DTC 5013.

After losing before the Board and the Federal Court, Trial Division, Massey-Ferguson Ltd appealed before the Federal Court of Appeal. Urie, J rendered the judgment. LeDain, J and Mackay, DJ agreed. This case is also well summarized in the Dominion Tax Cases:

The appellant taxpayer company, a Canadian resident corporation, was a parent company of a multi-national group which primarily engaged in the manufacturing and selling of various types of machinery. Company V was a wholly-owned Canadian subsidiary of the appellant and its sole function was to hold investments and assist in providing loans to other companies within the group. Company V held all the outstanding shares of company P, a US corporation, which was in need of additional capital. The appellant arranged for an interest-free loan to be made to company P through company V. In fact, the money was transferred directly to company P, but the appropriate entries were made in the records of company V reflecting the loan as an account payable by company V to the appellant. The Minister considered the interposition of company V as having no genuine business purpose in the transaction, and reassessed the appellant on deemed interest income pursuant to the subsection 19(1) of the former Act on the basis that the appellant had made an interest-free loan to company P, a non-resident corporation, which was not a subsidiary controlled corporation within the meaning of paragraph 139(1)(aq) and was, therefore, deprived of the advantage of subsection 19(3). The appellant appealed contending that the interest-free loan was made to company V, its wholly-owned Canadian resident subsidiary and, therefore, was not taxable on deemed interest income pursuant to subsection 19(3). In affirming an earlier decision of the Board (73 DTC 66), the Trial Division (74 DTC 6529) dismissed the appellant’s appeal and held that the evidence established a clear intention to lend the money directly to company P. There was no legitimate business purpose for the interposition of company V. The appellant was, therefore, taxable on the deemed interest income pursuant to subsection 19(1). The appellant appealed further.

Held: The appeal was allowed. The evidence established that one of the reasons for the incorporation of company V was to provide loans to the subsidiaries of the appellant. It was, therefore, perfectly legitimate for company V to get the loan from the appellant and then, in turn, make a loan to company P. As established by the evidence, the interest-free loan was made by the appellant to company V, its wholly-owned Canadian resident subsidiary, which was a subsidiary controlled corporation within the meaning of paragraph 139(1 )(aq). By so doing, the appellant availed itself of the advantage of subsection 19(3) and was, therefore, not taxable on deemed interest income.

4.3.2.4 The case of Leonard Mendels v MNR, [1976] CTC 2346; [1978] CTC 404; 76 DTC 1256; 78 DTC 6267

This Case is also well summarized in the Dominion Tax cases:

The taxpayer, a dentist, practised his profession in partnership with another. In 1966 the partners had incorporated M Ltd for the purpose of purchasing dental equipment and leasing it to the partnership. Each of the partners owned an equal number of shares in the company and were the only shareholders, officers and employees of the company. Although there was no agreement for the payment of management fee the partnership paid $20,000 to M Ltd in 1970 as management fees. No cheques or money actually exchanged hands, but the partnership and the company made the appropriate accounting entries. The partners carried on the same activities as employees of M Ltd as they did as partners. In computing his income in 1970 the taxpayer deducted $10,000, as his share of the management fees expenses. The Minister disallowed the deduction. When the taxpayer’s appeal to the Board (76 DTC 1256) was dismissed, he appealed further.

Held: The appeal was dismissed. The payment for the administrative services inaugurated in the taxpayer’s 1970 taxation year was a transaction which artificially reduced the taxpayer’s income since it was not shown by the taxpayer that the resulting tax saving was only incidental to a business advantage. The taxpayer and his partner fulfilled the same functions as employees of M Ltd as they did as partners and in fact, many of the activities allegedly performed by the management company were of such a nature that they could only be fulfilled by the taxpayer and his partner in their capacity as partners. Although the management company itself was not a sham, the deduction claimed for management fees was artificial within the meaning of subsection 137(1) of the former Act and was, therefore, properly disallowed.

