Date: 20010108
Docket: 97-2936-IT-G; 97-2937-IT-G; 97-2938-IT-G;
97-2939-IT-G; 97-2940-IT-G; 97-2941-IT-G
BETWEEN:
JAMES S. DUNCAN, ANTHONY R. YOUNG, NORMAN EDEN, MARK LANGDON,
TWIN OAKS VILLAGE ESTATES LTD., WATER'S EDGE VILLAGE ESTATES
(PHASE II) LTD.,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowie J.
[1]
These are the Reasons for Judgment in the appeals of James S.
Duncan, Anthony R. Young, Norman
Eden, Mark Langdon, Twin Oaks Village Estates
Ltd., and Water's Edge Village Estates (Phase II)
Ltd. Their appeals under the Income Tax Act (the
Act) were heard together on common evidence by agreement
of the parties. The years under appeal are:
Water's Edge Village Estates (Phase II) Ltd.
1992
Twin Oaks Village Estates
Ltd. 1990,
1991 and 1993
Anthony R.
Young
1991 and 1992
James S. Duncan 1991, 1992 and 1993
Mark Langdon 1991 and 1992
Norman Eden 1991 and
1992
All the appeals concern losses said to have been incurred by a
partnership and distributed to the Appellants under section 96 of
the Act. The issues in each year for each Appellant are
identical, except for some carry back or carry forward of the
claimed losses in some cases.
[2]
In December 1991, each of these Appellants purportedly purchased
an interest in a partnership by the name of Klink Development
Company (Klink).[1]
Klink was originally formed in the state of Ohio, USA, in 1979
under the laws of Ohio. Klink's original partners were five
in number, and were resident in Ohio, Michigan and Texas. Klink
purchased an IBM mainframe computer in 1982 for $3,700,000(US).[2] By 1991 Klink had
fully depreciated the computer, both for accounting purposes and
for the purposes of United States income tax laws. The total
capital cost of the computer to Klink, undepreciated and
converted to Canadian dollars, was $4,536,940. The Appellants,
along with three other individuals, paid $320,000 to acquire
interests totalling 93.57381% in Klink. On the same day, December
20, 1991, Klink became the only limited partner of a newly formed
British Columbia limited partnership, Interfin Leasing
Partnership (ILP). Klink's capital contribution to this
partnership consisted of the conveyance by it of the computer,
for which it received a credit to its capital account of $50,000.
In computing its income under section 96 of the Act at its
December 31, 1991 year end, Klink took a terminal loss on
the computer of $4,486,940. From this, it deducted its income
from operations of $45,550 to produce a net loss for income tax
purposes of $4,441,390 to be allocated among the partners and
claimed by them as non-capital losses, for the purpose of
computing their incomes under section 3 of the Act. Klink
also distributed a loss of $20,852 among its partners for 1992 as
at December 31, 1992.
[3]
The Minister of National Revenue has reassessed each of the
Appellants to disallow the deduction of their respective shares
of the Klink losses for the 1991 and 1992 taxation years in the
case of the individual Appellants, and for the 1992 and 1993
taxation years in the case of the corporate Appellants, both of
which have a May 31 year end. There were also consequential
reassessments to disallow losses carried forward or backward in
the case of some of the Appellants. The reassessments are
predicated upon the Minister's view that Klink was not a
subsisting partnership after December 13, 1991, and
alternatively, upon the application of the general anti-avoidance
rule found in section 245 of the Act.
the participants
[4]
Anthony Young and James Duncan are businessmen who have had very
successful careers in Victoria, British Columbia as developers of
residential, commercial and recreational real estate. They have
conducted their operation as equal partners for many years
through Swift Sure Developments Ltd., of which they each owned
50% through their personal holding companies. Norman Eden is a
Victoria businessman who has from time to time participated in
projects with Mr. Young and Mr. Duncan. Twin Oaks Village Estates
Ltd. (Twin Oaks) and Water's Edge Village Estates (Phase II)
Ltd. (Water's Edge) are two of the operating companies of
Mr. Young and Mr. Duncan which at the end of 1991, had
recently completed development projects and, therefore, were in a
liquid position.
[5]
Eng, Rozon & Floor (ERF) is a firm of chartered accountants
in Victoria which has provided accounting services to Mr. Young
and Mr. Duncan for some years. William S.F. Eng, Gordon Clarke
and Lawrence Rozon (through a holding company) were among the
group that purchased interests in the Klink partnership. Mark
Langdon is a chartered accountant, and was in 1991 in the firm
ERF, where he was the person principally responsible for the
clients Duncan, Young and their various corporate vehicles.
[6]
James Hutton is a person engaged in the financial service
industry. Nova Ban-Corp Financial Services Ltd. (Nova) is a
corporation through which Mr. Hutton conducts some of his
activities. The evidence was sparse, both as to Mr. Hutton's
background, and as to the exact relationship between him and
Nova. It would appear that Mr. Hutton, either personally or
through some corporate agency, fits the definition of
"promoter" of "tax shelters" as those
expressions are defined for the purposes of section 237.1 of the
Act.
[7]
Roger F. Belanger is an individual whose office is in Cincinnati,
Ohio. The evidence did not reveal any significant details of Mr.
Belanger's training or experience, but he purported to be in
a position to assist the Appellants in finding a market for the
services of a computer in Bulgaria, or perhaps some other Eastern
European country. Interfin Incorporated (Interfin) is a Delaware
corporation, and is apparently the corporate alter ego of
Belanger.
[8]
Interfin Leasing Partnership (ILP) was initially formed under the
name Moresby Enterprises Limited Partnership on November 1, 1991,
under the Partnership Act of British Columbia. Its only
general partner and its only limited partner were numbered
companies. On December 20, 1991 the numbered companies ceased to
be partners, the name was changed to Interfin Leasing
Partnership, Interfin became the general partner, and Klink
became the limited partner.
[9]
The IBM 3081-D16 mainframe computer, together with its peripheral
equipment, was purchased by Klink in November 1982 for
$3,700,000(US). It was leased to Federal Data Corporation, and
subsequently subleased to Crawford Long Memorial Hospital in the
United States. During the term of the sublease it was twice
upgraded by the addition of components which were paid for by
doctors at the hospital. By December 20, 1991, it had been fully
depreciated by Klink, both for accounting purposes and pursuant
to the income tax laws of the United States of America. It is not
disputed that its historical cost to Klink, converted to Canadian
dollars, was $4,536,940. I accept the evidence of Walter Seidel
that by December 1991 this computer was obsolete and had a market
value of about $7,000(US). To make it functional in Eastern
Europe would have required not only considerable transportation
expense, but also the cost of rewiring it to operate on
50-cycle electrical current.
the Appellants' acquisition of Klink
[10] In July
1991, Mr. Hutton approached ERF with what Mr. Langdon described
as an investment opportunity. A memorandum sent by Langdon and
Eng to Young and Duncan on September 17, 1991 describes this
investment opportunity. As it was the basis for much of what
followed, it is worth reproducing here in full:
Jim Hutton, our mutual business acquaintance in Vancouver, has
approached us with another investment opportunity which he
thought you might be interested in. He feels that he could
interest people in the local Vancouver area, however, given his
past numerous business dealings with you, he asked us to present
it to you first.
