Continental Bank of Canada v. R., [1997] 1 CTC 13, 96 DTC 6355, [1996] 3 CTC 14

Linden J.A. (Isaac C.J., McDonald, J.A. concurring): The main issue in this appeal is whether the taxpayer, Continental Bank Leasing Corporation (Leasing), is permitted to take advantage of subsection 97(2) of the Income Tax Act}, [1] a rollover provision which, if available, would allow Leasing to dispose of assets without triggering recapture. What is involved was a purported disposition to a “partnership that immediately after that time was a Canadian partnership of which the taxpayer was a member...” Subsection 97(2) reads in full:

97(2) Notwithstanding any other provision of this Act, other than subsection 85(5.1), where at any time after November 12, 1981 a taxpayer has disposed of any capital property, a Canadian resource property, a foreign resource property, an eligible capital property or an inventory to a partnership that immediately after that time was a Canadian partnership of which the taxpayer was a member, if the taxpayer and all the other members of the partnership have jointly so elected in prescribed form and within the time referred to in subsection 96(4), the following rules apply:

(a) the provisions of paragraphs 85(l)(a) to (f) apply to the disposition as if

(i) the reference therein to “corporation’s cost” were read as a reference to “partnership’s cost”,

(ii) the reference therein to “other than any shares of the capital stock of the corporation or a right to receive any such shares” and to “other than shares of the capital stock of the corporation or a right to receive any such shares” were read as references to “other than an interest in the partnership”,

(iii) the reference therein to “shareholder of the corporation” were read as references to “member of the partnership”,

(iv) the references therein to “the corporation” were read as references to “all the other members of the partnership”, and

(v) the references therein to “to the corporation” were read as references to “to the partnership”;

(b) in computing, at any time after the disposition, the adjusted cost base to the taxpayer of his interest in the partnership immediately after the disposition,

(i) there shall be added the amount, if any, by which the taxpayer’s proceeds of disposition of the property exceed the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property, and

(ii) there shall be deducted the amount, if any, by which the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property so disposed of by him exceeds the fair market value of the property at the time of the disposition; and

(c) where the property so disposed of by the taxpayer to the partnership is taxable Canadian property of the taxpayer, the interest in the partnership received by him as consideration therefor shall be deemed to be taxable Canadian property of the taxpayer.

A. FACTS

The relevant facts of this case are as follows. The Continental Bank of Canada (Continental) was incorporated in 1977 by a special Act of Parliament. [2] The respondent Leasing was incorporated in 1981 as a wholly owned subsidiary of Continental, as part of its amalgamation with Industrial Acceptance Corporation, a large leasing and financing company. The Order-in-Council permitting this amalgamation allowed Continental to hold directly only those leases obtained in the amalgamation. Consequently, any new leases, by virtue of paragraph 173( 1 )(f) of the Bank Act, were required to be held through a subsidiary. Leasing was incorporated as this subsidiary, and following the amalgamation, all new leasing transactions were performed through it.

In the mid-1980s, Continental encountered financial difficulty and was forced to sell Leasing. The difficulties were largely occasioned by the economic sluggishness of the 1980s, which caused a decline in investor confidence in the second tier banks. When two second tier banks went bankrupt in 1985, failing investor confidence went into an even steeper decline. [3] Many investments relied upon by second tier banks, such as term deposits, were not renewed as a result, and access to money markets quickly eroded. Continental found itself in a serious predicament.

In response to this crisis, Continental ultimately decided to close its doors. In 1986, it agreed with Lloyds Bank of London to sell to Lloyds substantially all of its assets. Lloyds, however, did not want the leasing business, which meant that Continental had to dispose of Leasing by other means. Continental sent information packages to a variety of potential purchasers of Leasing. A number of bids were received, with the most favourable coming from a company named Central Capital Corporation (Central). Continental pursued negotiations with Central, which in turn made a number of successive offers to purchase Leasing. These negotiations culminated in an offer dated and accepted by Continental on October 15, 1986, which transaction, however, was later aborted.

Under the aborted transaction, Central had agreed to purchase the business of Leasing through a purchase of Leasing’s shares. The purchase price named by Central reflected certain tax considerations, the most important of which involved the depreciated value of Leasing’s assets. Over the years, Leasing had taken almost the full extent of capital cost allowance permissible on its assets. The tax value of its assets, therefore, was far below their fair market value. [4] Any sale of the assets for a price above their tax value would therefore trigger recapture. This unrealized liability factored prominently in Central’s negotiations with Continental, and was the primary reason why Central initially suggested a share purchase in its bid to acquire Leasing and its assets.

The October transaction, however, soon foundered. It had been made subject to a number of conditions, and one of these eventually led to the deal’s undoing. Central had agreed to purchase Leasing only upon being satisfied with the income tax filing position taken by Leasing in the 1986 and five prior taxation years. A due diligence review performed by Central in respect of these filings revealed a significant possible tax liability. Central asked Continental to agree to indemnify it should the liability materialize, but Continental refused. There were also some problems with the credit-worthiness of seven lessees. The parties found themselves at an impasse and the share deal died.