4.3.2.5 The Alberta & Southern Gas Co Ltd v The Queen, [1976] CTC 639; [1977] CTC 388; 76 DTC 6362; 77 DTC 5244 case.

(a) Federal Court, Trial Division

This case was heard first before Décary, J of the Federal Court, Trial Division. It is well summarized in the Dominion Tax Cases:

The plaintiff taxpayer company, a wholly-owned subsidiary of an American corporation engaged in distributing natural gas and electricity in California, was incorporated in Alberta for the purpose of supplying its parent with a constant sup- ply of natural gas. However, pursuant to government regulations, the plaintiff had to satisfy the needs of the domestic consumers before exporting to its parent. Thus, for the purpose of ensuring itself of an adequate supply of gas to satisfy domestic needs and the quota requirements of its parent, the plaintiff bought gas in the ground, made loans to producers to assist in the development of resources and engaged in risk exploration activities. The funds for these exploratory activities were obtained by including a certain amount in the price of the gas sold by the plaintiff to its parent. In each of the 1972 and 1973 taxation years, the funds so obtained amounted to $4,000,000 which the plaintiff used to acquire certain rights and interests to take petroleum substances from the lands of a gas producing company. At the time of purchase of these rights and interests, however, the plaintiff did not have the funds in hand and as such had to borrow. In computing its income for each of the taxation years in issue, the plaintiff deducted (1) the sum of $4,000,000 on the basis that it was used to acquire a ‘Canadian resource property’ and as such constituted a Canadian exploration and development expense within the meaning of paragraph 66(1)(a) of the Act; (2) the interest on borrowed money on the basis that it was paid on money borrowed for the purpose of earning income pursuant to paragraph 20(1)(c) fo the Act; and (3) depletion allowances in respect of production income from a Candian resource property pursuant to subsection 1202.1(1) of the Regulations. The Minister disallowed the deductions contending that (1) the plaintiff was not a principal-business corporation and the rights and interests acquired from the gas production company did not constitute a Canadian resource property; (2) the interests were not paid on money borrowed for the purpose of earning income; (3) the depletion allowances were not in respect of production income from a Canadian resource property; and (4) the entire transaction was a sham designed to artificially reduce the tax liability of the plaintiff. The plaintiff appealed.

Held: The appeal was allowed. The evidence established that the plaintiff was engaged in the buying and selling of natural gas. It had a separate corporate existence and sold gas to other customers as well as to its parent and as a result was not the purchasing agent of its parent. It was a principal-business corporation. Since it was required to satisfy domestic needs first, it was proper for the plaintiff to ensure that it was adequately supplied with natural gas. Therefore, the purchasing of the rights to take petroleum substances from the lands of the gas producing company clearly constituted the acquisition of a Canadian resource property since the paramount right to take was exercisable upon ownership. The sum of $4,000,000 was, therefore, deductible in each of the relevant taxation years. Since the plaintiff did receive income from the transaction, the money was borrowed for the purpose of earning income and the interests paid thereon were also deductible. Further, the plaintiff was not an operator of the resource since the purchase agreement specifically provided that the operating costs were to be borne by the gas producing company. The depletion allowances were, therefore, deductible. In addition, the purchase agreements created rights and obligations intended by the parties and therefore, the transaction was not a sham.

(b) Federal Court of Apeal

The judgment rendered by the Federal Court of Appeal confirmed the one rendered by the Federal Court, Trial Division:

The taxpayer corporation acquired gas in Alberta and re-sold it to an associated company in California. The taxpayer received sufficient proceeds on the resale to enable it to invest in prepayments for known gas in the ground, to make loans to producers to assist in development of future resources and to make loans to assist in risk exploration, all of which were intended to insure the taxpayer of an adequate gas supply for resale. In 1972, the taxpayer received $4,000,000 for such purposes, but instead of using the funds in this manner it entered into an agreement with A Ltd, a company with which it had gas purchase agreements extending into the future. In consideration of $4,000,000 paid to A Ltd, the taxpayer obtained certain rights and privileges to produce and take petroleum substances from lands from which it was already entitled to receive gas. The rights were to end when the taxpayer received petroleum substances valued at $4,000,000 plus interest, or when A Ltd repaid the $4,000,000 plus interest.A Ltd repaid the $4,000,000 plus interest in a year from the proceeds of production. The taxpayer, claiming it had acquired a ‘Canadian resource property’ as defined by section 66 of the Act, sought to deduct the $4,000,000. The Minister disallowed the deduction on various grounds. The taxpayer appealed to the Trial Division which allowed the appeal (76 DTC 6362). The Minister appealed on the sole ground that the transaction artificially reduced the taxpayer’s income and therefore the deduction was prohibited by subsection 254(1) of the Act.