Preliminary details are as follows:
(1)
There is a general partnership in Ohio called the Klink
partnership.
(2)
In November 1982, Klink partnership purchased an IBM 3081-D16
computer for $3.7 Million U.S. ($4,537,000 CDN).
(3)
At that time, it leased the computer to AT & T who in turn
leased it to Crawford Long Hospital in Ohio.
(4)
This computer has had a long life, however, it is now obsolete in
North America given changes in technology.
(5)
The opportunity is as follows:
(a)
Jim Hutton wishes to enter into a minority position in the Klink
partnership. Given the existing partners demands, Jim feels he
can only afford about a 22% interest.
(b)
He is offering you the remaining 78% for approximately
$318,000.
(c)
At this point in time you and Jim would be 100% owners in the
Klink partnership.
(d)
Unknown to the current partners in Klink, there is another firm
(Interfin Lease of Cincinnati Ohio) who perceives a business
opportunity for this computer.
(e)
Interfin feels that while the technology maybe near obsolete in
North America, it is likely state of the art in Eastern Europe.
Interfin proposes that Klink will contribute the computer to a
new partnership while they will contribute the brain power and
expertise. This computer will then be leased to Eastern Europe
with the idea of making substantial long term profits.
(f)
It has been suggested that you purchase the existing partnership
rather than simply buying the computer for several reasons:
(i)
There is an existing legal structure in place. By buying the
existing partnership, it will save you the cost of having to
"re-invent the wheel".
(ii)
Because the Klink partnership has been in existence since at
least 1982, it has some degree of "presence" in Ohio.
Interfin, who will be a key to making this deal work, is familiar
with this name and maybe more comfortable dealing with Klink than
dealing with a completely new entity.
(6)
Jim Hutton's lawyer is still ironing out some of the key
details, however, it does appear to be an exciting opportunity to
diversify in a burgeoning market using somebody else's brain
power. There have been many articles recently projecting Eastern
Europe as being an area that is prime for high growth. This may
provide you with an opportunity to get in on the ground
floor.
(7)
Once Jim's lawyer has done his due diligence, we will take a
more detailed look at the business plan to see if the opportunity
is all that it appears to be.
We will keep you informed as things progress.
[11] At about
the same time, Hutton provided Langdon with what he described as
"an outline of the business plan to utilize such assets in
Eastern Europe". This consisted of a one and one-half page
letter from Belanger to Hutton which proposed that Interfin would
form something called the USSR Trading Company to establish
marketing relationships in the USSR, Bulgaria and other Eastern
European countries. The object was to obtain a number of what he
called third generation computers, to be leased to various
companies in the Eastern European countries, with payment being
made either by way of barter or trade credits. Two pages were
attached, describing in general terms how barter finance and cash
equivalent trade credits might work. These were not the outline
of any sophisticated business plan, nor would anyone with a
modicum of business experience be likely to draw the conclusion
from them that Mr. Belanger had either special expertise or
important business relationships that would facilitate trade with
East bloc countries. A letter of September 19, 1991, from
Belanger to Hutton said in part:
... At this time I'm in contact with a team of four
men going to Bulgaria on a discovery trip. They have arranged
meetings with political, educational, business and religious
leaders. I would like to use this team in helping us develop
contacts. ...
[12] At about
the middle of October 1991, Langdon went to Cincinnati to meet
Mr. Belanger and, as he put it, to do due diligence with respect
to him. His investigation of the bona fides of Mr.
Belanger appears to have consisted of checking the telephone
directory to ensure that the address listed there was the same
address at which he met with him, going to his office and looking
around to see that there were filing cabinets and other business
equipment, and having a discussion with Mr. Belanger about the
proposed deal. He said in his evidence that he had telephoned two
of Mr. Belanger's references, but he had no real recollection
about them or what they had to offer by way of information. He
took no notes of what they said. He does not appear to have
obtained a curriculum vitae of Mr. Belanger. He did
not, apparently, make any effort to talk to anyone who had done
business with Mr. Belanger, or otherwise inquire into his
ability, his expertise, or his claim to have business connections
in Eastern Europe. This is surprising, considering that he
asserted during his evidence that it was Mr. Belanger's
ability and his business connections that made the purchase of
the Klink partnership interest worth $320,000, although he knew
that the computer was Klink's only asset, and that it was
obsolete. Indeed, the trial record is remarkably devoid of any
evidence in relation to Mr. Belanger's education, experience,
background or previous projects.
[13] Mr.
Langdon did, however, write to the other prospective investors on
December 11, 1991, to inform them of what he had learned. The
first half of this memorandum refers to difficulties in
connection with moving Klink to British Columbia, and the
need to have a 2% ownership interest remain with the partners in
Ohio. It describes the current situation of the computer
equipment, which was at that time under lease to Federal Data
Corporation until March 31, 1992, with income of $14,133(US) to
be generated to Klink under that lease for December 1991,
and $100(US) for each of January, February and March, 1992. The
rest of the memorandum is devoted to the proposed structuring of
the arrangement with Belanger and the proposal for utilization of
the computer in a data centre in Bulgaria. There is reference to
an expectation of profits to Klink of $500,000(US) to
$600,000(US). However, there is nothing that would substantiate
this suggestion.
[14] Oddly,
Langdon and Eng sent to Young and Duncan on December 13, 1991 a
replica of their earlier memorandum dated September 17, 1991, but
with subparagraph 5(b) added as follows:
(b) Four other individuals, including myself, are interested
in acquiring 6%.
Messrs. Langdon, Young and Duncan met on December 13, 1991.
They decided at that meeting that they should enter into the
transaction as it was eventually structured, with both
Water's Edge and Twin Oaks acquiring substantial interests in
Klink, along with Young and Duncan, and with lesser interests to
be acquired by the members of ERF and Hutton.
[15] In their
evidence, both Mr. Langdon and Mr. Young took the position that
it was the expertise and the connections of Mr. Belanger that
made the Klink acquisition a viable business deal. It is
surprising, therefore, that they were willing to proceed without
a full business plan in hand. It was not until November 28,
1991, three weeks prior to closing the transaction, that
Water's Edge entered into a "consulting agreement"
with Interfin. Interfin was to be paid $3,000 down and $1,000 per
week from December 9, plus expenses, to do market research and
produce a business plan. The agreement is vague as to the work to
be done, and specifies no date for delivery. Mr. Langdon
sent the contract to Mr. Belanger on November 29 with a
cheque for $3,000, and proposed that the balance would be paid in
full on completion, rather than by instalments. He described the
"tentative timetable" as being for a draft of the
economic projections to be delivered by December 15, and
"the entire package ... by December 31, 1991". A
five-page document titled "Investment Summary" and a
seven-page "Business Plan" were faxed by
Mr. Belanger on December 16. They could fairly be described
as puerile. To the extent that they project revenues and
expenses, there is nothing to rationalize the estimates –
they are simply numbers selected by Mr. Belanger without
explanation.
[16] In the
meantime, on December 13, Hutton and Nova had purchased a 98%
interest in Klink. The other 2% remained with the U.S.
partners.
