Aztec Forest Products Limited v. Minister of National Revenue, [1974] CTC 2115

The Chairman (orally; December 14, 1973):—This is an appeal by Aztec Forest Products Limited against the reassessment of the Minister of National Revenue for the 1967 taxation year.

The issue arises out of a direction pursuant to subsection 138A(2) of the Income Tax Act as applicable to the 1967 taxation year that the appellant company and a company known as Green Forest Lumber Limited were deemed to be associated for the purposes of the said Act. It is agreed that, according to the provisions of section 39 of the Act, as it then was, the two companies would not be associated were it not for this direction.

There is a very heavy onus, of course, on an appellant when such a direction has been issued, and this Board and the Federal Court of Canada are both limited to the fact that they must find that none of the main reasons for the existence of the two companies as separate corporations was to acquire an income tax benefit. This not only leaves the taxpayer with the usual burden that he bears under the Act, but that burden is also increased by the effect of the wording of subsection 138A(3) of that Act.

Briefly, the facts are that Green Forest Lumber Limited was incorporated in 1957 and that at all relevant times Mr John T Sereny has been its sole beneficial shareholder. The appellant company, Aztec, was incorporated on March 20, 1967 and the shareholders of that company appear to be, and are in fact, the two sons of Mr Sereny. How the companies are set up makes no difference because, as I have said, it is agreed that the two companies were not associated within the meaning of section 39. Counsel for the Minister, however, would have me take note of the fact that there was sufficient knowledge in the sole beneficial shareholder of Green Forest to avoid the application of section 39, and he infers that, when dealing with this case, I should impute some sinister motive to him as a result of that knowledge, the sinister motive of course being to avoid the payment of tax.

The two companies differ only in that Green Forest was a licensed wholesaler under a federal sales tax licence and, as a result, was able to buy lumber and sell it without the necessity of collecting sales tax. Since 50% to 75% of Green Forest’s customers were in the United States (and never less than 50%, as I recall the evidence of Mr Sereny), it also was able to obtain a benefit under the Excise Tax Act by virtue of being licensed. In other words, Green Forest did not have to exact sales tax when lumber was purchased from it. Aztec was unlicensed and sold locally in Ontario.

It had appeared to Mr Sereny that there was a benefit to be achieved by the incorporation of a second company which would be an unlicensed company and which could take advantage of a situation that exists in the lumber industry whereby less than the usual 11% sales tax on lumber is payable to unlicensed dealers in lumber. How this lower rate is arrived at is of no consequence. It is a matter determined by the federal officers charged with the collection of sales tax, but it is clear on the evidence of Mr Goodyear that there is a benefit to the purchaser of the lumber to the extent that the sales tax is less than 11% of the invoiced price, being calculated instead at a flat rate per thousand board feet.

There is one other aspect I must mention in passing, and that is another agreement that had been explained by Mr Zambri, chief inspector for the Canadian Freight Association, who said that there is an arrangement between the operating railways in this country and the lumber dealers to grant a fixed rate for lumber shipped from certain listed points, provided that at least 90% of a dealer’s product at the points listed is forwarded by rail. It is made clear in the argument on behalf of the Minister that this is not 90% of the total volume of the appellant or any other company that may be a party to this agreement, because naturally the contract could not apply to lumber shipped from locations where no railway sidings or rail facilities exist. This freight rate advantage, along with the sales tax advantage, is alleged by the appellant to be the sole reason for the existence of the two companies, and it is argued that it made good business sense to take advantage of these two situations and therefore the consideration of any saving in income tax was not one of the main factors in the decision.

I think 1 would be naive if I were to leave the impression that the question of income tax advantage never entered into the decision to incorporate two separate companies, because obviously the participants were professionally advised, but the Income Tax Act, limiting as it may be, says that this must be one of the main factors in the creation of two companies such as exist here before they can be deemed to be associated under subsection 138A(2).

Counsel for the Minister has shown that in the year in question and for two subsequent years the combined income of the two companies would have been in excess of $35,000, which was the low rate ceiling at the material time. This is one factor that must be considered. He cites also many other factors that I think must be considered in their proper light in each case. Both companies carried on the same type of business and they were both operated by the same people. They had no warehouse and their offices were common. Aztec had one sales agent, purchaser or seller, and a different telephone number from that of Green Forest, but generally speaking everything was done by Green Forest, and although the evidence on this point is not very clear, I think there is sufficient for me to infer that some fee was paid by Aztec for this service provided by Green Forest.

I have said many times in this type of case that I do not think that it is necessary for a businessman to go to the expense of acquiring separate premises, hiring unnecessary employees and increasing his operating burden simply to create evidence that might assist him in fending off a reassessment that might never take place. I think it would have been less than good business practice to accomplish the desired result in any way other than it was done by these two companies, as least in so far as their bookkeeping and their day-to-day operations were concerned.

With regard to the agreed freight rate charge, great stress has been laid on the allegation that Aztec, although a member of the agreement and signatory to the contract, never really lived up to its agreement. Mr Zambri says ‘there were many, many times that Aztec trucked when it should have railed”, but Mr Sereny, in his evidence, has found only five instances where Aztec was in breach and one instance in which Green Forest was in breach, and then only to a very minor extent. However, Aztec appears to have been in breach substantially in at least one year. One never knows how rigidly the rail companies might interpret such agreements. I suppose it would depend on how badly they needed the business at the material time, but there was some evidence to substantiate that of Mr Zambri, if not to corroborate him completely.

