MFC Bancorp Ltd. v. R., 99 DTC 905, [1999] 4 CTC 2468 (TCC)

McArthur T . C.J.:

These are appeals from assessments of the Minister of National Revenue for the 1992, 1993 and 1994 taxation years. The Minister added the amounts of $8,137,982, $7,107,055 and $6,566,614 (the amounts) to the Appellant’s income for each taxation year, respectively, pursuant to subsection 56(4) of the Income Tax Act.! [1]

The Appellant, [2] a public corporation, acquired mining concessions and railway rights-of-way which it leased to a consortium of steel producers under various agreements referred to as the Royalty Assets. The Royalty Assets provided for payment of royalties (the amounts in issue) based on the tonnage of iron ore shipped from the leased lands.

Prior to trial, the Respondent abandoned reliance on subsections 56(2) and 245(2) of the Act. An agreed statement of facts reads as follows:

1. The Appellant was incorporated on June 28, 1951 as Canadian Javelin Foundries & Machine Works, Limited when it was granted letters patent under Part I of The Companies Act, 1934. A copy of the Appellant’s original letters patent is found at tab I of the Joint Book of Documents.

2. The Appellant’s name was changed to Canadian Javelin Limited on March 11, 1954.

3. On March 11, 1980, the Appellant was granted articles of continuance under the Canada Business Corporations Act. A copy of the Appellant’s articles of continuance under the Canada Business Corporations Act is found at tab 2 of the Joint Book of Documents.

4. The Appellant’s name was changed to Javelin International Limited on June 11, 1981.

5. The Appellant’s name was changed to Nalcap Holdings Inc. on August 21, 1987.

6. The Appellant’s name was changed to Arbatax International Inc. on March 27, 1996, and to MFC Bancorp Ltd. on February 19, 1997.

7. On May 26, 1956, the Newfoundland and Labrador Corporation Limited (“Nalco”) granted to the Appellant a lease (the “Nalco-Javelin Lease”) over a five square mile parcel of land (“Lot 1”) near Wabush Lake in northern Labrador for a term of 99 years less a day. A copy of the Nalco-Javelin Lease is found at tab 3 of the Joint Book of Documents.

8. On May 26, 1956, Nalco also granted to the Appellant a lease (the “Nalco Surface Lease”) of the surface rights on certain lands (Lots 2, 3 and 4) adjoining Lot I. A copy of the Nalco Surface Lease is found at tab 4 of the Joint Book of Documents.

9. On June 28, 1957, Nalco and the Appellant amended the Nalco-Javelin Lease to increase the area of the lands demised pursuant to that lease, and referred to as Lot 1, to 5.6 square miles.

10. On June 28, 1957, the Appellant granted to Wabush Iron Co. Limited (“Wabush Iron”) a sublease of a 3.36 square mile area of land comprising the east part of Lol I for a term equal to the term remaining under the Nalco-Javelin Lease, less five days. A copy of this agreement is found at tab 5 of the Joint Book of Documents.

Javelin Limited, Javelin International Limited, Nalcap Holdings Inc., Arbatax International Inc. and MFC Bancorp Ltd. are to be considered one and the same.

1 1. On June 28, 1957, the Appellant granted to Picklands Mather & Co. and

the Steel Company of Canada (“Stelco”) a sublease of a 2.24 square mile area of land comprising the west part of Lot I for a term equal to the term remaining under the Nalco-Javelin lease, less five days. A copy of this agreement is found at tab 6 of the Joint Book of Documents.

12. On June 28, 1957, the Appellant also granted to Wabush Iron a sublease of the surface rights of Lots 2, 3 and 4. A copy of this agreement is found at tab 7 of the Joint Book of Documents.