[17] On
December 20, the Appellants, together with William Eng, Lawrence
E. Rozon Inc. and Gordon Clarke (collectively "the Victoria
group"), proceeded with the purchase from Hutton and Nova of
interests in Klink totalling 93.57381%. Minutes thereafter, Klink
conveyed the computer to ILP for an agreed price of $50,000 as
its contribution to the capital of ILP, thereby giving rise to
the planned terminal loss. The following series of transactions
took place that afternoon.
[18] 1. The
Victoria group purchased from Nova the following partnership
interests in Klink:
Purchaser
Amount of Partnership Interest
Eden
8.91476%
Young
8.91476%
Duncan
8.91476%
Twin
24.51559%
Waters
37.88773%
Langdon
1.10654%
Eng
1.85899%
Rozon
1.10654%
Clarke
0.34414%
Clarke also purchased a 0.01% interest from Hutton. The
purchasers also obtained the following convenant from Nova:
3.3
Nova shall assist the Partnership from and after the Time of
Closing until December 31, 1995 in the remarketing of the
Partnership's computer assets in Eastern Europe by means of
providing such services and office facilities as the Partnership
may reasonably request from Nova's offices in Vancouver,
France and Germany.
For these interests the purchasers paid a total of $319,964.00 to
Nova, and an additional $36.00 for the interest purchased by
Clarke from Hutton.
2.
The Klink Partnership Agreement was amended to admit the Victoria
group as partners. The amended agreement provided in part.
The names of the Partners of the Partnership and their
respective ownership percentage interests in the Partnership are
as follows:
|
Norman Eden
|
8.91476%
|
|
Anthony R. Young
|
8.91476%
|
|
James S. Duncan
|
8.91476%
|
|
Twin Oaks Village Estates Ltd.
|
24.51559%
|
|
Waters Edge Village Estates (Phase II) Ltd.
|
37.88773%
|
|
H.K. Mark Langdon
|
1.10654%
|
|
William S.F. Eng
|
1.85899%
|
|
Lawrence E. Rozon Inc.
|
1.10654%
|
|
Nova Ban-Corp Financial Services Ltd.
|
0.01%
|
|
Gordon W. Clarke
|
.35414%
|
|
James A. Hutton
|
4.41619%
|
|
Nancy E. Klink
|
0.92%
|
|
Robert M. Klink
|
0.36%
|
|
Frank R. Leone
|
0.36%
|
|
Warren J. Rauhe
|
0.08%
|
|
Kay R. Rauhe
|
0.28%
|
3.
Klink and Interfin became, respectively, the limited partner and
the general partner of Moresby Enterprises Partnership in place
of the numbered companies, and the name of that partnership was
changed to Interfin Leasing Partnership. The business of Moresby
is described in the original partnership agreement executed by
the numbered companies as "The acquisition, maintenance and
disposal of Property as the General Partner may from time to time
determine." A certificate of limited partnership had been
filed with the Registrar of Companies on December 4, 1991. The
registered address of Moresby was 650 – 999 West Hastings
Street, which was also the address of Nova, and of the numbered
companies that were the original Moresby partners.
4.
Klink and ILP entered into an agreement whereby Klink transferred
title to the computer and all its peripheral equipment to ILP.
Klink and ILP agreed therein that the fair market value of the
computer equipment was $50,000, and the consideration received by
Klink for this equipment was a credit to the capital account of
Klink in ILP of $50,000. This was agreed to be in full
satisfaction of Klink's obligation to make a contribution to
the capital of ILP. Klink also assigned to ILP its rights as
lessor of the computer equipment to Federal Data Corporation.
[19] The
closing of these transactions took place on Friday, December 20,
1991 by teleconference. Mr. Hutton and his lawyer, Mr. Campbell,
were apparently in Mr. Campbell's office in Toronto. The
Victoria group was represented by their lawyer, Mr. Jones, in
Victoria. Mr. Jones reported to Mr. Young by a letter dated
Monday, December 23, 1991, which reads as follows:
Dear Tony:
Re: Klink Development Company
As I reported to Mark Langdon, we finally concluded the above
transaction in time late Friday afternoon.
Basically John Campbell reported that after he had perused the
bill there was nothing in it to affect his opinion, and,
accordingly, on receipt of your instructions I authorized him to
proceed, which he did.
There may be a few minor matters to clear up such as a new
limited partnership agreement and I emphasize again that every
effort must be made to market these products in the Eastern Block
countries.
Apart from that, I think that I should render my account
before the year end which I trust the investors find to be
satisfactory. I was pleased to be of service to you all.
[20] Exhibit
A-1, tab 49 is the minutes of a meeting held on December 20,
1991, immediately following the closing of the series of
transactions. Attending the meeting were Messrs. Young, Duncan,
Eden, Eng, Rozon, Clarke, Langdon and Jones in Victoria, and
Messrs. Hutton and Campbell by telephone in Toronto.
Mr. Langdon was appointed the managing partner of ILP, and
there was some discussion about leasing the computer in Eastern
Europe, and of a possibility of developing other business in
Eastern Europe in such areas as construction management, software
and accounting services. They scheduled a subsequent meeting,
which Mr. Belanger would attend, to be held in Victoria on
January 17, 1992.
[21] The
January 17 meeting was duly held, and it was attended by Messrs.
Young, Eden, Rozon, Clarke, Langdon, Belanger and Tom Baldwin, an
associate of Mr. Belanger's firm in Cincinnati. There
was discussion about alternative uses for the computer. The
options of selling it, re-leasing it in the North American market
and donating it to a university were all considered and rejected.
Mr. Belanger spoke of a meeting with a Mr. Nicolov, who he
said was an engineer in Bulgaria with a connection to a
petro-chemical firm called Neftochem.
[22] Mr.
Belanger wrote a one-page letter to Mr. Langdon on February 10,
1992, about discussions he had had concerning the potential use
of the computer. On February 28, 1992, Mr. Langdon wrote to Mr.
Belanger, indicating to him, among other things, "We are
still reviewing our options as to your final two points;
purchasing the upgrades for the computer and what to do with the
equipment after March 31".[3]
[23] Another
meeting was held on March 5 and 6, 1992, involving
Mr. Langdon, Mr. Rozon, Mr. Darc of Nova, Mr. Hutton and Mr.
Belanger. At this meeting Mr. Belanger continued to indicate that
there was a market in Bulgaria for leasing the computer through
the creation of some sort of data processing centre. Like his
business plan of December 16, 1991, Mr. Belanger's
advice at this meeting is vague, and consists entirely of
unsubstantiated hopes and opinions. Poland was also mentioned as
a possible site for a data centre.
[24] In the
meantime, the Klink partners decided to look into the possibility
of leasing the computer in Venezuela rather than Eastern Europe.
Mr. Duncan, Mr. Jones and Mr. Langdon travelled to Venezuela
to investigate this. On April 24, 1992, Mr. Langdon wrote to
Mr. Belanger, in preparation for this trip, to see whether
Mr. Belanger could assist in obtaining a salesman's manual
for the computer, maintenance records for it, and a synopsis of
its history and capabilities.