By mid-December, however, the parties renewed their negotiations based on a new proposal suggested by Central’s tax counsel in Calgary. Under the proposal, Central offered to purchase Leasing through a restructured transaction involving a partnership, which had as a feature the isolation of corporate liabilities. It seemed to be a convenient replacement for the defunct share transaction, because it appeared to duplicate the favourable tax consequences of the old deal while simultaneously eliminating the contingent tax liability. It also would allow the parties to take advantage of subsection 97(2). The impasse created by the due diligence review was overcome and the tax situation would be favourable.

The imaginative and sophisticated proposal was set down in a Master Agreement. This agreement generally contemplated the transfer of Leasing’s business and assets to a partnership involving Leasing and two wholly owned subsidiaries of Central. The provisions of the agreement outlined detailed steps to be taken and it was complied with by all concerned parties.

First, on December 24, 1986, Leasing purported to form a partnership with two Central subsidiaries, 693396 Ontario Ltd. and Central Capital Management Inc. Leasing then transferred its assets to the “partnership” in return for a 99 per cent interest in it. Central’s two subsidiaries each contributed cash to the partnership representing one per cent of the fair market sale value of the assets contributed by Leasing. [5] Each in turn took back a 0.5 per cent interest in the partnership.

The transfer of assets was later claimed as a partnership rollover pursuant to subsection 97(2). A central aspect of a rollover such as this is that the parties are required to elect a value for the assets transferred. The election effectively allows the parties to choose between certain tax consequences arising upon the transfer. The value elected in the present instance was the undepreciated capital cost of the assets. By electing this value, the partnership received the assets at their tax cost, and the recapture liability was effectively transferred with the assets into the partnership.

Second, on December 27, 1986, a year-end was triggered for the partnership. [6] The idea for a year-end emerged during the original negotiations over the partnership proposal. In these negotiations, representatives of the taxpayer expressed concern that the partnership “be, and be seen to be, a credible partnership where the parties actually were partners for a period of time.” [7] The parties therefore adjusted the original proposal, by extending the duration of the partnership from one day to five, [8] and by providing for an event to demonstrate that a partnership had in fact existed. The event chosen was a fiscal year-end to transpire at midnight on December 27. Also on December 27, Leasing wound up into Continental, and its 99 per cent partnership interest was transferred to it.

Third, two days later, on December 29, 1986, Continental sold this partnership interest for $130,071,985 to two numbered companies wholly owned by Central.

The Crown reassessed the taxpayer on the basis that no partnership was created. The issue was eventually brought to trial, and the Tax Court Judge decided in favour of the taxpayer. [9] To briefly summarize, the Judge found that the transaction was not a sham. It was, rather, what it purported to be, a valid, subsisting partnership into which assets were validly transferred pursuant to subsection 97(2) of the Act. Accordingly, it was a legally binding deal, and the scheme worked to defer the recapture liability. The Tax Court Judge also rejected the Crown’s arguments based on illegality and ultra vires.

The Crown appealed the Tax Court decision to this Court, arguing that a real partnership was not created so that subsection 97(2) was unavailable to the parties. This, it was argued, meant that there should be recapture in the hands of Leasing. Further, even if there was a partnership created, it was void because of illegality or ultra vires. In response to the Crown’s arguments, the taxpayer essentially relied on the Tax Court’s reasons.

B. ANALYSIS

1. Sham

In order for the sham doctrine to be applied, a Court must find an element of deceit in the way a transaction was either set up or conducted. This requirement is central to the doctrine and was stated as follows in Stubart Investments Ltd. v. R. [10] :

A sham transaction [is] ... a transaction conducted with an element of deceit so as to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a facade of reality quite different from the disguised reality. [11]

The doctrine is applied very narrowly in Canada. I agree with the Tax Court Judge that the parties here did not intend to deceive third parties, including the Minister. He stated:

If the legal relationships are binding and are not a cloak to disguise another type of legal relationship they are not a sham, however much the tax result may offend the Minister or, for that matter, the court, and whatever may be the ulterior economic motive. When something is a sham the necessary corollary is that there is behind the legal facade a different real legal relationship. If the legal reality that underlies the ostensible legal relationship is the same as that which appears on the surface, there is no sham.

Absent the essential component of deceit, the present transaction cannot be considered a sham according to current Canadian law. [12]

However, just because the transaction is not a sham, it does not necessarily follow that it was legally effective to achieve the tax savings the parties intended. As I have stated on another occasion [13] , form is important. Tax dollars can be saved by properly structuring one’s business affairs. Taxpayers are free to choose a business form that serves all their economic, including tax, purposes. Lord Tomlin’s statement in Inland Revenue Commissioners v. Duke of Westminster [14] that taxpayers are free to arrange their affairs in order to reduce their tax payable is generally still good law in Canada.