Held'. The appeal was dismissed. Although the triai judge erred in holding that subsection 245(1) was a general section which could not have application in circumstances where a specific section applied, as section 66 did in this instance, the transaction was not a sham. The transaction fell within the spirit and object of section 66 and therefore did not artificially reduce income.

4.3.2.6 The case of Anthony T Leon et al v MNR, [1974] CTC 588; [1976] CTC 532; 74 DTC 6443; 76 DTC 6303, is also very interesting. The Tax Review Board and the Federal Court, Trial Division, approved the taxpayer’s opinion. The Federal Court of Appeal, however, reversed the judgment of the Federal Court, Trial Division. The judgments of the Federal Court are also well summarized in the Dominion Tax Cases.

(a) The judgment of the Federal Court, Trial Division

The present case involved five respondents, each of whom had incorporated a ‘management company’. Each company was controlled by one of the respondents. The facts and decisions regarding three of the respondents were the same. Although the facts were somewhat dissimilar regarding the other two respondents, the decisions were the same.

In the first situation, each of the three management companies had entered into employment agreements with each of the three respondents. Each agreement provided for payment for services rendered by the respondent-employee and contained a provision for payment of a bonus. Each company had entered into a management contract with A company, a furniture distributing company in which each respondent had a substantial financial interest, to ‘manage, supervise, oversee and superintend the operations’ of certain of A company’s furniture and appliance stores. The management companies did not have any employees and were without the usual business facilities such as telephones or offices. All the services under the management agreements with A company were performed by the respondents. The position of the Minister was that during the taxation years in question each respondent had an arrangement with A company, that each had devoted his full time to the management, supervision, overseeing and superinten ding of the operation of certain of A company’s stores and that each became entitled to receive the payments made by A company, at the request of each respondent to the respondent’s management company. The position of the respondents was that each was employed by and received a salary from his particular management company and that the management company had an arrangement with A company to provide management services for which each company received management fees.

In the case of the fourth respondent, the facts were the same but the employment agreement provided that the respondent would provide promotion and public relations services to A company. In the case of the fifth respondent, an arrangement existed for the management of one of A company’s stores, for which the respondent’s company was paid a certain sum, the respondent mananging the store as an employee of the company.

Held: The Minister’s appeals with respect to the three respondents were dismissed. The management companies of the three respondents were carrying on active commercial businesses. A company had entered into an agreement with each of the three companies under which the companies were to provide management services. The companies did supply the services and were entitled to be paid and were paid for the services. Each company was a separate, distinct and existing corporate entity. It was a commonplace that notwithstanding that a shareholder might be in control of a corporation of which he was a shareholder, the shareholder and the corporation were separate and distinct entities.

The Minister’s appeal in the case of the fourth respondent was allowed. While the employment agreement was limited to promotion and public relations services to be provided to A company, the services which were performed by the respondent went far beyond that. The Court found that the respondent also managed, supervised, oversaw and superintended the operations of some of A company’s stores. Accordingly, payments made by A company were for all services performed, including those which were managerial. The onus for establishing both a right to apportionment and what the apportionment should be rested on the respondent. The respondent did not meet the onus.

The Minister’s appeal with respect to the fifth respondent was allowed. There was no written agreement between the respondent’s company and A company for the management of the one store. If there were a valid management agreement, some supporting written evidence of it should have been available. The respondent, and not his company, was entitled to receive payments from A company for services which he rendered as an employee of A company.