[25] At the
end of April 1992, Mr. Belanger wrote to Mr. Langdon about a
potential joint venture in Poland, to provide system integration
services there, and in other Eastern European countries. In that
memorandum he recommended that Klink should invest $350,000(US),
together with a line of credit for an additional $150,000(US),
and also contribute the computer. He concluded by offering to
prepare a complete business plan for this project for
$25,000(US). Under this proposal, another partnership called
Newmark Leasing Partnership (Newmark), would have joined Klink,
or ILP, in a joint venture. Paul Darc of Nova lent some
encouragement to this proposal. A company called Consolidated
Ventures International, Inc. of Ann Arbor, Michigan, was also a
proposed participant in this joint venture. A number of proposals
were advanced throughout the summer of 1992, and pro forma
financial statements were circulated by Belanger. Two common
elements of all Belanger's plans were that his company,
Interfin, would receive significant compensation for its efforts,
and that the Victoria group would make a substantial capital
investment. The other common element was a lack of anything
concrete to support Belanger's financial projections.
[26] In
November 1992, Klink and Newmark each agreed to invest up to
$150,000(US) in a Polish data centre in Krakow, contingent upon
the following:
a)
completion of a technical evaluation of how Newmark and
Klink's mainframe computers will be relocated to Kracow,
Poland and placed into use within the next six months, including
cost estimates supported by firm quotations or proposals from
suppliers of the services for transport, installation, set-up,
acquisition of operating and application software, conversion of
mainframe computers to Polish electrical standards and
acquisition and installation of peripheral equipment.
b)
receipt of a satisfactory revised business plan based upon
available capital resources;
c)
completion of binding contracts between all Polish Data Centre
joint venture partners satisfactory to Newmark and Klink
including employment contracts, tax holiday agreement and data
centre privatization agreement.
d)
finalization of arrangements for repatriation of capital
satisfactory to 365648 B.C. Ltd. and Klink, and;
e)
completion of an "agenda" for the implementation of the
Polish data centre with specific performance objectives
identified and estimates of time requirements for each objective
laid out, satisfactory to 365648 B.C. Ltd. and Klink
f)
Agreement from Bowen Enterprises Limited Partnership, Interfin
Leasing Partnership and Federal Data Corporation regarding their
contribution of 2 IBM mainframe computers.
[27] On March
1, 1993, Belanger reported to Langdon that this proposal had not
been accepted "... due to difficulties in securing
Privatization papers from Poland's Ministry of
Industry". In the same memorandum he reported on ten other
proposals for ventures in Germany, Russia, Bulgaria and the
Ukraine. There was no indication that any of these were likely to
amount to anything, and in fact none of them ever did. Mr.
Belanger concluded with a request to be paid $66,315(US) for fees
and expenses.
[28] In the
meantime, Mr. Langdon, Mr. Duncan and Mr. Jones had travelled to
Venezuela in mid-May 1992 to investigate what Mr. Langdon
described as "... a great opportunity to carry out
our original business plan in Venezuela rather than in Eastern
Europe". Mr. Langdon made a cash call on the partners, other
than the original United States partners, for $7,207 to cover
costs of the trip. A facsimile message from Gustuva Cabrera Mata
and Frank Hertel to Messrs. Duncan and Langdon on May 21, after
their return from Venezuela, proposed two joint ventures between
the Canadian and Venezuelan groups, one to develop building lots,
and one to create a data centre in Caracas. Nothing came of this,
however, and Mr. Langdon testified that by the middle of
June any prospect of concluding a deal in Venezuela was remote,
as the Venezuelans required too great an investment from
Klink.
[29] In April
1993, Mr. Belanger brought two associates, a Mr. Kordons and a
Mr. Spink, to Victoria to meet with Messrs. Duncan, Eden and
Langdon. Mr. Belanger and Mr. Spink had previously provided
a so-called business plan of some six pages for a proposed
investment bank venture to operate in Eastern Europe. This
document is so vague and unsubstantiated as to be completely
worthless as a business plan. I do not believe that Mr. Young or
Mr. Langdon, or any of their associates, would have considered it
to have any value at all. At the end of a meeting of about two
hours, Mr. Langdon seems to have concluded that Mr. Belanger and
his associates were in fact simply looking for investment money
for other deals quite unrelated to the computer.
[30] On May
27, 1993, Mr. Belanger wrote to Mr. Langdon and Mr. Darc. He made
it clear that the plans for a data centre in Krakow, Poland, were
not going to proceed. Now he proposed that each of Newmark and
Klink invest $150,000(US) in something called the Interfin
Emerging Markets Group. On June 18, Mr. Belanger sent a
further three-page proposal to Mr. Langdon which would have
required the Klink partners to invest a further $200,000(US), and
which would have required them to deliver and install the
computer in some undetermined Eastern European site. This
proposal did not proceed either, and by the middle of 1993
matters were at a standstill, with Mr. Belanger wanting a further
investment of capital by the Klink partners in the order of
$200,000(US), together with the costs of transporting the
computer to Europe, and additional fees and expenses of
Interfin.
[31] Some time
between June and October 1993, Roger Belanger was operated on to
remove a brain tumour. The operation was successful, but by the
end of January 1994, his business had apparently been taken over
by Mr. Kordons and Mr. Spink, and there was no longer any
prospect that a deal might be put together, if indeed, there ever
had been such a possibility.
the issues
[32] This case
raises the following three main issues:
(i)
Did Klink continue to exist as a partnership after December 13,
1991, or alternatively, after December 20, 1991?
(ii)
If Klink did continue to exist as a partnership, was it entitled
to establish the undepreciated capital cost of its computer at
the full historical cost, converted to Canadian dollars, of
$4,536,940, and thereby claim a terminal loss of $4,486,940 in
computing the income of the partnership for the 1991 taxation
year under section 96 of the Act? and
(iii) If
the Appellant is successful on the first two issues, then a third
issue arises. Was the Minister justified in applying subsection
245(2) to deny the Appellants the tax benefit that otherwise
would have resulted from the series of transactions that took
place on December 20, 1991?
[33] The
following are the essential parts of the sections of the
Act that are relevant to these issues:
13(21) In this section,
...
(b)
"depreciable property" of a taxpayer as of any time in
a taxation year means property acquired by the taxpayer in
respect of which he has been allowed, or, if he owned the
property at the end of the year, would be entitled to, a
deduction under regulations made under
paragraph 20(1)(a) in computing income for that year
or a previous taxation year;
...
(e)
"total depreciation" allowed to a taxpayer before any
time for property or a prescribed class means the aggregate of
all amounts each of which is an amount deducted, or that but for
section 67.3 would have been deducted, by the taxpayer by reason
of paragraph 20(1)(a) in respect of property of that class
or an amount deducted under subsection 20(16), or that would have
been so deducted but for subsection 20(16.1), in computing his
income for taxation years ending before that time;
(f)
"undepreciated capital cost" to a taxpayer of
depreciable property of a prescribed class as of any time means
the amount by which the aggregate of
(i)
the capital cost to the taxpayer of each depreciable property of
that class acquired before that time,
...
(iii) the
total depreciation allowed to the taxpayer for property of that
class before that time,
...