13. On June 28, 1957, the Appellant and Wabush Iron entered into the Jave- lin-Wabush Iron contract (the “Wabush Iron Contract”) pursuant to which the Appellant assigned 90% of the shares of Wabush Lake Railway Company Limited (“Wabush Railway”) to Wabush Iron and granted Wabush Iron an option in respect of its remaining shares of Wabush Railway. Wabush Railway held a right-of-way entitling it to construct and operate a railway line between Lot 1 and a railway operated by the Quebec North Short and Labrador Railway which connected to a deep-water port at Seven Islands, Quebec on the Gulf of St. Lawrence. A copy of the Wabush Iron Contract is found at tab 8 of the Joint Book of Documents.

14. On or about January 30, 1959, Wabush Iron exercised its option under the Wabush Iron Contract.

15. On September 2, 1959, Picklands Mather & Co. and Stelco each assigned their respective interests in the June 28, 1957 mining lease of the west part of Lot I (tab 6 of the Joint Book of Documents) to Wabush Iron. The Appellant and Wabush Iron then entered into an Amendment and Consolidation of Mining Leases dated September 2, 1959 consolidating the leases of the west and east parts of Lot 1. A copy of the Amendment and Consolidation of Mining Leases is found at tab 9 of the Joint Book of Documents.

16. On May 16, 1962, Nalco granted to the Appellant a mining lease over Lots 2, 3 and 4 of the Knoll Lake Area and the Wabush Mountain Area in northern Labrador for a term of 99 years, less one day. A copy of this lease is found at tab 10 of the Joint Book of Documents.

17. On May 17, 1962, the Appellant granted to Wabush Iron a sublease (the “Knoll Lake Mining Lease”) over Lots 2, 3 and 4 of the Knoll Lake Area and the Wabush Mountain Area for a term of 99 years less five days. A copy of the Knoll Lake Mining Lease is found at tab 11 of the Joint Book of Documents.

18. On February 22, 1991, 395848 B.C. Ltd. (“395848”), a wholly-owned subsidiary and nominee of the Appellant, purchased 8,897,800 common shares (the “West F.C. Shares”) in the capital of F.C. Financial Corp. (“West F.C.”) from Hi-Lo Holdings Ltd. in accordance with the terms of a letter agreement dated February 18, 1991. The West F.C. Shares constituted 51% of the issued and outstanding common shares of West F.C. A copy of the February 18, 1991 letter agreement is found at tab 12 of the Joint Book of Documents.

19. Immediately prior to the acquisition by 395848 of the West F.C. Shares:

(a) West F.C. was the legal and beneficial owner of 10,097,341 common shares in the capital of Elisway Limited (“Elisway”), which shares constituting all of the issued and outstanding common shares in the capital of Ellsway.

(b) Ellsway was the legal and beneficial owner of all of the issued and outstanding shares in the capital of Harfree Holdings Limited (“Harfree”).

(c) Harfree was the legal and beneficial owner of 9,955 common shares and 86,000 preferred shares of Constitution Insurance Company of Canada (“CICC”), which shares constituted all of the issued and outstanding shares in the capital of CICC apart from 45 directors qualifying shares.

(d) West F.C. was the legal and beneficial owner of 3,842,500 common shares in the capital of CanCapital Corporation (“CJC”) which shares constituted 37.9% of the issued and outstanding shares in the capital of CJC.

(e) CJC was the legal and beneficial owner of:

(i) 4,683,500 common shares in the capital of West F.C., which shares constituted 26.9% of the issued and outstanding common shares in the capital of West F.C.

(ii) 750,000 preferred shares in the capital of West P.C., which shares constituted all of the issued and outstanding preferred shares in the capital of West F.C. The West F.C. preferred shares were convertible into 37,500,000 common shares in the capital of West F.C. at $0.80 per common share.

(iii) À $5,500,000 convertible debenture of West F.C. convertible into 1,222,222 common shares in the capital of West F.C. at $4.50 per share.

(iv) A $4,500,000 promissory note from West F.C.

(f) CJC had issued and outstanding $20,000,000 of convertible debentures, of which $15,000,000 were held by West F.C. and $5,000,000 were held by First City Trust. The CJC convertible debentures were convertible at the option of the holder into 2,424,242 common shares of CJC at $8.25 per share.