(b) The judgment of the Federal Court of Appeal

The respondent taxpayers were brothers, each of whom was an employee of a management company he controlled. The companies were contracted to render management services to a business enterprise in which all the taxpayers had financial interests. The only employees of the companies were the taxpayers who provided the services required by the contract. Management fees paid to the companies under the contract in the taxation years 1965, 1966, 1967 and 1968 were treated by the Minister as the income of the taxpayers on the basis that the interposition of the companies was a tax avoidance device assigned to reduce the tax liabilities of the taxpayers. The taxpayers appealed contending that the contract for services was between the business enterprise and the companies and, therefore, they were not taxable on management fees. Instead, they were only taxable on the salaries they received from their employers, the companies. In affirming an earlier decision of the Board (unreported), the Trial Division (74 DTC 6443) dismissed the Minister’s appeal and held that the management fees were not the income of the taxpayers. The Minister appealed further.

Held: The appeal was allowed. The evidence disclosed that the interposition of the management companies between the taxpayers and the business enterprise was a sham. The transaction was designed to reduce tax liability. There was no genuine business reason for the payment of management fees to the companies under the contract. The management fees were, therefore, the income of the taxpayers.

4.3.3 What tests to be applied?

Among the main factors given by the jurisprudence which must be considered in the application of section 245 of the new Act the following one (the main one) will be studied in the present case.

Is the transaction (including incorporation of Vacatia Limited and division of profits) a sham or a bona fide commercial one and consequently with significant business purpose?

As Vacatia Limited was the wholly-owned subsidiary of the appellant company and at first glance as the activities of the appellant company were not restricted to the holding of shares, the question must be put differently. In other words, who, in the present case, was really carrying on the business? Vacatia Limited or Natural Retreats of Nova Scotia Ltd?

To answer such a question, Atkinson, J, in the matter of Smith, Stone and Knights Ltd v Lord Mayor, Aldermen and Citizens of the City of Birmingham, [1939] 4 All ER 116, established (on the basis of the jurisprudence) six criteria (which were quoted and used by Décary, J in Dominion Bridge Co Ltd). They are summarized and adapted to the present case as follows:

1. Were the profits of Vacatia Limited treated as those of the parent company ie, the appellant company?

2. Were the persons conducting the business of Vacatia Limited appointed by the parent company?

3. Was Vacatia Limited the head and the brain of the transactions?

4. Did Vacatia Limited govern the transactions, decide what should be done and what capital should be embarked on the venture?

5. Did Vacatia Limited make the profits by its skill and direction?

6. Was Vacatia Limited in effectual and constant control?

4.3.4 Application of the various tests

(a) The first test is whether or not the profits were treated as profits of the appellant or as profits of Vacatia Limited. In fact, 55 to 65% of the gross sales was treated as being that of the appellant company. Even if at first glance the other 35% to 45% was treated as the profits of Vacatia Limited, in fact “Vacatia Limited often is requested by its parent to help out with interest-free loans periodically during the year’’ and the loans repaid with the dividends issued by Vacatia Limited (See paragraph 3.07.7 of the Facts).

(b) The second question concerns the appointment of the persons conducting the business. The president of Vacatia Limited was Mr Tustian, president of the appellant company (see paragraph 3.07.3 of the Facts). Mr Tustian approached Mr Merrill to become the sales manager of Vacatia Limited (see paragraph 3.08 of the Facts). Even if Mr Mike Collins, nominated as treasurer and general manager by Mr Tustian, hired “staff as needed’’ (see paragraph 3.07.2 of the Facts) the evidence did not give the number of persons who had worked for Vacatia Limited but it is not more than a secretary. The address of Vacatia Limited was the personal address of Mr Collins. It did not have its own office.

(c) The third criterion pertains to the identity of “the land and the brain’’ of Vacatia Limited. The Board has no hesitation whatsoever that it was not the general manager, Mr Collins (see paragraph 3.19 of the Facts) nor Mr Merrill, an officer and the vice-president of marketing, according to Mr Tustian (see paragraph 3.07.3 of the Facts) who never had a share of Vacatia Limited nor was an employee, nor an officer of Vacatia Limited, who never made an investment in Vacatia Limited and who never went to Bermuda (see paragraph 3.16 of the Facts; pages 158 and 159 of the transcript). The only one who made decisions was Mr Tustian, who owned 92% of the shares of the appellant (see paragraph 3.15 of the Facts; p 70 of the transcript). The appellant owned 11,997 of the 12,000 shares of Vacatia Limited. Mr Tustian wrote the decisions to Mr Merrill concerning transactions and made the decision to liquidate Vacatia Limited (see paragraph 3.20 of the Facts).