Mr Zambri said he had heard rumblings, or his men in the field nad heard rumblings, as to the excessive amount of trucking by Aztec. He has some 33 or 34 men between Thunder Bay and the East Coast doing these checks at least once a year, and he very fairly and honestly said that he had (and I paraphrase) great faith in his men and he would hope that they would catch deficiencies or breaches of contract. However, it might happen that, if invoices were not scrutinized carefully enough, or if they had been falsified, something could happen, but “if everything that should be made available was made available” he felt that his men would catch any deficiencies.

Quite frankly, I am more impressed with the evidence produced by Mr Bossin (of William Eisenberg & Company, Chartered Accountants, who are the auditors now—as of this year—for this company), and in the letter dated April 2, 1973, that he obviously prepared for the purposes of this appeal, in which he shows that, in 1972, out of a total of 552 shipments, 162 were purchased from mills which have a flat rate of federal sales tax. On the evidence, and as he points out, Green Forest would have been unable to accept the business represented by the 419 truck shipments referred to in his note 1 {on the first page of his letter) had it not been for Aztec, because this volume would have placed Green Forest in breach of its contract with the railroads and, if these shipments had been accepted and shipped by Green Forest, they would have been noted in the course of audit by inspectors from the Canadian Freight Association. He goes on to state, and he gave this in evidence but I am reading it from his letter, that the 162 shipments purchased from mills with flat rates of federal sales tax were made up of 94 by rail and 68 by truck, and that Green Forest made a saving of $26,960 as a result of this arrangement—and there are invoices attached to substantiate his finding.

As an example of actual saving when purchases are made from a mill with a flat rate of federal sales tax by a company purchasing federal sales tax included, as is the case with Aztec, he shows that when Green Forest purchased 1,000 board feet of lumber from Great West Timber Limited it had to pay $206.56 f o b destination with federal sales tax included, whereas, by switching the order for delivery to Aztec instead of Green Forest, the cost is reduced to $194 per thousand board feet. In this way, on one shipment of approximately 50,000 board feet, some $600 was saved.

In his letter he further shows lumber purchased at market prices in 1973 and ranging between $160 and $170 per thousand board feet f o b mill and federal sales tax exempt would bear tax at 11% or be- tween $18 and $19 per thousand feet, whereas tax on the same lumber (coming out from Chapleau Lumber Co Ltd, which delivers half of its output to the Ontario market and now has a flat rate of federal sales tax) would be only $10.80 per thousand feet when purchased by Aztec federal tax included. Fifteen million board feet being the anticipated deliveries from Chapleau within Ontario, the resulting saving on this quantity would be in the region of $120,000. He emphasized that this saving is only possible because of the existence of Aztec and represents the saving from one supplier alone.

Several cases have been cited to me, particularly by counsel for the respondent. Levitt-Safety (Eastern) Ltd and Levitt-Safety Limited v MNR, [1973] CTC 483; 73 DTC 5374, which is a recent case, is a decision of the Honourable Mr Justice Urie that I think can be distinguished from this case by referring to his words at page 491 [5380], and I quote only two or three lines:

... Mr Levitt’s evidence was not sufficiently compelling to convince me that the vehicle selected ...

and I think the crux of what he goes on to say is that he didn’t believe that the true purpose of creating three separate entities was to operate the business in a more efficient manner, but rather that it was motivated by the tax advantage that would result.

Again, in the Levitt case, Mr Justice Urie (at p 491 [5380]) referred to a quotation of Mr Justice Jackett, then President of the Exchequer Court of Canada, in Holt Metal Sales of Manitoba Limited et al v MNR, [1970] Ex CR 612 at 622; [1970] CTC 144 at 149-50; 70 DTC 6108 at 6111-12, which has been read to me by counsel for the appellant:

If the evidence were such as to convince me that some or all of these and other reasons that have been advanced were sufficiently compelling in the minds of William Holt and his advisers to constrain them to select the creation of the Appellants in preference to all other possible methods of achieving the same results, I should have thought that it might be open to me to conclude that the probable reduction in income taxes through having three companies instead of one to enjoy the 18% tax rate was not one of the “main” reasons for deciding to have three companies instead of one. An example of a case where the other considerations dictated the creation of several corporations and the income tax benefit arising therefrom was only an incidental benefit is Jordans Rugs Limited et al v MNR, [1969] CTC 445.

I adopt those words of Jackett, CJ to that point. To me there has been demonstrated, through the evidence of Mr Sereny and of Mr Bossin, and particularly through the evidence contained in the letter of April 2, 1973 by William Eisenberg & Company, that if income tax advantage entered into this picture at all, and it probably did, it was not one of the main factors that determined that this was how the two companies should carry on their business. I think there is a perfectly valid reason for operating the appellant’s business as it is being operated in conjunction with Green Forest Lumber, and I do find that none of main reasons for the separate existence of the two corporations is to reduce the amount of income tax that would be otherwise payable under the Income Tax Act.

Having been able to come to that conclusion on the evidence before me, the appeal must be allowed, the Minister’s direction set aside, and the matter referred back for reassessment accordingly.

Appeal allowed.