(g) CJC was indebted to Voyager Energy Inc., a subsidiary of Poco Petroleums Ltd., under a $6,240,000 demand loan due January 1, 1992.

(h) Loewen Ondaatje McCurcheon International Limited (“LOMI”) was the legal owner of 18,500,000 preferred shares in the capital of Ellsway, which shares constituted all of the issued and outstanding preferred shares of Ellsway.

20. The respective share ownership and intercorporate debt described in paragraph 19 is set out in the diagram attached as Schedule “A” hereto.

21. Under the February 18, 1991 letter agreement, it was a condition of closing that the directors of CJC other than John Fleming resign and the nominees of 395848 have been appointed directors of CJC. Concurrent with the closing of the purchase of the West F.C. Shares by 395848, the board of directors of CJC other than John Fleming resigned, and Jimmy Lee, Michael Smith and William Atkinson were also appointed directors of West F.C. At the same time, Messrs. Lee, Smith and Atkinson were also appointed directors of West F.C. At that time, Messrs. Lee, Smith and Atkinson were also directors of the Appellant.

22. At the end of December 31, 1991, the respective share ownership and intercorporate debt described in paragraph 19 above remained unchanged, save and except as expressly set out below:

(a) The number of issued and outstanding preferred shares in the capital of Elisway was 10,097,342 all of which were beneficially owned by West F.C.

(b) Ellsway was indebted to 395847 B.C. Ltd. (“395847”), a wholly-owned subsidiary and nominee of the Appellant, under a $9,250,000 demand loan.

(C) West F.C. was indebted in the additional amount of $10,097,342 to CJC.

23. The respective share ownership and intercorporate debt described in paragraph 22 as at December 31, 1991 is set out in the diagram attached as Schedule “B” hereto.

24. Pursuant to section 2.1 of an agreement dated for reference January 1, 1992 (the “Assignment Agreement”), the Appellant transferred and assigned to CJC all of its beneficial right, title and interest in and to the “Royalty Assets”, a term defined in section 1.1 (p) of the Assignment Agreement. A copy of the Assignment Agreement is found at tab 13 of the Joint Book of Documents.

25. The relevant material leases and agreements comprising the Royalty Assets as defined in the Assignment Agreement are:

(a) the Nalco-Javelin Lease found at tab 3 of the Joint Book of Documents;

(b) the Nalco Surface Lease of Lots 2, 3 and 4 found at tab 4 of the Joint Book of Documents;

(c) the June 28, 1957 surface rights sublease of Lots 2, 3 and 4 found at tab 7 of the Joint Book of Documents;

(d) the Wabush Iron contract found at tab 8 of the Joint Book of Documents;

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(e) the September 2, 1959 Amendment and Consolidation of Mining Leases found at tab 9 of the Joint Book of Documents:

(f) the May 16, 1962 lease between Nalco and the Appellant of Lots 2, 3 and 4 of the Knoll Lake Area and the Wabush Mountain Area found at tab 10 of the Joint Book of Documents:

(g) the May 17, 1962 Knoll Lake Mining Lease found at tab 11 of the Joint Book of Documents;

(h) the following amendments to the Wabush Iron Contract;

(i) a Javelin-Wabush Iron Amendment Contract between the Appellant and Wabush Iron dated January 30, 1959, a copy of which is found at tab 14 of the Joint Book of Documents;

(ii) an Amendment Agreement between the Appellant and Wabush Iron dated September 2, 1959, a copy of which is found at 15 of the Joint Book of Documents;

(iii) an amendment to Javelin-Wabush Iron contract dated May 31, 1962, a copy of which is found at tab 16 of the Joint Book of Documents; and

(1) an Amendment of Mining lease dated November 27, 1987, a copy of which is found at tab 17 of the Joint Book of Documents, amending the Amendment and Consolidation of Mining Leases dated September 2, 1959.

