Walton v. R., [1999] 1 CTC 2105, 98 DTC 1780

Bonner T.C.J.:

This is an appeal from assessments of income tax for the 1986 and 1988 taxation years. On assessment the Minister of National Revenue included in the Appellant’s income amounts calculated under section 94.1 of the Income Tax Act in respect of “offshore investment fund property” held by the Appellant.

Section 94.1 was added to the Income Tax Act in 1984. It is an antiavoidance provision which may require an inclusion in income when a taxpayer acquires or holds offshore investment fund property. Inclusion is required if it may reasonably be concluded that one of the taxpayer’s main reasons for acquiring or holding such property is to derive a benefit from underlying investments held by the fund in a manner that reduces or defers the tax that would have been exigible under Part I of the Act had those underlying investments been held by the taxpayer directly. The section was enacted as a measure designed to thwart the use of offshore investment funds which permitted taxpayers resident in Canada a complete escape from or indefinite deferral of tax on passive income.[1]

Subsection 94.1(1) reads in part:

94.1 (1) Where in a taxation year a taxpayer, other than a non-resident-owned investment corporation, holds or has an interest in property (in this section referred to as an “offshore investment fund property’’)

(a) that is a share of the capital stock of, an interest in, or a debt of, a nonresident entity (other than a controlled foreign affiliate of the taxpayer or a prescribed non-resident entity) or an interest in or a right or option to acquire such a share, interest or debt, and

(b) that may reasonably be considered to derive its value, directly or indirectly, primarily from portfolio investments of that or any other nonresident entity in

(i) shares of the capital stock of one or more corporations,

(ii) indebtedness or annuities,

(iii) interests in One or more corporations, trusts, partnerships, organizations, funds or entities,

(iv) commodities,

(v) real estate,

(vi) Canadian or foreign resource properties,

(vii) currency of a country other than Canada,

(viii) rights or options to acquire or dispose of any of the foregoing, or

(ix) any combination of the foregoing,

and it may reasonably be concluded, having regard to all the circumstances, including

(c) the nature, organization and operation of any non-resident entity and the form of, and the terms and conditions governing, the taxpayer’s interest in, Or connection with, any non-resident entity,

(d) the extent to which any income, profits and gains that may reasonably be considered to be earned or accrued, whether directly or indirectly, for the benefit of any non-resident entity are subject to an income or profits tax that is significantly less than the income tax that would be applicable to such income, profits and gains if they were earned directly by the taxpayer, and

(e) the extent to which the income, profits and gains of any non-resident entity for any fiscal period are distributed in that or the immediately following fiscal period,

that one of the main reasons for the taxpayer acquiring, holding or having the interest in such property was to derive a benefit from portfolio investments in assets described in any of subparagraphs (b)(i) to (ix) in such manner that the taxes, if any, on the income, profits and gains from such assets for any particular year are significantly less than the tax that would have been applicable under this Part if such income, profits and gains had been earned directly by the taxpayer,...

The assessments in issue were based on the holding by the Appellant during the taxation years in question of shares of a corporation resident in Bermuda, Santa Maria Enterprises Limited (“Santa Maria”). It was not suggested that the Appellant’s Santa Maria shares did not constitute property described in paragraph 94.1(1)(a) of the Act. As well, paragraph 94.1 (!)(/?) did not give rise to any dispute. The shares of Santa Maria derived their value from shares in two incorporated funds operated by the Bank of Bermuda. Virtually all of the capital of Santa Maria was invested in the two funds and Santa Maria did not carry on any other business activity. It was not argued that the shares of the two funds were not “portfolio investments” within the meaning of paragraph (b).

Section 94.1 is based on a “one of the main reasons” test. The sole issue in this appeal is whether it may reasonably be concluded in accordance with subsection 94.1(1) that none of the main reasons for the holding by the Appellant of the Santa Maria shares during the years in question was to derive a benefit from Santa Maria’s portfolio investments in the manner contemplated by the concluding part of the subsection. It was the position of the Appellant that his main reasons for investing in and continuing to hold the Santa Maria shares were to preserve his capital and to have a fund available for investment in a business which he hoped to undertake in association with a colleague named Samuel Hannan. The tax advantages of the arrangement were, the Appellant said, “number three, a pleasant result”.

Counsel for the Appellant approached the case as one which must turn on acceptance or rejection of the Appellant’s testimony regarding his subjective purpose.

The Appellant was the only witness at the hearing of the appeal. He was born and raised in Canada. He commenced his career as an engineer and businessman in this country. In 1977 he ceased to reside in Canada, took up residence in England and commenced to work there. In 1979 he moved again, this time to Brazil, where he took up residence and served as a senior executive of a large corporation. His second-in-command was Mr. Hannan, a resident of Brazil. In September 1981 the corporation for which the Appellant worked was bought out. The Appellant sold his shares and options to purchase shares in that corporation and received consideration in the amount of approximately 2.5 million dollars (U.S.). He deposited the money in an account at the Bank of Bermuda. In mid-1982 the Appellant terminated his employment in Brazil and decided to return to Canada. At that time Mr. Hannan was also considering a career change. He was looking for a business which he could purchase and manage. The Appellant was interested in participating as an investor in a venture with Mr. Hannan if the latter could find an appropriate business opportunity. It is at this point that the Appellant made the investment arrangements which continued essentially unchanged until 1989 and ultimately led to the assessing action now under appeal.