But this does not mean that, by merely presenting the Court with certain signed documents and other evidence that a particular business form was chosen, the parties have complied with the Act. Paperwork by itself, no matter how clever, detailed and thorough, is not necessarily enough. As Cartwright J. stated in Dominion Taxicab Assn. v. Minister of National Revenue [15] :

It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Act its substance rather than its form is to be regarded. [16]

Tax planning and the careful organization of one’s business affairs must be more than an intellectual game. Schemes may be designed with great imagination, but in the end they must be real. The Income Tax Act must be complied with. A business form that is used cannot be fanciful. Hence, if a partnership is chosen for a particular business purpose, the parties must, in law, create a real partnership. If property must be held for the purpose of producing income, it must really be so held. [17] If a change in control is required as part of a corporate reorganization, a real change in control must occur. In every instance, a Court will look to the “true commercial and practical nature of a taxpayer’s transactions.” [18] Where legal reality is found to be lacking, a transaction, even though it may not be a sham, may not achieve what parties may have earnestly desired. The present case is an example of this.

2. Partnership

In my view, the transaction of December 24, 1986 did not comply with subsection 97(2) because the parties did not create a valid partnership. With respect, the Tax Court Judge erred in law by relying exclusively on documents and forms and did not give proper consideration to the reality of the situation. [19] The facts as found by him should have led him to the conclusion that there was no valid partnership formed, even though the parties tried to make it appear that there was. In coming to his conclusion on this issue, the Judge asked the wrong question when he stated:

If at any point during the short participation of CBL or CB a third party were to ask CB or CBL “Are you a partner in the partnership Central Capital Leasing?” they could not be heard to say “No, we are not. Our participation in the partnership is nothing more than a camouflage to disguise a sale of assets. This whole elaborate structure is merely an exercise with smoke and mirrors designed to fool the tax department.”

The proper question is not whether the parties could deny they were partners. It is, rather, whether they met the legal requirements to form a partnership. This question can be answered only by the Court, not by third parties.

A partnership is defined in section 2 of the Ontario Partnerships Act [20] as follows:

2. Partnership is the relation that subsists between persons carrying on a business in common with a view to profit...

Partnership is a contractual relation. [21] It is, in essence, an agreement between two or more persons to run a business together in order to make profit. No person can become a partner unless that person intended, or by their conduct can be seen to have intended, to do so. This is what was meant by Duff J. when, in Robert Porter & Sons Ltd. v. J.H. Armstrong and Another, et al., [22] he stated:

Partnership arises from contract, evidenced either by express declaration or by conduct signifying the same. [23]

The existence of partnership is therefore in every case determined by what the parties actually intended. As stated in Lindley and Banks on Partnership:

[I]n determining the existence of a partnership...regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case. [24]

Intention, to be sure, may be evidenced by the express terms of an agreement, if any. It may also be demonstrated by the conduct of the parties toward each other, toward third parties, or by other circumstances sur- rounding the arrangement. What is most important is how the business was operated in reality. No single fact or document is conclusive. Rather, a Court will draw its conclusion from all the relevant circumstances.

As I have stated, form must give way in this analysis to substance. Parties can insist that they are not partners, and can still be found by a Court to be partners, based on an evaluation of all the evidence. This was the issue before this Court in Schultz v. R., [25] , where Stone J.A. stated:

It is trite to say that the express denial of a partnership, as in this case, does not of itself show that no partnership existed.... In the present case we can find no declaration to the effect that the appellants intended to carry on business as partners. However an intention to do so may be inferred from all of the surrounding circumstances and especially from the manner in which the parties conducted themselves in arranging their affairs and in transacting the business in question. [26]

The converse is also true; parties can insist that they are partners and can be held not to be. [27] . The substance of the relationship is the key. Form, though certainly important, is not enough. Nor is it conclusive that “the parties have used a term or language intended to indicate that the transaction is not that which in law it is.” [28] In my view, in this case, language and form was used to make it look like the transaction “was not that which in law it is.”

Counsel for the taxpayer, however, suggests that a partnership existed and that the elements of the partnership definition were present. There is, says counsel, a written agreement, and this agreement is said to contain terms one normally finds in a partnership agreement. There is a business operated as a revenue producing enterprise. There is, too, the evidence that the parties held themselves out as partners to third parties, and that separate bank accounts and books and records were maintained solely on account of the “partnership.”

Yet despite this array of facts, I am of the view that this was not a business carried on in common with a view to profit. The scheme lacked the necessary glue to hold it all together, which is intention. The parties must not only do in form what the statute prescribes, they must also intend it in substance, and this intention must be demonstrated on the facts. In other words, what occurred in the present circumstances as mere incidents of adopting a form of partnership cannot be seen as substantive evidence of an intention to create a partnership in fact. Hence, even if a business was transferred into the vehicle the parties called a partnership, and even if this business was claimed to be carried on in common, which I doubt it actually was, it was not run with the intention of earning profit. The parties, rather, intended to conduct a sale of assets through a device they chose to call a partnership, even though, in reality, it was not one.