20(1) Notwithstanding
paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's
income for a taxation year from a business or property, there may
be deducted such of the following amounts as are wholly
applicable to that source or such part of the following amounts
as may reasonably be regarded as applicable thereto:
(a)
such part of the capital cost to the taxpayer of property, or
such amount in respect of the capital cost to the taxpayer of
property, if any, as is allowed by regulation;
...
20(16) Notwithstanding paragraphs
18(1)(a), (b) and (h), where at the end of a
taxation year,
(a)
the aggregate of all amounts determined under subparagraphs
13(21)(f)(i) to (ii.2) in respect of a taxpayer's
depreciable property of a particular class exceeds the aggregate
of all amounts determined under subparagraphs
13(21)(f)(iii) to (viii) in respect thereof, and
(b)
the taxpayer no longer owns any property of that class,
in computing the taxpayer's income for the year
(c)
there shall be deducted the amount of the excess determined under
paragraph (a), and
(d)
no amount shall be deducted for the year under paragraph
(1)(a) in respect of property of that class,
and the amount of the excess determined under paragraph
(a) shall be deemed to have been deducted under paragraph
(1)(a) in computing the taxpayer's income for the year
from a business or property.
245(1) In this section and in
subsection 152(1.11),
“tax benefit” means a reduction, avoidance or
deferral of tax or other amount payable under this Act or
an increase in a refund of tax or other amount under this
Act;
“tax consequences” to a person means the amount of
income, taxable income, or taxable income earned in Canada of,
tax or other amount payable by or refundable to the person under
this Act, or any other amount that is relevant for the purposes
of computing that amount;
“transaction” includes an arrangement or event.
245(2) Where a transaction is an
avoidance transaction, the tax consequences to a person shall be
determined as is reasonable in the circumstances in order to deny
a tax benefit that, but for this section, would result, directly
or indirectly, from that transaction or from a series of
transactions that includes that transaction.
245(3) An avoidance transaction means
any transaction
(a)
that, but for this section, would result, directly or indirectly,
in a tax benefit, unless the transaction may reasonably be
considered to have been undertaken or arranged primarily for bona
fide purposes other than to obtain the tax benefit; or
(b)
that is part of a series of transactions, which series, but for
this section, would result, directly or indirectly, in a tax
benefit, unless the transaction may reasonably be considered to
have been undertaken or arranged primarily for bona fide purposes
other than to obtain the tax benefit.
245(4) For greater certainty,
subsection (2) does not apply to a transaction where it may
reasonably be considered that the transaction would not result
directly or indirectly in a misuse of the provisions of this
Act or an abuse having regard to the provisions of this
Act, other than this section, read as a whole.
245(5) Without restricting the
generality of subsection (2),
(a)
any deduction in computing income, taxable income, taxable income
earned in Canada or tax payable or any part thereof may be
allowed or disallowed in whole or in part,
(b)
any such deduction, any income, loss or other amount or part
thereof may be allocated to any person,
(c)
the nature of any payment or other amount may be recharacterized,
and
(d)
the tax effects that would otherwise result from the application
of other provisions of this Act may be ignored,
in determining the tax consequences to a person as is reasonable
in the circumstances in order to deny a tax benefit that would,
but for this section, result, directly or indirectly, from an
avoidance
245(6) Where with respect to a
transaction
(a)
a notice of assessment, reassessment or additional assessment
involving the application of subsection (2) with respect to the
transaction has been sent to a person, or
(b)
a notice of determination pursuant to subsection 152(1.11)
has been sent to a person with respect to the transaction,
any person (other than a person referred to in paragraph
(a) or (b)) shall be entitled, within 180 days
after the day of mailing of the notice, to request in writing
that the Minister make an assessment, reassessment or additional
assessment applying subsection (2) or make a determination
applying subsection 152(1.11) with respect to that
transaction.
245(7) Notwithstanding any other
provision of this Act, the tax consequences to any person,
following the application of this section, shall only be
determined through a notice of assessment, reassessment,
additional assessment or determination pursuant to subsection
152(1.11) involving the application of this section.
245(8) On receipt of a request by a
person under subsection (6), the Minister shall, with all due
dispatch, consider the request and, notwithstanding subsection
152(4), assess, reassess or make an additional assessment or
determination pursuant to subsection 152(1.11) with respect to
that person, except that an assessment, reassessment, additional
assessment or determination may be made under this subsection
only to the extent that it may reasonably be regarded as relating
to the transaction referred to in subsection (6).
the positions of the parties
[34] The
Appellants take the position that they purchased interests in a
subsisting partnership, Klink, whose business was moved from Ohio
to British Columbia, and which then became subject to Canadian
tax laws, and that their primary reason for doing so was their
desire to carry on a computer leasing business in common with a
view to profit. They point to evidence of an existing computer
leasing business being carried on by Klink since November 1982,
and during December 1991 and January, February and March 1992.
This, they say, satisfies the requirements of the first and third
issues as I have outlined them above. The Appellants also take
the position that even if the transactions were avoidance
transactions, there was no misuse of a section of the Act,
nor any abuse of the provisions of the Act read as a
whole, because the terminal loss claimed by Klink is specifically
provided for by sections 13 and 20 of the Act, together
with Regulation 1100. For this reason, they argue,
they succeed on the second issue; and for the same reason, even
if the transactions were avoidance transactions, section 245
does not apply because of subsection (4).
[35] The
Respondent's position is that the Klink partnership ceased to
be a partnership on December 13, 1991, when a 98% interest was
acquired by Hutton and Nova, or alternatively, on December 20,
1991, when the Victoria group acquired their interests from
Hutton and Nova. This position is predicated on a view of the
evidence that none of Hutton, Nova or the members of the Victoria
group had any intention of carrying on business in common with
the others with a view to profit. What they purchased, it is
said, was simply interests in common in the one partnership asset
owned by Klink in December 1991, the computer. It had a value of
$7,000(US), and it was under a lease which would produce
$14,133(US) for the month of December and $100(US) for each of
the ensuing three months. This, the Respondent says, is not a
business.
[36] The
Respondent also argues, in the alternative, that if there was a
subsisting partnership there is nevertheless no entitlement to
claim capital cost allowance in respect of the computer, and so
no entitlement to claim a terminal loss on the disposition of it.
This argument is put on two bases. The first is that by
December 1991 the computer had been fully depreciated
pursuant to the tax laws of the United States. The second is that
the computer was not acquired for the purpose of gaining or
producing income.
[37] Finally,
the Respondent relies on section 245 of the Act, arguing
that the Appellants' only purpose in acquiring the
partnership interests in Klink was to obtain a tax benefit, and
that for the Appellants to obtain that benefit would result in
misuse of a provision of the Act, or in an abuse of the
provisions of the Act read as a whole. Section 245 should,
therefore, be applied to nullify the effect of the transactions
and disallow the deduction by the Appellants of the terminal
loss.
the partnership issue
[38] The
Appellants take the position that Klink survived the sale of a
98% interest to Hutton and Nova, and the subsequent resale of
interests totalling almost 94% to the Victoria group. They rely
on the Supreme Court's judgment in Continental Bank
Leasing Corp. v. Canada.[4] There Bastarache J., whose reasons on this point
were adopted by the majority of the Court, makes it clear that,
sham aside, whether a partnership exists is a matter that must be
determined by an examination of the facts and circumstances of
each case to determine whether the essential ingredients of a
partnership are to be found. Partnership is a relationship that
subsists among persons carrying on a business in common with a
view to profit. The essential ingredients, then, are "...