The Appellant testified that he was concerned with maintaining the value of his capital and for that reason did not want to bring it with him to Canada where the dollar was declining in value and foreign exchange controls were thought to be a possibility. Moreover, as already noted, he said that he wanted to keep his funds available for investment if he and Mr. Hannan could find an appropriate project. He discussed the matter with in- vestment managers at the Bank of Bermuda who recommended that he consult John Carson, a Toronto lawyer. The Appellant stated that he consulted Mr. Carson in order to ascertain what his Canadian tax position would be for, as he observed, he was about to return to Canada. He insisted that “corporate advice” was paramount and income tax advice was a subsidiary matter only.

The consultation with Mr. Carson resulted in a lengthy written report to the Appellant dated September 9, 1982. That report focused almost exclusively on the foreign accrual property income (FAPI) rules contained in sections 91 to 95 of the Income Tax Act. Mr. Carson appears to have taken great pains to locate the precise boundary between arrangements which attracted the tax under the FAPI rules and those which did not. Mr. Carson’s reporting letter emphasized that the FAPI rules which attribute the passive income of a controlled foreign affiliate to its Canadian shareholder do not apply if the foreign affiliate is not a “controlled foreign affiliate”.

As a result of the consultation, Mr. Carson, on behalf of the Appellant and Mr. Hannan, caused Santa Maria to be incorporated under the laws of Bermuda on September 29, 1982. The Appellant invested the 2.5 million dollar proceeds from the sale of his shares and options in Santa Maria. Mr. Hannan invested almost 2 million dollars in the company. Each of the two became owner of 50 percent of the Class “A” voting shares of Santa Maria. Each also became owner of non-cumulative redeemable preference shares of Santa Maria although not in equal proportions. The preference shares were non-voting and thus neither the Appellant nor Mr. Hannan controlled the company. For that reason Santa Maria could not be regarded as a controlled foreign affiliate of the Appellant under paragraph 95(1 )(«) of the Act. The Appellant testified that the voting shares of Santa Maria were equally divided between himself and Mr. Hannan so that the two would be able to work together as partners.

Santa Maria was an “exempt undertaking” under the laws of Bermuda, that is to say, it was exempt from existing and future Bermuda tax on its profits and capital assets. The shares of Santa Maria were held for the Appellant and Mr. Hannan by a Bermuda firm, Murdoch and Company, which provided Bermuda-resident directors and managers for Santa Maria. The directors acted on the instructions of Mr. Hannan and the Appellant given through Mr. Carson. Prior to 1990 all meetings of directors and shareholders of Santa Maria were held in Bermuda. On the basis of the central management and control test Santa Maria was resident in Bermuda. Santa Ma- ria could not be regarded as resident in Canada on the basis of place of incorporation.

Virtually all of the money invested by the Appellant and Mr. Hannan in Santa Maria was in turn invested by it in capital shares of Bermuda International Bond Fund Limited and managed shares of Bermuda International Currency Fund Limited. The two funds were open-ended investment companies incorporated under the laws of Bermuda. The manager of the funds was a subsidiary of the Bank of Bermuda. The funds earned income from investments in foreign currencies and in government bonds, treasury bills and similar high quality investments yielding fixed income. Each fund held an undertaking from the Bermuda government exempting it from income, profits and capital gains taxes until March 2006. The shares in the two funds did not entitle the holders thereof to cash dividends. Net profits of the funds were accumulated and were reflected in the price of the shares which were redeemable at prices based on the net assets of the funds.

The venture which the Appellant and Mr. Hannan hoped to find did not materialize. The Appellant stated that one enterprise which appeared to have potential was investigated by Mr. Hannan in 1983 but nothing came of it. According to the Appellant other investments were considered. The timing and extent of those investigations were not revealed. Ultimately the plans evaporated when Mr. Hannan was named Chief Executive Officer of a large Brazilian mining concern. The evidence does not indicate when this happened. Thus from the outset until 1989 virtually all of Santa Maria’s money remained invested in the two funds earning interest income, albeit indirectly.

It was admitted that if the income, profits and gains from the Bond Fund assets and from Currency Fund assets had been earned directly by the Appellant, the Appellant’s income, net taxable capital gains and federal tax payable thereon by the Appellant in 1986, 1987 and 1988 would have been, as follows:

In my view the evidence of the surrounding circumstances supports a conclusion that one of the main reason for interposing Santa Maria between the Appellant and the underlying investments was the avoidance of the tax that would have been imposed on the Appellant as a resident of Canada if he had held his pro-rata share of those investments directly. Mr. Carson’s role extended beyond offering advice. He created a structure which does not appear to have been designed solely to satisfy the objectives described by the Appellant in his testimony. The evidence does not identify any compelling reason for the selection of Bermuda as a jurisdiction for the incorporation of Santa Maria save for the availability of exempt undertaking status. No business-driven non tax reason for the use of Murdoch and Company was suggested. Initially there may have been an intention to invest the funds of Santa Maria in a business to be operated by the Appellant and Mr. Hannan if such a business could be found. There is no suggestion in the evidence however that such intention continued to exist in the years in question. The only clearly identifiable reason for the continued holding of Santa Maria shares by the Appellant during the years in question was the potential to insulate the Appellant from taxation on profits from the underlying investments. It is difficult to imagine how the capacity to accomplish tax savings of the sort set out above was a less important reason for holding the Santa Maria shares than the subjective reasons on which the Appellant relied. In Symes v. R. (1993), 94 D.T.C. 6001 (S.C.C.) lacobucci J. stated at 6014:

As in other areas of law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will be guided only by a taxpayer’s statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances.

In my view the Appellant’s recollection of the reasons which led him to acquire and to continue to hold the Santa Maria shares is imperfect. The evidence does not support a conclusion that the Minister of National Revenue erred in applying section 94.1 of the Act in the circumstances of this case.

The appeals will be dismissed with costs.

Appeal dismissed.