The statement of facts was supplemented by the evidence of Jimmy Lee who was, during the relevant period, chairman of the board of directors and chief executive officer and a trustee of Asiamerica Equities which effectively owned an 86% interest in the Appellant through a wholly-owned subsidiary. He was also a director of the Appellant and CanCapital Corporation (CJC).

Mr. Lee offered a brief history of Canadian Javelin (Javelin). After a chance meeting on an airplane, John C. Doyle, then president of Javelin, and Joey Smallwood, the premier of Newfoundland, commenced discussions that led to Javelin’s obtaining certain mining concessions and railway rights in the Wabush area of Labrador. Javelin did not have the resources to develop these lands that were rich in iron ore deposits. Through a series of subleases and agreements, it made the lands available to a consortium of steel producers that included Picklands Mather & Company, the Steel Company of Canada (Stelco) and Dofasco. Mr. Doyle and Javelin became embroiled in legal controversies in Canada and the United States which led to his moving his business operations to Panama. He directed Javelin to incorporate some 20 subsidiary companies from locations in Panama, none of which have relevance to these appeals.

In the mid-1980s, Javelin was placed into receivership. When it emerged from receivership, Asiamerica Equities [3] obtained effective control. At the time of take-over, it had approximately $16,000,000 in accumulated cash, $11,000,000 of which was eventually paid to the Province of Newfoundland. Although Javelin owned many subsidiaries involved in mining and oil and gas explorations in Canada and other countries, the only assets of consequence during the relevant period were the lucrative subleases for the Labrador lands from which it continued to receive substantial royalty payments.

In 1991, a wholly-owned subsidiary of the Appellant purchased a 51% interest in F.C. Financial Corp. (West F.C.) which beneficially owned 37% of CJC. Ostensibly, the acquisition was made to become a beneficial owner of Constitution Insurance Company of Canada (CICC). CJC was a troubled corporation with approximately $60,000,000 in income losses and substantial debt. Mr. Lee testified that the Wabush leases were transferred to CJC to give it financial support and which would protect the assets of CJC. The Nalcap — CJC agreement that transferred the Royalty Assets was dated January 1, 1992. An independent appraiser valued the Royalty Assets at $36,000,000. [4] The Appellant’s sale price to CJC was $30,000,000.

Since 1992, all Royalty Assets from the Appellant have been deposited to CJC’s account. Dividends from CJC in favour of the Appellant have been accumulated but not paid. Mr. Lee stated that the Appellant was advised that the payment of dividends by CJC to the Appellant would attract tax and for this reason, dividends have not been paid. The Appellant’s counsel is of the opinion that such dividends could flow tax-free. Mr. Lee denied that the purpose of the transfer of the Royalty Assets was to take tax advantage of the $60,000,000 losses in CJC.

With regard to the Appellant’s activities during the relevant period, I find that it acted as a holding company that had six or fewer employees who were administrative staff and were occupied particularly during the period from 1986 to 1991 with defending law suits. The Appellant did not incur any exploration or development expenditures. While the Appellant did not have any geologists, engineers or mining consultants on staff, it did contract services of the same. The Appellant was not granted any exploration licenses or permits during the period 1989 through 1994.

It is clear that the Appellant did not have de jure control over CJC and the Appellant and CJC were not “related parties” for purposes of the Act. At the time of the Nalcap — CJC Agreement, the Appellant owned a 38% minority interest in CJC. [5] The Nalcap - CJC Agreement was subject to the approval of the majority of the “disinterested” shareholders of CJC. The exercise price payable in respect of the shares to be acquired under the CJC Debenture was $8.25 per share. The trading price of the CJC shares quoted on the Toronto Stock Exchange in January 1992 ranged between $.02 and $.50 per share.

The Minister relied exclusively on subsection 56(4) which has two tests to be satisfied, namely, the beneficial entitlement test and the arm’s length test. Subsection 56(4) of the Act reads in part as follows:

56(4) Where a taxpayer has, at any time before the end of a taxation year ... ,

transferred or assigned to a person with whom the taxpayer was not dealing at arm’s length the right to an amount ... that would, if the right thereto had not been so transferred or assigned, be included in computing his income for the taxation year, ... the amount ... shall be included in computing the taxpayer’s income for the year unless the income is from property and the taxpayer has also transferred or assigned the property.