The Tax Court Judge found that there was a partnership notwithstanding that in the following passage he found as a fact that the requisite intention was lacking:

One thing is clear. Notwithstanding the pious assertions of a number of witnesses that they intended to enter into a partnership with the other parties, CB’s and CBL’s [Leasing’s] intention was patently not to go into the leasing business in partnership with CC.... The whole object of the exercise was precisely the opposite — to get out of that business. The partnership was merely a means to that end. It was a structure designed to enable CB and CBL to divest themselves of the leasing assets at a tax cost roughly equivalent to that which they would have incurred on the sale of CBL’s shares. The partnership was a form of legal package which was intended to encapsulate the potential recapture which inhered in the leasing assets and ensure a capital gain to CB. [29]

[Emphasis added. I

The deal was arranged so that there would be some revenues gained from the leasing assets. Though a fiscal y ear-end of the so-called partnership was declared on December 27, 1986, and though an accounting and distribution of profits was performed pursuant to it, it does not follow that a partnership necessarily existed. Profit sharing is evidence but is not conclusive evidence of a partnership. This is made clear in subsection 3(1) of the Partnerships Act, which reads in part:

3(1) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but the receipt of such a share or payment, contingent on or varying with the profits of a business, does not of itself make him a partner in the business....

Thus, even if there was a sharing of profits, which I am not convinced there was, it is not the only or even the most important factor to consider. It is but one circumstance to be weighed in the balance of facts taken as a whole. This view is supported by the case law. In Davis v. Davis, [30] North J. stated:

[T]he receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in it, and if the matter stops there, it is evidence upon which the Court must act. But if there are other circumstances to be considered, they ought to be considered fairly together; not holding that a partnership is proved by the receipt of a share of profits unless it is rebutted by something else; but taking all the circumstances together, not attaching undue weight to any of them but drawing an inference from the whole. [31]

The Court’s duty, then, is to assess the circumstances together as a whole, not placing “undue weight” on any of them.

In the present case, a variety of circumstances, including the so-called profit sharing, must be considered. I note, first, that the idea to share profits was an afterthought when the parties originally put the deal together. Furthermore, and more importantly, Leasing was not even legally entitled to a share of profits. The first fiscal y ear-end of the partnership was fixed as midnight of December 27, 1986. But the transfer of Leasing’s interest to Continental was slated to occur, and did occur, earlier that same day. Leasing, therefore, was not even a partner at the fiscal year-end and was, therefore, not entitled to a share of the revenues paid, despite having originally received the cheque in its name.

I observe further that as regards Leasing’s involvement, the purported partnership lasted a mere three days over the 1986 Christmas holiday - a very short duration, it seems, for a very large business. While a short period of time is not determinative, the period in question was a time which ensured that no business would be conducted. It is not surprising, then, that no meetings were held during the duration of the arrangement, that no new business was transacted, and that no decisions were made by the parties. Even though rental revenues on the leasing assets were being earned during this time, they were earned as a matter of course - quite independently of any conduct of the parties, or carrying on of any business by them during the period that the purported partnership subsisted.

Consistent with these observations is that each and every “indicator” which the taxpayer suggests as evidence of a partnership was but one or another component of a sequence of transactions, all of which were agreed upon before the sequence was put into effect. The Master Agreement confirms this where it states:

A. 10. ...[A]ll parties hereto by their execution hereof confirm their intention to proceed to complete the Sequence of Transactions. [32]

Everything was prearranged by December 24, 1986 when the contracts and other documents were signed. [33] After that, nothing remained to be — and nothing in fact was — settled, transacted, bargained over or in any manner dealt with as an incident of an active business being carried on. Each prearranged step was simply followed as a matter of course. In short, there just was no business activity going on over the period the purported partnership was meant to be operating.

Another item, perhaps not important by itself, is nonetheless illuminat- ing. The formal servicing agreement between the “partnership” and a third party for operating the leasing business was not signed until February, 1987, long after Leasing and Continental had quit their involvement. Neither Leasing nor Continental had any employees of their own as of December 24, 1986. There is also evidence that the parties, if it had been legally permitted, might have backdated the transaction, the “Sequence of Events,” to November 1, 1986, the closing date of the original share deal. Instead of backdating, which for obvious reasons they could not do, they agreed that the revenues earned on Leasing’s assets during the period in question, November 1 through December 23, 1986, would be paid into the partnership. As regards this payment, Mr. Lewis testified:

A. ...[W]e were trying to replicate the October 15th agreement and that because we had to have a closing — had to have a year end, it was not possible to back-date the transaction, so what we were doing is making adjustments to simulate as if the transaction had been done on November 1st. [34]

This “simulation” is consistent with the objective of the parties to replicate the economic effects of the share transaction, that is, to give Central the benefit of the transfer as if it had occurred on the original date proposed.