(d) The fourth standard decision is whether Vacatia Limited governed the transaction, decided what should be done and what capital should be invested in the venture.

As the evidence showed Mr Tustian, president of the appellant and of Vacatia Limited (from the inception to the liquidation, passing by the day to day decision), governed everything.

On one hand, concerning the capital invested in Vacatia Limited which has been paid, the evidence shows that the appellant paid the $12,000 for the shares only in September 1974 (one year after the incorporation of Vacatia Limited). The amount was retained on declared dividends as “payment of call on share capital’’ (Exhibit R-9). This means that there was no initial investment in incorporating Vacatia Limited.

On the other hand, concerning the amounts invested in the transactions, paragraph 3.07.8 of the Facts describes that if financing is very high the appellant has “the first call and longest term form of security in a 1st mortgage’’ and Vacatia Limited “the shortest term second mortgage’’.

(e) The fifth criterion raises the question of skill and direction through which the profits were made. The appellant company which owned the lands, sole them to purchase and divided the gross income with Vacatia Limited. Without the participation of the appellant in each transaction, I do not see how it would have been possible for Vacatia Limited to complete only one transaction. Inquiries concerning lands were made by the employees of the appellant. The latter was part of all the contracts and guaranteed the main mortgages.

(f) Finally, considering the effectual and constant control of Vacatia Limited by the appellant, there is no doubt that the control of the appellant was not only on the legal aspect with its 11,997 of 12,000 shares but on the actual aspect of the participation of the appellant in each transaction which was passed. Mr Tustian had full power. As the president and main shareholder of the appellant and the president of Vacatia Limited, Mr Tustian was the soul of both. In fact, it would have been surprising that the business of the two companies had not been carried on as if there were only one.

4.3.5 It is the Board’s opinion that the incorporation of Vacatia Limited was not necessary to reach the same ends.

Indeed, the evidence showed that substantially all the transaction of Vacatia Limited were directed and operated by the appellant company:

(a) the president of Vacatia Limited was Mr Tustian, president of the appellant company (see paragraphs 3.07 and 3.15 of the Facts);

(b) the seller of the land was the appellant company (see paragraph 3.05 of the Facts);

(c) the appellant had “the first call and longest term form of security” in the 1st mortgage” (see paragraph 3.07 of the Facts);

(d) fifty-five to sixty-five percent of the gross sales was the part of the appellant company that had to pay the cost of the sold property (see paragraph 3.18 of the Facts);

(e) four of the five transactions involved were completed by Mr Merrill (see paragraph 3.19 of the Facts) who was agent for the appellant company before the incorporation of Vacatia Limited (see paragraph 3.17 of the Facts). Mr Merrill, even if he never went to Bermuda, had contacts “through Bermuda” (accountants or selling agents who wrote him, called him or came to him) (pages 159 and 160 of the transcript).

Despite the intention of Mr Tustian in incorporating Vacatia Limited as described in paragraph 3.06 of the Facts, the Board cannot but conclude from the evidence that in reality Vacatia Limited was the agent of the appellant.

But how to reconcile the Sazio judgment with the Leon judgment?

To answer that question, the Board is in accordance with the comments made by Mrs Michelle Rochon in the article cited about (paragraph 4.2), at 443:

Dans l’affaire Sazio, le juge semble s’être fondé sur le fait que si l’incorporation était motivée par des motifs commerciaux véritables, toutes les opérations de la compagnie étaient par le fait même, à l’abri de tout soupçon.

Or, dans l’affaire Leon, le juge Heald a affirmé que le but commercial doit être considéré par rapport à chaque transaction de la compagnie et non seulement par rapport à l’incorporation elle-même. Et sur ce point, le juge Urie est d’accord avec le juge Heald (voir l’affaire Massey-Ferguson).