(1) a business, (2) carried on in common, (3) with a view to
profit".[5]
[39] Counsel
for the Respondent relied heavily on the fact that in December
1991 only a short period remained unexpired on the lease of the
computer for the proposition that there was no business carried
on by Klink after December 13, 1991. However, it seems clear from
the decision in Continental Bank Leasing that despite the
short duration of potential income production remaining, the
relatively small amount of income to be produced, and the
completely passive nature of the earning process, a business
existed until the end of the term of the lease.
[40] Was that
business carried on in common? And if so, was it with a view to
profit? I am not able to examine the terms of the Partnership
Agreement to see if it contains "the type of provisions
typically found in a partnership agreement" to which
Bastarache J. referred in Continental Bank Leasing[6] because it was not
put into evidence. All that is in evidence is the amending
agreement of December 20, 1991, which was executed in order to
implement the transactions of that date and admit the Victoria
group as partners. There is also evidence that the
post-December 20, 1991 revenue to ILP from the lease of the
computer was $16,194. Against this was charged depreciation of
$15,000 (30% of $50,000) and professional fees of $14,458,
producing a net loss of $13,264.
[41]
Mr. Langdon was made managing partner at a meeting held
immediately after the closing took place.[7] The relationship (for partnership is
not an entity but a relationship) between the United States
partners who continued to hold a 2% interest among them, and the
"new partners" who had bought 98% is unexplained. It is
difficult to see how they can be said to be "carrying on
business in common". None of the U.S. partners gave
evidence. Nor was there any evidence as to the terms upon which
they sold a 98% interest in Klink to Hutton and Nova. They were
the owners of a computer which, but for the four remaining lease
payments, had reached the end of its useful life. It was fully
depreciated, and had a value of $7,000(US). There is evidence
which satisfies me that they retained a 2% interest only because
one of the lawyers involved in advising the Canadian purchasers
expressed concern that unless some interest remained with the
U.S. owners Klink might, as a matter of law, cease to exist.
There is no evidence before me as to what advice, if any, was
given to those U.S. partners. In these circumstances I am not
prepared to infer that they had an intention to carry on business
in common with Hutton, Nova, and the Victoria group, and in doing
so to assume potential liability for any indebtedness which that
group might incur. Nor could any of the partners, old or new,
have expected profits. The operating loss for the period from
December 20 to 31 was entirely predictable. It was also known
that the computer was obsolete, and had no prospect of earning
any revenue in North America after the expiry of the existing
lease.
[42] In
addition to the six Appellants, Hutton, Nova, Eng, Rozon and
Clarke, all acquired interests in Klink in December 1991. Only
Mr. Langdon and Mr. Young gave evidence. Mr. Langdon said in his
evidence that he was motivated to purchase his 1.10654% interest
in Klink entirely by the prospect of participating in the
business of a data processing centre to be established in Eastern
Europe. He did agree, however, that he was aware of the potential
tax advantage to be had from the claimed terminal loss arising on
the disposition of the computer to ILP on the same day that he
and the other members of the group purchased their interests.
Mr. Young was somewhat more candid; he admitted that the tax
loss to be generated in Klink was a motivating factor. He
insisted, however, that the major motivation was the opportunity
to participate in the then emerging Eastern European market by
establishing a data centre there. For the reasons that follow, I
do not believe their evidence on this point.
[43] The fact
that these nine taxpayers paid $320,000 for somewhat less than
full ownership of a partnership whose only asset was a computer
which had a value of $7,000(US) obviously calls for some
explanation. The rationale offered by the two members of the
group who testified was that they were not simply buying the
computer, but they were buying access to Roger Belanger's
expertise, and to his business connections, which would provide
them with the opportunity to participate in the data processing
business in Eastern Europe. They also said that they were paying
for the covenant of Nova to assist in remarketing the computer.
This explanation makes no sense. They made no investigation into
the value of the computer before purchasing; they made virtually
no investigation of the bona fides, the experience or the
capabilities of Mr. Belanger. If they believed that
Mr. Belanger had the business experience and acumen that he
claimed, which I doubt they did, that belief must surely have
been dispelled by the first business plan that he produced. These
Appellants are not naive; I do not believe that any of them would
have been taken in for even a short while by the kind of
documents that Mr. Belanger was producing. Certainly the two
who testified before me would have known better. Mr. Langdon
was emphatic that, along with the computer, the group was paying
for both the knowledge and experience of Mr. Belanger and his
concept for a data centre in Eastern Europe, yet he, a chartered
accountant, could not explain how the price of $320,000 had been
arrived at, and his "due diligence" in respect of
Mr. Belanger was, at best, cursory. Nothing in the evidence
explains why anyone would pay even a nominal amount for
Nova's covenant to assist.
[44] Taxpayers
are, of course, free to structure their affairs in whatever way
they choose. The legal effect, however, is determined according
to the facts. The transactions of December 13 and December 20,
1991, whereby the Victoria group acquired 93.5% of a partnership
whose only asset was a nearly worthless computer with a large
historical cost, and then caused that partnership to acquire a
50% interest in another partnership, and to convey the computer
to that second partnership at a price having no basis in the
evidence, also calls for some explanation. The explanation
offered is that the Klink partnership had a "presence"
in Ohio, and so Interfin would be more comfortable dealing with
it than with strangers, and that the partnership provided the
group with an existing legal structure. The ILP partnership, they
said, provided incentive to Belanger to produce results for them.
These explanations do not stand scrutiny. The purchasers
certainly did not intend to carry on business in Ohio, or
anywhere in the U.S. Mr. Belanger knew perfectly well
throughout who the new owners were. Nothing in the evidence
suggests that any of the U.S. partners would have any continuing
interest, except nominally holding 2% to satisfy the lawyers'
technical concerns about the law of partnership.
[45] Equally
troubling are the failure of the other members of the Victoria
group to testify, and the failure of the Appellants to call Mr.
Hutton, Mr. Belanger, or any of the several people who worked for
them and had a part to play in this matter from time to time. No
evidence was offered to suggest that any of them were unable to
testify. There was some evidence that Mr. Belanger recovered
successfully from his surgery; there was no evidence to explain
his absence from the trial, nor was any application made to take
his evidence by commission in the United States. Counsel for the
Appellants sought to deal with these omissions by showing that
the Revenue Canada assessor had not himself investigated either
Mr. Belanger or the Eastern European market for data
processing, and by arguing that he was under an onus to do so.
Mr. Cadman relied upon the statement of Gonthier J., speaking for
a unanimous Court, in Corporation Notre-Dame de Bon-Secours v.
