Herman Fratschko v. Minister of National Revenue, [1972] CTC 506, 72 DTC 6426

Heald, J:—This is an application by Notice of Motion for an order directing and requiring the defendant in both of the above styled actions to produce and show to counsel for the plaintiffs the income tax returns for the fiscal years ending in 1964, 1965 and 1966 of an Ontario corporation known as Pelon Holdings Limited (hereafter Pelon).

These actions are tax appeals involving the 1965, 1966, 1967 and 1968 assessments of Huron Steel Fabricators (London) Limited (hereafter Huron Steel) and the 1965, 1966 and 1967 assessments of Herman Fratschko (hereafter Fratschko).

The Notice of Appeal, Statement of Defence and lists of documents have been exchanged and examinations for discovery of Fratschko, of Huron Steel’s representative and of one Sterling Adams (hereafter Adams) one of the Minister’s assessors, were held in July of this year. It was the refusal of defendant’s counsel to produce the aforementioned income tax returns of Pelon on the examination of Adams that has resulted in the bringing of this motion by the plaintiffs. In its Notices of Appeal, the plaintiffs allege the following facts:

On or about January 28, 1965, Huron Steel entered into a written agreement with Pelon whereby Pelon agreed to provide Huron Steel with certain consulting services. The term of the agreement was 260 weeks from February 5, 1965. Pursuant to the agreement, Huron Steel paid Pelon $4,800 in 1965, $5,300 in 1966, $5,200 in 1967 and $5,200 in 1968. On or about the same date, Fratschko entered into a written agreement with one Leslie Peckham (hereafter Peckham) whereby Fratschko agreed to loan Peckham $5,000 and Peckham agreed to put up his 25% common share interest in Huron Steel as collateral. Peckham defaulted under this agreement and the 25% common share interest so hypothecated by him was transferred to Fratschko on or about April 6, 1965.

Prior to January 29, 1965 one Joseph Toth (hereafter Toth) owned 37 /2% of the common share interest of Huron Steel. As stated above, Peckham owned 25% at that time and the remaining 372% was owned by Fratschko. Fratschko purchased Toth’s 37 /2% interest on or about January 29, 1965.

At issue in these appeals is the validity of the above described agreements and the payments alleged to have been made thereunder. In effect, the defendant alleges that the agreement between Huron Steel and Pelon and the agreement between Fratschko and Peckham are a sham and a subterfuge. The Minister says that Peckham and Fratschko entered into a course of conduct whereby Fratschko acquired Toth’s shares and then acquired Peckham’s shares by virtue of the above two agreements which the Minister says should be read together. The Minister says that the moneys paid under the Pelon and Huron Steel agreement are in effect a payment by Fratschko to Peckham for his 25% common share interest in Huron Steel, which had been hypothecated as security by Peckham for the $5,000 loan he received from Fratschko.

In both actions, the defendant in his Statement of Defence makes certain allegations with respect to Pelon. In the Huron Steel action, paragraph 2(c) of the Statement of Facts reads as follows:

2. He does not admit paragraph 2 of the Notice of Appeal and says that the facts which he alleges in support of the assessments are as follows:

(c) One Leslie E. Peckham (hereinafter referred to as “Peckham”), for some time prior to the 6th of April, 1965 was a shareholder and Director of the Plaintiff, and at all relevant times owned beneficially the shares of Pelon Holdings Limited (hereinafter referred to as “Pelon”).

Paragraph 2(c) of the Statement of Defence in the Fratschko action is substantially the same.

At the examination for discovery of Adams, the Minister’s assessor and representative, plaintiff’s counsel sought to question Adams on the various assumptions of fact made by the Minister in support of the subject assessments. The pertinent questions and answers relating to paragraph 2(c) of the Statement of Defence read as follows:

48. Q And then in paragraph (2)(c) you say that one Leslie E. Peckham hereinafter referred to as Peckham was some time prior to the 6th of April, 1965, was a shareholder and director of the Plaintiff and at all relevant times owned beneficially the shares of Pelon Holdings Limited. Now let’s just break that in two. You say for some time. You mean from the time of incorporation? A. That’s right.

49. Q And that the Minister refers in the fourth line to relevant times. What are the relevant times? A. Let’s put it I can’t state authoritatively but from the knowledge that I have is that he was at least a shareholder for ’63, ’64 and ’65 in Pelon Holdings.

50. Q Well this is Director of Huron Steel? A. You asked me about Pelon Holdings.

51. Q Well how do you know that, that he owned beneficially the shares of Pelon Holdings? A Well from the return of the company Pelon Holdings.

52. Q Any other source of information? A. No, there was no other source that could be located.

53. Q So that there is no other evidence you rely on in support of this allegation other than what you have now told me? A. That’s right.