Further evidence putting in doubt the existence of a real partnership is that Leasing expressly refused in the agreement it signed to warrant that “it is duly registered and qualified...to carry on the business of the Partnership.” It also refused to warrant that it “can fulfil its obligations as a Partner.” I agree with the Tax Court Judge who stated that:

It is a little surprising that anyone seriously contemplating a partnership would do so with someone who declined to represent that it could lawfully fulfil its obligations as a partner. Presumably this did not matter to CC as the arrangement was only a temporary means to an end.

In addition to each of the factors mentioned above — the contrived nature of the profit sharing, Leasing’s legal non-entitlement to a share of the revenues, the short duration, the pre-arranged nature of the events, the lack of any active business having been conducted, the date the service agreement was signed, the lack of employees, the “simulated” backdating, and the refusal to warrant partnership obligations - the testimonial evidence clearly demonstrates the lack of a bona fide partnership intention. Mr. Rattee, President and Chief Operating Officer of Continental, testified that:

A. ...I think there was a particular purpose to this series of transactions which was to enable us to achieve what we and the purchaser set out to do, as described in the letter of 15th of October. [35]

Another witness stated:

A. [S]peaking in business terms of what the objectives of the parties were, overall business, economic terms...the intention was to do a deal and sell a business. [36]

It is plain that the parties did not intend to run a business together by virtue of the arrangement they called a “partnership,” but which in reality was something else.

Indeed, they could not have carried on a partnership, because even before the so-called partnership agreement was signed, Continental had already resolved that Leasing would be dissolved pursuant to section 203 of the Canada Business Corporations Act. [37] Continental itself had already been given approval on November 1, 1986 by the Minister of Finance for its application for letters patent to dissolve its operations. On that same date, the Governor in Council had approved the sale of Continental’s assets to Lloyds Bank, thereafter restricting Continental to carrying on business only to the extent necessary to wind up its affairs. [38] In such circumstances, it has been held that where the object of an arrangement was to wind up a business, the arrangement was not a partnership. [39] In other words, the parties in such a situation simply do not intend to run a businesses as a going concern.

The arrangement, rather, was transparently just a vehicle to sell assets in a way that did not trigger certain tax consequences. The scheme — in all its complicated aspects — was really just a contract of sale. It was a replacement for the old share deal put together and brought to completion in a matter of a few days’ negotiations. In its factum, the taxpayer states:

182. ...For this reason, the parties agreed to restructure the share transaction as a partnership transaction the central purpose of which was to sell a business entity.

The Tax Court Judge found that the arrangement was but a means of transferring assets. Though the form of the legal package was called a “partnership,” in substance the package was what the parties really intended it to be, a sale. These intentions determine the matter, and “no phrasing of it by dexterous draftsmen,” to quote Lord Halsbury, “will avail to avert the legal consequences.” [40] Lacking any intention whatsoever to run a business in common with a view to profit, it cannot be said that the parties had created a partnership, even though they insisted in the documents that they had.

I find support for my view in a recent case of this Court, Hickman Motors Ltd. v. Æ. [41] In that case, a taxpayer attempted to claim capital cost allowance in circumstances where the allowance was transferred through a complicated corporate reorganization. The Trial Judge affirmed the Minister’s decision to disallow the deduction on the basis that the equipment on which the allowance was taken was not acquired and held by the taxpayer company for the purpose of gaining or producing income. That purpose was solely to gain a tax advantage, which was evidenced in part by the fact that the assets were held for only four days and then conveniently transferred after the desired tax consequence was attained. This situation resembles the present case. On appeal, Hugessen J.A. upheld the Trial Judge’s decision, stating:

[T]he intended course of action of the appellant ... was admittedly to turn such assets over to “Equipment (1985)” within five days time. While I would not wish to be taken as suggesting that there is any temporal requirement to a taxpayer’s holding of property for the purposes of earning income, the fact that this taxpayer held the property here in issue only over the period of a long holiday week-end is surely indicative of the fact that it had no intention of actually earning income from the property. For practical purposes, the roll-over from the appellant to “Equipment (1985)” might as well have occurred immediately following the winding-up of “Equipment”. The trial judge’s use of the word “notional” was appropriate.

The evidence also makes it plain that the appellant itself did not at the time treat the property which it acquired from the winding-up of “Equipment” as being a potential or actual source of income.... [42]

What this case teaches us is that where the law requires that a person intend something, this intention must be demonstrated on the facts, or a Court will simply conclude it did not exist. Hence, if a person’s sole intention in transferring a business operation into a corporate or partnership structure is to gain a tax consequence from that transfer, and that upon the happening of this tax consequence the facilitating structure is discarded or the person is removed from it, that person had in fact no intention to run the business within that structure. It follows that any intention to earn income from such business from within the structure, to adopt the Trial Judge’s characterization from Hickman, supra, can only be described as “notional.” This was put as follows in Lindley and Banks on Partnership'.