Communauté urbaine de Québec et al.,[8] where he said:
It should at once be noted that there is a risk of confusion
between the rule that a taxing provision is to be strictly
construed and the burden of proof resting upon the parties in an
action between the government and a taxpayer. According to the
general rule which provides that the burden of proof lies with
the plaintiff, in any proceeding it is for the party claiming the
benefit of a legislative provision to show that he is entitled to
rely on it. The burden of proof thus rests with the tax
department in the case of a provision imposing a tax obligation
and with the taxpayer in the case of a provision creating a tax
exemption. It will be noted that the presumptions mentioned
earlier tend in more or less the same direction. This explains
why these concepts have been at times superimposed to the point
of being confused with each other. With respect, they are
nevertheless two very different concepts. In any event, the rule
of strict construction relates only to the clarity of the wording
of the tax legislation: regardless of who bears the burden of
proof, that person will have to persuade the court that the
taxpayer is clearly covered by the wording of the legislative
provision which it is sought to apply.
There the Supreme Court was considering an exempting provision
of a provincial statute concerned with municipal taxes.[9] It was settled by the
Supreme Court of Canada some 75 years ago that in appeals from
assessments to income tax the onus of proof as to the inquiry
into the facts of the case rests with the Appellant: Anderson
Logging Co. v. The King.[10] This principle remains as valid today as it was
then: Hickman Motors Ltd. v. Canada.[11]
[46] I reject
the proposition that the Minister's assessor must investigate
at first hand every improbable explanation offered by taxpayers
for transactions which, on their face, appear much more
consistent with tax avoidance than with commercial enterprise, by
travelling the globe to seek out witnesses who might shed light
on the taxpayer's real intentions. That is the
Appellants' burden, and no credible evidence was led before
me to shift it to the Respondent. I infer from the absence of any
evidence from either Hutton or Belanger that their evidence would
not have been of any assistance to the Appellants. I draw the
same inference with respect to the Appellants Duncan and Eden,
and the other members of the Victoria group.[12] My conclusion on this point is
that the Appellants did not intend to carry on any business
involving the Klink computer. They simply intended to create a
large tax loss for themselves at a relatively modest cost. The
meetings held and the memoranda generated after December 20,
1991, and much of what was written before that date, were simply
window-dressing designed to create the illusion of an intention
to carry on a business in common, with a view to profit. The
Appellants never had any such intention.
[47] In my
view, the Klink partnership came to an end on December 13, 1991
when a 98% interest passed to Hutton and Nova. If I am wrong in
that, then it came to an end on December 20, 1991 when a 93.5%
interest was assigned to the Victoria group.
[48] In view
of this conclusion it is not necessary to decide whether the
business of Klink was moved from Ohio to British Columbia as the
Appellants contended.
[49] The
conclusion that the Klink partnership did not survive the
transactions which took place in December 1991 leads to the
conclusion that it could not suffer the terminal loss that is
claimed to be the result of the disposition of the computer. This
in turn leads to the conclusion that the Minister's
assessments are correct, and the appeals must be dismissed.
However, in case a higher Court should disagree with my
conclusion as to the termination of Klink as a partnership, I
shall now consider the remaining issues. In doing so, I shall
assume that the Klink partnership survived the transactions of
December 1991.
the cca issue
[50] If Klink
was a valid subsisting partnership at the end of its fiscal
period which coincided with the calendar year 1991, then
subsection 96(1) of the Act required it to compute its
income, or non-capital loss, for the year as if it were a
separate person resident in Canada. The only depreciable property
that it owned during 1991 was the computer. Its undepreciated
capital cost is governed by paragraph 13(21)(f), which, so
far as it is relevant here, provides that:
"undepreciated capital cost" ... means ... the
amount by which the aggregate of the capital cost to the taxpayer
of each depreciable property of that class acquired before that
time ... exceeds ... the total depreciation allowed to the
taxpayer for property of that class before that time ...
[51] The
capital cost to Klink, converted to Canadian currency, was its
historical cost of $4,536,940. Counsel for the Respondent argued
that the proper deduction from this for "... total
depreciation allowed to the taxpayer ..." is the
depreciation allowed pursuant to the United States tax laws. It
is not disputed that the computer had been fully depreciated
pursuant to those laws, as well as for accounting purposes.
Moreover the evidence clearly shows that by December 1991 its
market value was $7,000. The Respondent therefore takes the
position that the undepreciated capital cost should be zero.
[52] Counsel
for the Appellants argued that this ignores the statutory
definition of "total depreciation". Paragraph
13(21)(e), so far as it is relevant here, defines
"total depreciation" allowed to a taxpayer to mean:
an amount deducted ... by the taxpayer by reason of paragraph
20(1)(a) in respect of property of that class or an amount
deducted under subsection 20(16) ... in computing his income for
taxation years ending before that time;
[53] Klink has
never computed income pursuant to the Canadian Act prior
to 1991. It therefore has never deducted any amount by reason of
paragraph 20(1)(a), or under subsection 20(16). The
undepreciated capital cost of the computer in its hands,
therefore, is the full historical cost, $4,536,940, with no
deduction. There can be no doubt that this line of reasoning,
while applying literally the plain words of the Act, leads
to an anomalous result. Klink's entitlement to calculate a
terminal loss on the basis of the total historical cost of the
computer, after fully depreciating it both for accounting
purposes and under the U.S. tax laws, is certainly inconsistent
with the object and spirit of the provisions of the Act.
As paragraph 20(1)(a) shows, the provisions dealing
with capital cost allowance, including terminal losses, are
intended to account for the consumption of capital in the income
earning process. It was not Parliament's intention to provide
the opportunity to permit the manufacture of non-capital losses
by the acquisition of an interest in a foreign partnership having
capital assets that have been fully depreciated.
[54]
Nevertheless, the words of paragraphs 20(1)(e) and
(f) and subsection 20(16) are not ambiguous, and must be
applied: Shell Canada Ltd. v. Canada.[13]
[55] It
follows that if Klink had continued to exist as a partnership
then the Appellants would have been entitled to succeed on the
second issue.
gaar
[56] Again on
the assumption that I am wrong in respect of the first issue, I
turn to consider the application of section 245 of the
Act. The following questions arise.
(i)
But for the application of section 245, would the
December 20, 1991 transactions have resulted in a tax
benefit to the Appellants?
(ii)
If the answer to the first question is yes, may the transactions
reasonably be considered to have been undertaken or arranged
primarily for bona fide purposes other than to obtain the
tax benefit? and
(iii) If
the answer to question (i) is yes, and the answer to question
(ii) is no, did the transactions, result directly or indirectly
in a misuse of the provisions of the Act, or an abuse of
the provisions of the Act as a whole?
[57] It was
not disputed by either of the Appellants who testified, or by
their counsel in argument, that the December 20, 1991
transactions gave rise to a substantial tax benefit to them in
the form of their share of the Klink loss, which was attributable
almost entirely to the terminal loss claimed on the disposition
of the computer. Without the acquisition from Hutton and Nova of
the partnership interests in Klink, and without the disposition
of the computer to ILP for $50,000 (an amount arrived at
arbitrarily), there could have been no terminal loss to attribute
under section 96 of the Act, and so no non-capital loss
for the Appellants to include in the computation of their incomes
under section 3 of the Act. In fact, the Victoria
group among them secured non-capital losses totalling $4,152,700
(93.5% of $4,441,390) at a cost to them of $320,000, or 13 ¢
per dollar. Clearly the answer to question (i) is
"yes".