The Appellant’s strongest argument was with respect to beneficial entitlement. Even if the Court concludes that at the time the Appellant transferred a “right to an amount” to CJC and the parties were not dealing at arm’s length, subsection 56(4) could not have application in the present circumstances, “if the right had not been so transferred or assigned”. It is the Appellant’s submission that this precondition to the application of subsection 56(4) is not met in the present circumstances.

The Appellant submitted that after January I, 1992, it had no entitlement to receive any payments due under the Royalty Asset Agreements. From that date onwards, CJC was beneficially entitled to the payments by virtue of its beneficial ownership of the leases and other agreements comprising the Royalty Asset Agreements.

Counsel for the Appellant repeated that even if the Court finds that the preconditions are met, subsection 56(4) does not apply since the income that is being attributed to the Appellant is “from property”, namely the Roy- alty Asset Agreements, and the Appellant transferred or assigned that property.

With respect to the arm’s length test, the Appellant adds that it is important to note that Nalcap was not in a position to control the board of CJC. In fact, the directors of CJC which approved the Nalcap/CJC Agreement were those who had been elected as a slate by the shareholders of CJC at its annual shareholders meeting. The arm’s length nature of the Nalcap/CJC Agreement is demonstrated by the procurement and delivery of the Semeniuk valuation [6] and the approval sought and obtained from the majority of the shareholders of CJC, other than West F.C., for the transaction.

Respondent’s Position

The Respondent submits that subsection 56(4) applies in that the Appellant and CJC were not dealing at arm’s length and the Royalty income would have been included in the Appellant’s income had it not been transferred to CJC. The Respondent adds that no property was transferred to CJC within the meaning contained in the exception in subsection 56(4).

Analysis

For the reasons that follow, I conclude that the appeal should be allowed. While I find that the Appellant and CJC were not dealing at arm’s length, the Appellant falls within the exclusionary words of subsection 56(4). The Royalty income is from property and that property was transferred by the Appellant to CJC.

The issue is resolved upon the application of subsection 56(4) to the present circumstances. It provides that where a taxpayer has transferred to a person (with whom he was not dealing at arm’s length) the right to an amount, such as the Royalty payments, which amount would otherwise have been income of the taxpayer, such amount shall be included in the taxpayer’s income. Had subsection 56(4) ended at this point, the Respondent would be successful. However, there is an exception to this rule which applies to the present circumstances. It arises where the income is from property and the taxpayer has also transferred that property.

I will first deal with the issue of arm’s length. For subsection 56(4) to apply, the transfer must be between the Appellant taxpayer and a person with whom he is not dealing at arm’s length. Both parties acknowledge that the Appellant did not have de jure control of CJC and they were not related persons as envisaged in section 251 of the Act. For parties not so related, paragraph 251 (1)(b) states:

251(1) For the purposes of this Act,

(b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm’s length.

In determining whether persons are at arm’s length, the facts surrounding their relationship must be ascertained. The meaning of “arm’s length” within the Act is a questions of law.’ [7] In RMM Canadian, Bowman J. considered the expression arm’s length and quoted Bonner J. in McNichol v. R. [8] who stated at pages 117 and 118 of that decision:

Three criteria or tests are commonly used to determine whether the parties to a transaction are dealing at arm’s length. They are:

(a) the existence of a common mind which directs the bargaining for both parties to the transaction,

(b) parties to a transaction acting in concert without separate interests, and

(c) “de facto" control.

The common mind test emerges from two cases. The Supreme Court of Canada dealt first with the matter in M.N.R. v. Sheldon’s Engineering Ltd. At pages 1113-14 Locke J., speaking for the Court, said the following:

Where corporations are controlled directly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm’s length. Apart altogether from the provisions of that section, it could not, in my opinion, be fairly contended that, where depreciable assets were sold by a taxpayer to an entity wholly controlled by him or by a corporation controlled by the taxpayer to another corporation controlled by him, the taxpayer as the controlling shareholder dictating the terms of the bargain, the parties were dealing with each other at arm’s length and that subsection 20(2) was inapplicable.