Where a partnership was formed with some predominant motive other than the acquisition of profit, e.g. tax avoidance, but there is also a real, albeit ancillary, profit element, it may still be permissible to infer that the business is being carried on “with a view to profit.” However, it is apprehended that if any “partner” entered the partnership solely with a view to being credited with a tax loss (or, formerly, a capital allowance), and it was contemplated from the outset that, whilst he remained a member of the firm, no profits (in the sense of net gains) would be derived from carrying on its business, he could not be said to have the requisite “view of profit” to qualify as a partner. [43]

In the case before me, fiscal and other elements dominated the parties intentions and compel the conclusion that they did not intend to create a genuine partnership. [44] The parties may have created certain contractual and other obligations of a legally binding nature, but these were not sufficient to create a partnership.

To conclude, the arrangement before me is not a sham, but it did not meet the requirements of the partnership definition. It accomplished a convenient sale of assets at tax cost. That was its sole purpose. The parties really intended nothing beyond that. Once certain purposes necessary to this sale were accomplished, both Leasing and Continental removed themselves from the “partnership.” In fact, they went further and caused the Partnership Agreement to be amended upon their leaving to remove any trace of their having had any involvement therein. Despite the heroic efforts to make it appear so, there was no partnership created. Subsection 97(2) was, therefore, unavailable to the parties.

3. Illegality and Ultra Vires

However, even if I found the arrangement before me to be a partnership according to the partnership definition, Leasing’s and Continental’s participation in the partnership would be legally invalid by virtue of their contravention of the Bank Act.

Paragraph 174(2)(i) of the Bank Act forbids banks from participating in a partnership in any way. That paragraph states:

174(2) Except as authorized by or under this Act and in accordance with such terms and conditions, if any, as are prescribed by the regulations, a bank shall not, directly or indirectly,

(i) acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or limited partnership;

The purpose of this prohibition seems clear enough. Because banks are entrusted with depositors’ money and with the financial affairs of their clients, they are regulated through strict controls on their capital. Controlling a bank’s capital requires that a bank’s liabilities be fixed also. Banks are therefore prohibited from participating in a partnership because of the joint and several liability which partners carry to each other. [45] By becoming a partner, a bank exposes the affairs of its clients and depositors to liabilities quite unrelated to the bank’s objects or activities, and to the full extent of those liabilities. This exposure is a public hazard. Parliament has, therefore, for the good of the public, prohibited banks, upon criminal sanction, [46] from participating in partnerships.

Here, Continental clearly participated in a partnership by allowing Leasing its wholly-owned subsidiary, to join it. This conduct violated the Bank Act. [47] This has not been contested by the parties, who appear to accept the Tax Court Judge’s conclusion:

There can be little doubt — indeed the point was not challenged — that the entry into the partnership by CBL constitutes a breach by CB of paragraph 174(2)(i) of the Bank Act. The contravention of the Bank Act is a contravention by CB in that it is an “indirect” investment or participation in a partnership by a “bank” as defined in section 2.... The words “directly or indirectly” are in my view broad enough to cover a participation in a partnership through a subsidiary that is not a bank.

What is contested, however, is the effect of the violation.

A partnership agreement, like any other contract, [48] may be rendered illegal and void either expressly through statute or by common law. In my view, the agreement in this case was made illegal and void both by statute and by common law.

(a) Partnership Act: Section 34

I am of the view that section 34 of the Partnerships Act expressly dissolves any partnership that may have been established here. This section reads:

34. A partnership is in every case dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.

Whether a violation, including a violation of section 174 of the Bank Act, makes it “unlawful” within the meaning of section 34 for members of the firm to carry on the partnership is a question of construction that must be answered in light of the purposes of section 34. This view was stated in Lindley and Banks on Partnership:

[A]lthough a statute may appear to prohibit certain activities and impose a penalty for failure to observe its provisions, it does not follow that conduct which would attract the penalty is necessarily illegal. If the statute can genuinely be classed as prohibitory, as will be the case if the penalty is imposed for the protection of the public, then such conduct will be illegal. [49]

The proper question, then, concerns whether the violation is of sufficient public concern to cause a Court to void a partnership. In order to meet this test, the statutory provision violated must be prohibitory and must be aimed at protecting the public. In the present circumstances, the Bank Act provision was clearly one meant to protect the public. Contravention of this provision, furthermore, is not an insignificant offence, for any such contravention carries a criminal sanction. The bank’s violation of the provision circumvented the public protection intended by the prohibition. It was also a criminal act. And because this violation is “expressly forbidden”, the illegality of the bank’s act, to quote Cheshire, Fifoot and Furmston, “is undoubted.” [50] It was clearly unlawful within the meaning of section 34 of the Partnerships Act.

Counsel for the taxpayer suggests, however, that the penalty prescribed by the Bank Act is in fact not “for the protection of the public.” It is, rather, for the protection of depositors, creditors, and shareholders. At paragraph 180 of its factum, the taxpayer states:

[P]aragraph 174(2)(i) of the Bank Act...is intended to protect depositors, creditors and shareholders of banks, rather than members of the public. On a true construction of the relevant provisions of the Bank Act, the $500 penalty imposed by subsection 174(17) [sic] of the Act represents what Lord Lindley has described as “the price of a licence for doing what the statute apparently forbids”, and does not compel the conclusion that the Bank was somehow incapable of becoming a member of a valid and subsisting partnership.