[58] I have
already concluded at paragraphs 42 to 47 above that the
Appellants had no intention of carrying on any business involving
the use of the computer, but intended simply to derive a tax
advantage through the artificial creation of a terminal loss on
the disposition of it to ILP. Strayer J.A. said in The Queen
v. Wu:[14]
In this connection we refer to the decision of this Court in
H.M. v. Placer Dome Inc., decided after the trial judgment
in the present case. The provision in question in that case,
subsection 55(2) of the Income Tax Act, required for
its application that "one of the purposes" be to
support a significant reduction in capital gain realized. It did
not contain the words "may reasonably be considered that ...
". This Court, for purposes of decision, assumed, without
finding, that the test was subjective. But it was held that in
the face of the Minister's presumption that this was one of
the purposes:
the taxpayer must offer an explanation which reveals the purposes
underlying the transaction. That explanation must be neither
improbable nor unreasonable ... the taxpayer must offer a
persuasive explanation that establishes that none of the purposes
was to effect a significant reduction in capital gain.
In our view, with the additional words in subsection 15(1.1)
allowing for its application where "it may reasonably be
considered" that one of the purposes of payment is
alteration of the value of the interest of a shareholder, the
onus is even greater on a taxpayer to produce some explanation
which is objectively reasonable that none of the purposes was to
alter the value of a shareholder's interest.
[59] The
Appellants were unable to give an explanation other than tax
avoidance for these transactions which could meet the test of
being "... neither improbable nor unreasonable ..."[15] when viewed
subjectively. A fortiori they cannot do so when the
test is the objective one imposed by the words "may
reasonably be considered" that appear in paragraphs
245(3)(a) and (b). The second question must
therefore be answered "no".
[60]
Subsection 245(4) saves transactions from the reach of subsection
(2) if they do not result in "... a misuse of the provisions
of this Act or an abuse having regard to the provisions of
this Act ... read as a whole". On this issue the
Appellants rely on Husky Oil Limited v. The Queen.[16]In that case Beaubier
J. found that the transactions in question were entered into for
bona fide commercial reasons, and not to secure a tax
benefit, and so it was not necessary for him to consider
subsection 245(4). Nor does Jabs Construction Ltd. v. The
Queen[17]
assist the Appellants. In that case the taxpayer gifted certain
properties which had appreciated in value to a charitable
foundation to which it was related, designating the adjusted cost
base to be the proceeds of disposition. The foundation then sold
the properties at arm's length, realizing a substantial
capital gain which was immune from taxation because of the
foundation's charitable status. The foundation then loaned a
portion of its proceeds of the sale to the taxpayer, which was
able to deduct the interest paid on the loan in computing its
income. Judge Bowman allowed the taxpayer's appeal from an
assessment made under section 245, but he did so on the basis
that the transactions in question were not avoidance transactions
within subsection 245(3). Again, subsection (4) did not have to
be considered.
[61] In
OSFC Holdings Ltd. v. The Queen,[18] I adopted the following passages
from the judgments of Judge Bonner in McNichol et al. v. The
Queen,[19] and of Judge Bowman in RMM Canadian
Enterprises Inc. et al. v. The Queen:[20]
... The transaction in issue which was designed to effect, in
everything but form, a distribution of Bec's surplus results
in a misuse of sections 38 and 110.6 and an abuse of the
provisions of the Act, read as a whole, which contemplate
that distributions of corporate property to shareholders are to
be treated as income in the hands of the shareholders. It is
evident from section 245 as a whole and paragraph
245(5)(c) in particular that the section is intended
inter alia to counteract transactions which do violence to
the Act by taking advantage of a divergence between the
effect of the transaction, viewed realistically, and what, having
regard only to the legal form appears to be the effect. For
purposes of section 245, the characterization of a transaction
cannot be taken to rest on form alone. I must therefore conclude
that section 245 of the Act applies to this
transaction.
---
To what Bonner J. has said I would add only this: the Income
Tax Act, read as a whole, envisages that a distribution of
corporate surplus to shareholders is to be taxed as a payment of
dividends. A form of transaction that is otherwise devoid of any
commercial objective, and that has as its real purpose the
extraction of corporate surplus and the avoidance of the ordinary
consequences of such a distribution, is an abuse of the
Act as a whole.
These passages were also adopted by Tardif J. in Nadeau v.
The Queen.[21]
[62] Sections
13 and 20 of the Act, together with Regulation 1100, make
provision whereby a taxpayer is allowed, when computing income
from a business, to deduct an amount as capital cost allowance.
The purpose of capital cost allowance is to reflect in the
computation of profit the diminution in value from year to year
of the capital assets used in the business. The rates of capital
cost allowance which may be charged are fixed by Regulation, and
they approximate the rates at which various capital assets are
consumed.[22] The
system whereby assets of the same class are pooled for purposes
of capital cost allowance, the terminal loss provision in
subsection 20(16), and the recapture provision in section 13, are
all there to ensure that when an asset that has been used in the
business is disposed of, an adjustment is made which will reflect
any difference between the capital cost allowance claimed during
the period that the asset was held and the actual extent to which
its value has been consumed over that period. The obvious purpose
is to ensure that in computing business income taxpayers may take
into account the cost, but only the actual cost, of capital
assets used up.
[63] In the
present case, the series of transactions which took place on
December 20, 1991 was designed and carried out to put these
provisions to a use that is totally inconsistent with their
purpose, and with the overall scheme of the Act. The
terminal loss claimed is quite unrelated to any decrease in value
of the computer resulting from its use for the purpose of earning
income. In fact the loss claimed is many times the value of the
computer when the Victoria group first acquired their interests,
and many times the price that they paid to acquire those
interests. The argument that there was no misuse or abuse
involved because the capital cost allowance claimed was
specifically provided for in the Act has no merit. It is
obvious that section 245 can never have any application if the
saving provision of subsection (4) can be invoked on that basis.
Every tax avoidance scheme depends on the application of some
section of the Act to achieve its purpose. The clear
intent of section 245 is to negative those tax avoidance
transactions which, although technically within the
Act’s provisions, are abusive in nature. The
transactions in the cases at bar are in that category. The
Minister was justified in applying section 245.
conclusion
[64] To
summarize the foregoing, the Klink partnership ceased to exist
either on December 13, 1991 with the acquisition of a 98%
interest by Hutton and Nova, or at the latest on December 20,
1991 with the acquisition from them by the Victoria group of
interests totalling 93.57381%. In either event Klink did not, as
a matter of law, exist at the time it purported to convey the
computer to ILP, and it therefore could not take the terminal
loss and distribute it under section 96 of the Act to the
Appellants and others. The appeals fail on that basis. If I am
wrong in that conclusion the appeals nevertheless must fail,
because the Minister was justified in applying section 245 of the
Act.
[65] The
appeals of each of the Appellants are dismissed. The Respondent
is entitled to costs, but with one counsel fee only for each of
senior and junior counsel. The Appellants will be jointly and
severally liable for the costs.
Signed at Ottawa, Canada, this 8th day of January, 2001.
"E.A. Bowie"
J.T.C.C.
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