L’évolution de la jurisprudence s’explique sans doute, en partie, en fonction de l’évolution semblable en droit corporatif. On sait que le principe énoncé dans le célèbre arrêt Salomon a été considérablement atténué dans les années subséquentes. Dans un cas comme dans l’autre, les juges se montrent de moins en moins réticents à “soulever le voile corporatif”.

The appeal is dismissed.

5. Four Secondary Issues Raised by the Appellant

At the conclusion of his submission, counsel for appellant raised four issues:

If, notwithstanding the foregoing, it is concluded that Vacatia Limited was an agent of the appellant and therefore that the appellant is properly taxable upon the income that was reported as the income of Vacatia Limited.

5.1 Annulment of sale of Indian Falls

The appellant’s 1974 income as reassessed should be reduced by the profit shown on the books of the appellant (before deducting the commission paid to Vacatia Limited) as a result of the sale of Indian Falls, which was nullified in 1974. This would require that the reassessed income be reduced by $11,255.

After producing three letters (Exhibits A-8, A-9 and A-10) concerning the agreement of the appellant to repurchase Indian Falls for $15,500, especially a letter dated June 9, 1975 from Stewart, MacKeen & Covert, Barristers and Sollicitors (Exhibit A-10) requiring the payment of $15,500 or to commence legal proceedings immediately, counsel for appellant asked Mr Tus- tian (p 40, line 23 of the transcript):

Q. Apparently he, according to the letter, was now representing Mr Newbury and again was seeking the payment of the $15,500. Did you do anything in response to that letter?

A. I didn’t buy back the property.

In fact, the reason given was that the appellant company had no money.

Perhaps it is possible that Mr Tustian had a lack of memory and that in fact the sale was nullified. Unfortunately, it is not proven. The Board is bound by the evidence and must conclude that the Indian Falls transaction was never nullified.

The Board maintains the assessment on that point.

5.2 Reserve under 20(1)

The appellant should be entitled to claim a “reserve” under paragraph 20(1)(n) in respect of the second mortgage on Evans Island, which would reduce its incomes for 1973,1974, and subsequent years to the extent of the portion of the appellant’s profit on the sale of that property (before deducting the commission paid to Vacatia Limited) represented by the principal on the second mortgage that was not due at the end of each of those years respectively. The matter should then be referred back to the Minister of National Revenue for reassessment accordingly.

Despite the argument of the respondent that the appellant had not proven the mortgage, the Board’s opinion is that it is not necessary for a creditor to be guaranteed by a mortgage to establish an entitlement to a reserve under paragraph 20(1)(n). Moreover, the respondent in its arguments admitted the existence of a second mortgage in the amount of $50,000 by establishing the total sale price of Evans Island.

The Board allows the reserve.

5.3 /s the amount of $16,650 related to Whitehead transaction taxed twice?

The appellant’s income for 1974 should be further reduced by allowing, as cost of land sold in that year, a further $16,650, in respect of Whitehead.

Where does the $16,650 come from?

As explained in paragraph 3.13(e) of the Facts, according to the respondent, the total proceeds of the Whitehead transaction was $75,000, of which the appellant reported as gross income the amount of $47,250. The balance $27,750 (see paragraph 3.25) was a fee earned by Vacatia Limited. According to Mr Green, accountant for the appellant, his client recognized the adjusted cost of Whitehead at 63% of the adjusted cost base of $45,000 which equals $28,350 (p 181 of the transcript).

However, according to Mr Tustian (p 98 of the transcript), Whitehead was resold for $75,000. It seems that Whitehead was received in partial payment for the Evans Island transaction (p 180 of the transcript). It is not clear, but probably the “adjusted cost base of $45,000’’ comes from that partial payment. The amount of $16,650 in dispute comes from the difference between $45,000 and $28,350.

According to Mr Merrill (p 181 of the transcript), “this difference indicates, over a two year period, that the 1973 income was under-stated by $16,650. However, 1974, when Whitehead was sold, the net income was over-stated by a similar amount’’.