If I am understanding this correctly, the gist of counsel’s argument here is that violating the Bank Act, is not only acceptable, it pays. I do not agree. And I do not see the distinction counsel attempts to draw. Depositors and other clients of a bank are clearly included in the term “the public.” A depositor may be any person who walks in off the street and deposits money in the Bank. A client may be any person who has any financial dealings with the Bank. Such persons — homeowners, consumers, business persons and the like — are members of the general public, and the prohibition is clearly meant for their benefit.

Counsel further suggests that because the fine imposed by the Bank Act is insignificant, the violation giving rise to it should not make the partnership illegal. Again, I disagree. The prohibitions protect the rights and financial affairs of those who deal with a bank. At their minimum, these prohibitions allow the Superintendent of Financial Institutions to issue a cease and desist order when a violation is proved. They also allow a Court to review the validity of the offending acts. Finally, the prohibitions do not exclude the application of other statutes in respect of violations proven under them. In light of these remedies, a large fine is not necessarily required. Nor, in any event, would such a fine serve the purpose intended by the prohibitions, which is to protect a bank’s capital. It would make little sense for Parliament to jeopardize by a large fine what it has sought to protect by prohibition. Furthermore, it seems to me reasonable that Parliament knew that attaching a criminal sanction to the act of participat ing in a partnership by a bank triggered section 34 of the Partnerships Act. Any partnership, in my view, was, therefore, illegal and was dissolved ab initio.

(b) Common Law Illegality and Ultra Vires

I am furthermore of the opinion that the violation of paragraph 174(2)(i) renders invalid the participation of Leasing and Continental in the partnership because the action is both illegal at common law and ultra vires the bank. [51]

Subsections 18(1) and 20(1) are relied on by the taxpayer to offset the illegality and ultra vires doctrines. These subsections read:

18(1) A bank has the capacity and, subject to this Act, the rights powers and privileges of a natural person.

20(1) No act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act.

As to subsection 18(1), counsel for the taxpayer argues that in absence of an express provision to the contrary, paragraph 174(2)(i) does not impair the capacity of banks to enter into partnerships. As there is no such contrary provision, the argument goes, banks are free to enter into partnerships. I do not agree. Paragraph 174(2)(i) clearly states that a bank “shall not, directly or indirectly...acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or limited partnership.” These are strong words, and they admit of the widest application. The state, in short, that a bank shall not in any manner participate in a partnership. This mandatory prohibition, in my opinion, clearly limits a bank’s ability to act as though it were a natural person. This is only to be expected. It is, first, consistent with the wording of subsection 18(1). Moreover, and I will further expand on this point below, banks are creatures of statute and in this important respect are very different from an ordinary corporation incorporated under a corporations statute.

Counsel for the taxpayer also argues that subsection 20(1) renders valid, or keeps from being rendered invalid, all acts of a bank that are in violation of the Act.

I do not agree. The provision merely says that an act of a bank is not invalid by reason only that it violates the Act. The provision, by its wording, does not prohibit a finding of invalidity, but in fact contemplates that such findings can be made. Subsection 20(1) could have easily and clearly stated that all findings of invalidity are prohibited. It does not state that. In my view, the wording of the provision is wide enough to allow a Court to hold invalid some acts and, in proper circumstances, to give relief in cases where it would be inequitable to render an act invalid. The provision gives a Court discretion in granting relief and was included to protect third parties who innocently rely on a bank’s authority, or who might suffer irreparably should an act be invalidated. [52] The subsection also permits Courts to render invalid certain acts of a bank in circumstances where the Court considers it appropriate.

In considering violations, then, a Court may fashion a remedy appropriate to the circumstances. The concept of ultra vires nowadays is treated much like the common law principles of illegality. Professor Waddams explained this approach in referring to remedies fashioned for illegal contracts and those prohibited by statute:

Distinctions should be drawn, it is suggested, among the various remedies that may be sought. In each case the remedy sought should be assessed according to the policies of the statute in question. [53]

In my view, the act of entering into a partnership in this case, with the full knowledge that doing so would violate the Bank Act, and for the sole purpose of obtaining the deferral of a tax liability, is not a circumstance for which this Court should grant relief under subsection 20(1). Flagrant breaches of the law will not be ignored by this Court. Here, both Leasing and Continental had been advised by counsel that signing the partnership agreement was a violation of the Bank Act. They nevertheless signed the agreement with this knowledge and may not now be heard to ask this Court to ignore the illegality of their actions.