57. Q Going back to (2)(c) do you have the tax returns of Pelon Holdings Limited? A. They are in the possession of the Department. They are right here yes.

58. Q They are in the possession of the Department? A. That’s right.

59. Q Will you produce them? A. No.

MR. RIP:

No we can’t produce those.

MR. GRIFFEN:

60. Q I want the record to show that I am requesting their production. I believe I am entitled to them under Section 133. A. I think the Judge at the last Appeal Court made that clear.

MR. RIP:

No, this is different. A. I know but he said—

MR. RIP:

Just a moment.

MR. GRIFFEN:

61. Q I have taken the position that they are producable and should be produced under Section 133 of the former Act under Section 241 of the present Act and all of the cases decided thereunder and I am demanding their production now.

MR. RIP:

They will not be produced at this time.

MR. GRIFFEN:

62. Q They won’t be produced without a Court order?

MR. RIP:

That’s right.

MR. GRIFFEN:

63. Q Will they be produced with the consent of Mr. Peckham in writing? A. I think not.

MR. RIP:

Well just a minute. I will say no for the moment.

The other allegation in the Statements of Defence relative to the income tax returns of Pelon is contained in paragraph 3(a) of the Statement of Defence and reads as follows:

3. In further support of the assessments, the defendant states that:

(a) Pelon provided no services of any kind or description to the Plaintiff in the years 1965, 1966, 1967 and 1968 and in fact was an inactive corporation in the years 1966, 1967 and 1968, and therefore the Plaintiff did not pay and Pelon did not receive any amount of money on account of services.

Paragraph 3(a) of the Statement of Defence in the Fratschko action contains the same allegation.

At the examination for discovery of Adams, plaintiff’s counsel questioned him concerning this allegation on pages 42 to 46 inclusive of the transcript covering questions and answers 381 to 417 inclusive. It is clear from the answers to these questions that for the purposes of the allegations of fact in paragraph 3(a) of the Statement of Defence, the defendant is relying in whole or in part on the Pelon income tax returns which he again refused to produce after being requested to do so by plaintiff’s counsel.

The defendant bases his right to refuse to disclose the said income tax returns on the provisions of subsection 41(1) of the Federal Court Act which reads as follows:

41. (1) Subject to the provisions of any other Act and to subsection (2), when a Minister of the Crown certifies to any court by affidavit that a document belongs to a class or contains information which on grounds of a public interest specified in the affidavit should be withheld from production and discovery, the court may examine the document and order its production and discovery to the parties, subject to such restrictions or conditions as it deems appropriate, if it concludes in the circumstances of the case that the public interest in the proper administration of justice outweighs in importance the public interest specified in the affidavit.

Pursuant to the provisions of said subsection 41(1) an affidavit of Elgin Armstrong, Deputy Minister, Taxation, of the Department of National Revenue was filed. The pertinent portions of said affidavit read as follows:

4. I have carefully examined the returns of income filed by Pelon Holdings Limited for its 1964, 1965 and 1966 taxation years, and each return of income comprises the corporate income tax return prescribed by the Defendant together with a balance sheet and operating statement for Pelon Holdings Limited.

5. I am of opinion that the completeness and the accuracy of the information which a taxpayer is required by law to disclose in his return of income would be prejudiced if the Defendant was required on an examination for discovery or by way or production or inspection of documents to produce or disclose returns of income and attached financial statements of persons who were not parties to the litigation.

6. I am of opinion that the practice of the Defendant in refusing to make production on an examination for discovery of the returns of income filed by persons who are not parties to the litigation is essential to the proper administration of the Income Tax Act and for the protection of the revenue.

7. On the grounds of the public interest set forth in the previous two paragraphs, I am of opinion that the returns and attached financial statements of Pelon Holdings Limited filed with the Defendant for its 1964, 1965 and 1966 taxation years are documents which belong to a class and which contain information which should be withheld from production and discovery.

Following the rationale contained in the judgment of my brother Gibson, J in the case of Churchill Falls (Labrador) Corporation Limited v The Queen,* [1] I decided to exercise the authority given to the Court under said subsection 41(1) of the Federal Court Act to examine the said income tax returns. Accordingly, the said documents were deposited with the Court in a sealed envelope and they have now been examined by me.

In my opinion, there is nothing in these particular documents which could conceivably affect adversely any public interest nor did defendant’s counsel make any such submission. As I understand his submission, it was to the effect that the whole of the class of documents, that is to say, all income tax returns of persons who are not parties to a particular litigation, should be protected for the reasons stated in the affidavit notwithstanding that no harm to any public interest will be caused by disclosure of the particular documents in a particular case.