The decision of Cattanach J. in M.N.R. v. TR Merritt Estate is also helpful. At pages 5165-66 he said:

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same mind that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm’s length. In other words where the evidence reveals that the same person was “dictating” the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.

The acting in concert test illustrates the importance of bargaining between separate parties, each seeking to protect his own independent interest. It is described in the decision of the Exchequer Court in Swiss Bank Corporation v. M.N.R. At page 5241 Thurlow J. (as the [sic] then was) said:

To this 1 would add that where several parties — whether natural persons or corporations or a combination of the two — act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the “mind” that directs may be that of the combination as a whole acting in concert or that of any of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to be made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest form the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqualify the transaction as one between parties dealing at arm’s length. The Sheldon ’s Engineering case [supra], as I see it, is an instance of this.

Finally, it may be noted that the existence of an arm’s length relationship is excluded when one of the parties to the transaction under review has de facto control of the other. In this regard reference may be made to the decision of the Federal Court of Appeal in Robson Leather Company Ltd. v. M.N.R., 77 D.T.C. 5106.

Looking at the present situation, I find from the evidence that the bargaining between the Appellant and CJC was directed by a common mind. Why else would the Appellant transfer its very valuable asset to CJC? Mr. Lee, Michael Smith and William Atkinson dictated the terms of the Nal- cap — CJC Agreement. They were also directors of both corporations. When 395848, a wholly-owned subsidiary of the Appellant purchased 51% of the common shares of West F.C. who held a 38% interest in CJC, the Appellant imposed the condition that all CJC directors resign but for John Fleming, and the nominees of 395848 be appointed. The nominees were the same Mr. Lee, Mr. Smith and Mr. Atkinson. The Appellant emphasized that a majority of the shareholders voted in favour of the Nalcap — CJC Agreement. It appears that Mr. Lee decided the purchase price would be $30,000,000 rather that the appraised amount of $36,000,000.

The Appellant, Mr. Lee and CJC decided, prior to the minority shareholder vote, to transfer the Royalty Assets under their terms. Mr. Lee is an extraordinarily talented businessman and he established the sale price which was 20% less than professional evaluator’s fair market value. I am satisfied the parties were acting in concert. The purchase price was arrived at prior to obtaining the valuation report. There is no doubt that the Appellant was well aware of the financial rewards in obtaining access to CJC’s losses by providing CJC with a source of income. This approach strengthens the conclusion that they were not operating at arm’s length. The Appellant argued that it was acting in the best interests of its shareholders. Bonner J. addressed a similar submission in Noranda Mines Ltd. v. Minister of National Revenue? [9] and his following comment applies to the present situation:

Counsel for the Appellant argued that Noranda and Orchan were public companies the Directors and officers of which were under a fiduciary duty to their corporations. He said that to suggest that an officer or Director of Orchan could be guided in such a way to prefer one interest over another would be to suggest that he was failing to discharge the fiduciary duty he owed to Orchan. A finding that the same mind directed the actions of both parties to the transaction does not, in my view, involve a finding that the mind was not, as regards both corporations, acting honestly, in good faith and with the best interests of both corporations In view.

Even accepting that the Appellant and CJC were acting in the best interests of both corporations, they were still acting in concert. There is no doubt that the Appellant had de facto control of CJC at the time of the transfer of the Royalty Assets in that the Appellant had the absolute right to appoint CJC’s board of directors. [10] For these reasons, I conclude that the Appellant and CJC were not dealing at arm’s length.

The Beneficial Entitlement Test

The second condition for the application of subsection 56(4) is that the amounts payable in respect of the Royalty Assets would, if the right had not been so transferred or assigned (to CJC), be included in computing the tax- payer’s income. I have no difficulty in concluding upon a simple and obvious interpretation of the plain meaning of the words above quoted that the amount would have been included in the Appellant’s income but for the transfer to CJC. The Appellant was clearly the owner of the Royalty income prior to transfer.