Mr Harris, counsel for appellant, questions Mr Merrill:

Q. Now, how has the Department treated this aspect of the transaction in reassessing Natural Retreats?

A. The Department has treated the $16,650 as actually a commission paid to Vacatia.

Q. Even although it represented an unsold or a portion of an unsold piece of land, would you agree with that treatment?

A. No.

Q. Why not?

A. Well, it’s an artificial figure. It’s, through the correspondence that Mr Tustian has had with his previous accountants he indicated that an individual named Bur- bidge was employed by H R Doane, at the time the statements were prepared which recorded the purchase of Whitehead at 63%. The difference of 37% was confused in that Mr Tustian had indicated to Burbidge that the property or the 37% would be a commission paid to Vacatia on the sale of the property and not on the purchase, and land was actually booked net of the commission paid.

Q. In your opinion then this portion of the commission was not earned till ’74?

A. Yes.

Q. And was wrongly assessed as being commission earned in ’73?

A. Correct.

After that testimony, it seems clear to the Board that the notices of reassessment issued on March 6, 1978 have corrected the situation (see paragraph 3.25 of the Facts).

However, Mr Harris asked Mr Terris, accountant for the respondent (p 201 of the transcript):

Q. Then I put to you, Mr Terris, that that $16,650 got lost as an expense in Natural Retreats because you attributed everything to Natural Retreats and never got the deductions?

A. That is possible. I don’t know.

On the other hand, to a question of counsel for respondent, Mr Terris answered that “in adding to income the amount of $27,250 attributed to Vacatia Limited on the Whitehead sale of 1974’’, he added exactly what Vacatia Limited had shown on its books (p 202 of the transcript). The least the Board can say is that it is not very clear.

As the burden of proof however is on the shoulders of the appellant, and as the proof is not clear, the Board must maintain the assessment on that point.

5.4 Deduction of expenses made by Vacatia Limited

The appellant should be entitled to deduct, as business expenses, the expenses incurred by Vacatia Limited in Bermuda in the course of earning the income in question, which would be represented by the portion of the reassessed amounts that was never received by the appellant. These amounts would be computed as follows:—

Total reassessed amounts

1973	$119,605.47
1974	10,607.00
1975	3,781.00
		$133,993.47
Received as dividends
and payment for share
capital		79,700.00
Net amount not received		$ 54,293.47

It is the Board’s opinion that the appellant is right in claiming the expenses incurred by the subsidiary in the course of earning the income in question. The Board however states that the amounts added by the respondent (1973: $119,605.47; 1974: $10,607) are net income which means that the expenses were deducted. The year 1975 not being in appeal, the Board does not have documents to verify the figure of $3,781.

Concerning 1973 and 1974, however, when one studies the form T7W-C annexed to the assessment for 1973 and 1974 issued on June 10, 1977, one can see the following figures:

In fact, the appellant’s contention is that the amounts paid by the appellant (parent company) to acquire the shares of Vacatia Limited (subsidiary) and the amounts received by the appellant as dividends from Vacatia Limited should be considered as expenses incurred in the course of earning the income in question.

The Board cannot share such an opinion. Indeed, the amounts paid and received by the appellant were not involved in the computation of the net income of the subsidiary.

The amounts received by a company for shares sold are computed in the capital surplus. The dividends paid by a company are taken from the earned surplus which come from the profits after payment of expenses and even income taxes.

The Board thinks it is the fundamental reason based on accounting principles. Those principles must be used to construe the Income Tax Act inasmuch as there is no special section to contradict them (Royal Trust Co v MNR, [1957] CTC 32; 57 DTC 1055). Furthermore, there is no section in the Act to allow the deduction of the amount paid for the said dividends and to oblige a company to include in the income and the amounts received for the shares sold.

Moreover, if the appellant company alone had to complete the involved five transactions (and it is the basic point after rejecting the appeal), it would have not paid the shares nor received dividends. On the same basis, the interests earned by Vacatia Limited (1973: $2,451; 1974: $3,782) must be included in the appellant’s income.

Consequently, the Board maintains the assessments on those points.

6. Conclusion

The appeal is allowed in part and the matter is referred back to the respondent for reassessment in accordance with the above reasons for judgement.

Appeal allowed in part.