Counsel for the taxpayer argued that an obiter statement of the Alberta Court of Queen’s Bench should be followed in this context. In Canadian Deposit Insurance Corp. v. Canadian Commercial Bank, [54] a bank entered certain agreements with third parties which gave rise to fiduciary obligations. It was argued by parties external to these agreements that the bank thereby violated 174(2)(b) of the Bank Act, which prohibits a bank from engaging in fiduciary activities. Though Wachowich J., as he then was, did not find a violation as such, he stated that the activities, in effect, would in any event have been saved from being found ultra vires by subsection 20(1). He stated:

It seems to me that by statutorily conferring upon a bank the capacity of a natural person, no issue of ultra vires is possible in the context of third parties dealing with the bank by its charter. This is not to say that shareholders are precluded from enforcing restrictions imposed upon a bank, but rather that other parties can rely upon their dealings with the bank. With respect to illegality, the Act would appear to encompass the field in two ways. First, the Act expressly states that any contravening action by a bank is not invalid (subsection 20(1)). Second, the Act prescribes the consequence arising from a violation, that is, the Act imposes a penalty in subsection 314(1). Therefore, in my view, these two sections are a complete answer to the alleged violations of the Act raised by the unsecured creditors. [55]

I have two comments on this statement. First, it seems to me that subsection 20(1) is properly characterized as a saving provision. As Wachowich J. stated, the provision ensures that “other parties can rely upon their dealings with the bank.” The provision, in other words, is intended to keep from being rendered invalid illegal transactions where doing so would harm innocent parties who rely on the bank’s authority. In my view, apart from the statement by Wachowich J. implying that subsection 20(1) automatically makes all illegal acts valid, with which I in any event disagree respectively, the fact situation in issue in that case would be a proper one for the application of the section. The parties who entered the agreements with the bank were entitled to rely on the bank’s authority.

Second, while this statement may be appropriate to private sector corporations, it is too broadly worded as regards the Bank Act prohibitions. If every act of a bank were rendered valid by subsection 20(1), the prohibitions would serve no useful purpose. Parliament, in my respectful view, cannot be taken to have enacted useless laws. In the words of Ritchie C.J. of the Supreme Court of Canada:

This prohibition, as Chief Justice Dorion justly remarks, is a law of public policy and in the public interest...It would be a curious state of the law if, after the Legislature had prohibited a transaction, parties could enter into it, and, in defiance of the law, compel courts to enforce and give effect to their illegal transactions. [56]

I do not find that much has changed since Ritchie C.J. uttered those remarks. Though the ultra vires doctrine may be of less practical concern for non-statutory corporations nowadays, the same cannot be said for their statutory counterparts. I agree with the House of Lords when it stated:

Whenever a corporation is created by Act of Parliament, with reference to the purposes of the Act, and solely with a view to carrying these purposes into execution, I am of opinion not only that the objects which the corporation may legitimately pursue must be ascertained from the Act itself, but that the powers which the corporation may lawfully use in furtherance of these objects must either be expressly conferred or derived by reasonable implication from its provisions. [57]

On this issue, the Supreme Court of Canada underlines this view in the recent decision, Communities Economic Development Fund v. Canadian

Pickles Corp. [58] *:

[I]n spite of the general trend toward the abolition of the doctrine of ultra vires, the limited aspects of the doctrine, as seen from the above review, may be present with respect to corporations created by special act for public purposes. Not only is there a long line of cases supporting the principle, but one may argue that this protects the public interest because a company created for a specific purpose by an act of a legislature ought not to have the power to do things not in furtherance of that purpose.

In the present circumstances, I am not inclined to overlook the prohibitions listed in section 174 in the manner suggested by counsel. In my view, it is obligatory on this Court to apply the doctrine of illegality and ultra vires and to view Continental’s actions as invalid.

(c) Subsection 273(6)

The taxpayer’s counsel, in one last argument on this issue, suggests that section 174 applies only in the day to day business of a bank; it does not apply to a bank which is in the process of winding up its affairs. Rather, he argues, the bank’s activities in such situations are governed by subsection 273(6), which states:

273(6) When the Governor in Council has approved a sale agreement, the selling bank may thereafter carry on business only to the extent necessary to enable the directors to carry out the sale agreement and wind up the business of the bank.

Counsel then suggests that the partnership transaction was simply a form of carrying on business “to the extent necessary” for the bank to finalize its affairs. The partnership transaction therefore did not violate the Act.

This argument is without merit. Subsection 273(6) does not broaden the powers of banks in winding up situations — rather, it restricts them even further as they are being wound up. There is no reason to think that banks in the process of being wound up are suddenly freed from the restrictions imposed upon banks operating in the normal course of business. Banks may only carry on the business of “banking” as defined by the Act. This definition includes the prohibitions of section 174. Banks may not do more. I therefore disagree with counsel when he says that, while winding up, banks may do as they please disregarding the usual limitations on them. Furthermore, subsection 174(2) states that “Except as authorized by or under this Act,” a bank shall not do the things then listed. The plain meaning of those words is that any prohibited activity, such as participation in a partnership, will be allowed only if expressly authorized by the Act. No provision expressly authorizes a bank to enter a partnership, whether during the winding-up of its affairs or any other time.

4. DISPOSITION

This appeal will, therefore, be allowed with costs. The decision of the Tax Court Judge will be set aside and the Minister’s reassessment for the taxation year 1987 will be restored. Appeal allowed.