The Appellant relied on Shaw v. Minister of National Revenue^ [11] In that appeal, the Appellants had operated a BP service station in partnership. In 1975, they transferred all the partnership property except for the real estate, to their company. The original agreements between the Appellants and the oil company were replaced by new agreements which contained similar provisions for gallonage payments as contained under the head lease. The Court held that the transfer of the partnership property to the company included a transfer of the head lease and therefore, the right to the gallonage payments was held by the company. The Court concluded that there had been no transfer of the right to the amount because the new company already owned it. That finding by the Federal Court clearly distinguishes Shaw from the present case where I find that the Appellant was clearly the owner of the right to the amount.

Transfer of the Property Exclusion

Up to this point, the income amounts would be included in the Appellant’s income “unless the income is from property and the taxpayer has also transferred or assigned the property”. This exclusion in the final words of subsection 56(4) presents two requirements:

1. the income must be from property; and

2. the property from which the income flows must have been transferred or assigned.

The Respondent argued that the Royalty income was income from the Appellant’s business and not income from property. The Respondent cited a number of cases to support this position. [12] The income at issue is, of course, the income derived from the Royalty Assets. The Royalty Assets, as defined in the Nalcap — CJC Agreement, constitute “property” as defined in subsection 248(1). [13]

Attempting to make a distinction between income from business and income from property is difficult. That distinction has to be made because the Respondent’s position depends on it. Subsection 56(4) is an anti-avoidance section concerning the transfer of income rights. Surely, the exclusionary words “unless the income is from property” are not to be read so narrowly as to prohibit a taxpayer from benefiting from the exclusion when the income is from property which is an integral part of the taxpayer’s business. McNair J. in Shaw , supra, gives support to this statement where he stated at page 5205:

In my opinion, rent payable for the use and enjoyment of property and a lease stipulating payment of the same are both comprehended by the broad definition of property in subsection 248(1) of the Income Tax Act. I have already found that the 1975 sale agreement and the director’s resolution of January 2, 1976 and the plaintiffs’ consistent course of conduct, viewed from a practical business prospective as a matter of substance and not of form, combined to vest in Jack Shaw Enterprises Limited the benefits and obligations of the service station business, including, as part and parcel thereof, the head lease and the additional rent payable thereunder. Moreover, I consider that the oral sublease between the plaintiffs and Jack Shaw Enterprises Limited eliminates any element of doubt that the net effect of the whole transaction was to transfer the head lease and the gallonage payment rentals to the corporation, notwithstanding that there was no express formal assignment of the head lease itself. 1 am therefore of the opinion that the plaintiffs are entitled to the benefit of the exclusion contained in subsection 248(1) of the Income Tax Act.

The assignment by the Appellant of its beneficial interest in the Royalty Assets cannot be distinguished from the nature of the transfer made by the Shaws to a corporation of their interest in the BP cross-lease arrangement.

It would appear that the Respondent’s interest arose from a suspicion that the sole purpose of the transfer of the Royalty Assets was to avoid tax.

(1986), 86 D.T.C. 6526 (S.C.C.); American Leaf Blending Co. Sdn. Bhd. v. Director-General of Inland Revenue (1978), [1979] A.C. 676 (Malaysia P.C.); Supreme Theatres Ltd. v. R. (1981), 81 D.T.C. 5136 (Fed. T.D.); Fontaine Watch Co. v. Minister of National Revenue (1960), 60 D.T.C. 535 (Can. Tax App. Bd.).

Originally the Respondent resorted to the general avoidance rules [14] in section 245 which Bowman J. refers to as the “heavy artillery”. [15] The Minister expressly abandoned this route prior to the hearing of these appeals. I do not believe subsection 56(4) is designed to reattribute income where the transferor has disposed of all of the interest it had in property for fair market value with additional commercial considerations as motivating factors for the transfer. What we have here is a taxpayer, the Appellant, paying tax on somewhere in the range of $8,000,000 per year in Royalty payments. Through a series of complex manoeuvres, it obtains de facto control of a company, CJC, with $60,000,000 in losses. It transfers the right to this income and the lease agreements that gives rise to the income to CJC for the sale price of $30,000,000. Presumably, CJC can make use of its losses to offset Royalty income. Subsequent to the transfer, there is no evidence that CJC paid dividends to the Appellant which the Respondent suggests would flow tax-free. Mr. Lee stated that it was his understanding that such dividends would be taxable in the hands of the Appellant. The evidence was that CJC actually received the Royalties after the transfer. There was also the uncontradicted evidence of Mr. Lee that commercial considerations, including saving CJC from bankruptcy as a result of a debt to Voyager Energy Inc., [16] were the prime motivation.

I accept the evidence of Mr. Lee that commercial considerations were an important reason for the transfer. While I conclude that the transfer was not solely tax motivated, this conclusion does not influence my decision providing the Appellant falls within the subsection 56(4) exception. [17] Again, the key words boil down to “unless the income is from property and the taxpayer has also transferred or assigned the property”.

In the multiple lease agreement, the Appellant was entitled to exploit the Wabush Iron Mining rights upon certain contingencies. It is clear that the Appellant transferred to CJC more than a mere “right to receive amounts” which represents “property” of the Appellant. The term “property” is defined in subsection 248(1) of the Act as follows:

“property” means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

(a) a right of any kind whatever, a share or a chose in action,

(b) unless a contrary intention is evident, money,

(c) a timber resource property, and

(d) the work in progress of a business that is a profession;

Justice McNair in Shaw et al, supra, refers to the “broad definition of property in subsection 248(1)” quoted earlier. I have no difficulty concluding that the Royalty Assets are “property” as defined in subsection 248(1). This is consistent with the finding of Justice McNair in Shaw . The Appellant transferred more to CJC than a simple “right to receive amounts”. The lease agreements included revisionary interests and under certain terms, the lessor, now CJC, had the right to enter the mining business. These rights clearly represented “property” for the purposes of the Act. The income was derived from these property rights.

Were the Royalty Assets “transferred or assigned” to CJC?

Having decided that the Royalty Assets are property, was this property “transferred” to CJC? The Respondent argues that no property was transferred within the context of the exception in subsection 56(4). The Nal- cap — CJC Agreement must be referred to. Paragraph 2.1 reads:

2.1 Nalcap hereby agrees and covenants to transfer and assign to CJC all of

its beneficial right, title and interest in and to the Royalty Assets subject to the Permitted Encumbrances in consideration of an amount equal to the Final Determination, which shall be paid and satisfied by CJC as set out in Article 3 of the Agreement.

I find that the entire beneficial interest of the Appellant in the Royalty Assets was transferred pursuant to the Nalcap — CJC Agreement on January 1, 1992. After January 1, 1992, the Appellant no longer had any right to payments under the Royalty Assets and in fact, these payments were deposited to CJC’s bank account. CJC assumed the obligations under the agreements including making payments to Nalco (in effect, the government of Newfoundland). The Appellant also executed a Declaration of Trust in favour of CJC which included:

Nalcap is or will stand possessed of the Royalty Assets in trust for CJC.

Nalcap acknowledges that it has no interest in the Royalty Assets, save as bare trustee and that all monies, profits and advantages arising from the Royalty Assets will be held by Nalcap in trust for the use, benefit and advantage of CJC and that the beneficial ownership of the Royalty Assets belongs to and resides in CJC.

Nalcap agrees to account to CJC for all monies, profits and advantages realized by Nalcap from the Royalty Assets.

Since the Royalty Assets are property and have effectively been transferred, there exists no revisionary interest in favour of the Appellant. The Royalty income is excluded from the Appellant’s capital under subsection 181.2(3) of the Act. The appeals are allowed, with costs.

Appeal allowed.