The confidentiality of income tax returns was discussed in detail in the Supreme Court case of Regina v Snider, [1954] SCR 479; [1954] CTC 255; 54 DTC 1129. At page 483 [260, 1131], Mr Justice Rand said:

. . . The disclosure of a person’s return of income for taxation purposes is no more a matter of confidence or secrecy than that, say, of his real property which for generations has been publicly disclosed in assessment rolls. It is in the same category as any other fact in his life and the production in court of its details obtained from his books or any other source is an everyday occurrence. The ban against departmental disclosure is merely a concession to the inbred tendency to keep one’s private affairs to one’s self. Now that, in this competitive society, is a natural and unobjectionable tendency but it has never before been elevated to such a plane of paramount concern. The most confidential and sensitive private matters are daily made the subject of revelation before judicial tribunals and it scarcely seems necessary to remark on the relative insignificance to any legal or social policy of such a fact as the income a man has been able to produce. I should say, therefore, that the only privilege furnished is that given by the statute and that it is a privilege for the benefit of the individual and not the Crown.

And at page 488, Kellock, J, concurred in by Kerwin, Taschereau and Fauteux, JJ (as they then were) said:

In considering the proper answers to be given to the questions asked, it is pertinent to consider whether, in the legislation itself, parliament has indicated whether or not any secrecy, from the standpoint of the state, is to attach to documents of this class. The situation will sufficiently appear if I refer only to the provisions of the Income Tax Act (1948) 11-12 Geo VI, c 52.

By s 82(2), which deals with appeals by a taxpayer to the Income Tax Appeal Board from the decision of the Minister, it is not the Crown but the appellant who is given the right to require a hearing in camera. The present form of the section emphasizes the intention of Parliament in that the right formerly given by the previous s 68 to the Crown to require the hearing to be in camera, no longer exists. It would seem difficult to contend in the light of this legislation that any state secrecy was intended by Parliament to surround the class of document herein in question. S 93, which deals with appeads to the Exchequer Court, is similar to s 82(2). These provisions, in my view, indicate that any secrecy which is in contemplation of the statute is for the benefit of the taxpayer only.

I might add, parenthetically, that in the present statute (the Income Tax Act, as amended by 1970-71-72, c 63), the only references to secrecy and confidentiality are contained in section 179 (which gives the taxpayer [italics mine] a right to request that the proceedings before the Tax Review Board and the Federal Court be held in camera), and section 241 which deals with communication of information. Section 241 has no application to the situation here because subsection (3) thereof exempts the provisions of subsections (1) and (2) from income tax proceedings such as this. Subsections (1) and (2) are the provisions dealing with confidentiality.

I accordingly have the opinion that the above quoted remarks of Kellock, J apply with equal force to the case at bar.

Again, Mr Justice Estey had this to say at page 493 of the Snider case:

We are here concerned only with documents and information associated therewith filed pursuant to the requirements of the above-named statutes. Issues are constantly being tried before our courts relative to the liability of the taxpayer as well as prosecutions for the failure to perform duties imposed by these statutes. Accordingly, such documents and information in relation thereto have been repeatedly before the courts without any suggestion that the public safety or security has been at all imperilled; nor does there appear to be any reason in principle why these documents and information in relation thereto should, under ordinary circumstances, not be disclosed. It must follow that as a class these documents, in the ordinary course, do not involve questions of safety or security and as such their production would not be prevented upon the basis of public interest.

In my opinion, in the present case, the public interest in the proper administration of justice far outweighs in importance any public interest that might be protected by upholding the claim for privilege for the whole class.

In these cases, as in all income tax cases of this kind, the Minister has detailed the assumptions upon which he relies to defend his income tax assessments of the plaintiffs. With respect to Pelon, he has assumed that one Peckham owned, beneficially, at all revelant times, all the shares of Pelon. He has also assumed that no services of any kind or description during the relevant period were furnished to the plaintiffs or either of them and that neither of the plaintiffs paid any moneys to Pelon as is claimed.

Counsel for the plaintiffs, in his examination for discovery of the defendant’s assessor, has sought to challenge these assumptions. In the course of the examination, it is established that the sole basis for the assumption that Peckham was the beneficial owner of all Pelon shares comes from Pelon’s income tax returns. It is also established that said income tax returns were relied on to a large extent for the Minister’s second assumption concerning services by Pelon to the plaintiffs and payment by the plaintiffs to Pelon.

In income tax appeals, the onus is on the taxpayer to demolish the Minister’s assessments. In order to do this, he must demolish the assumptions of fact upon which the Minister’s assessments are based. And yet, in this case, the Minister refuses to produce documents upon which some of his assumptions are admittedly based.

The taxpayer is entitled to have full discovery of all documents relied on by the Minister in support of subject income tax assessments and, in my opinion, that would certainly include the income tax returns in question.

There will therefore be an order directing and requiring the defendant in each of the above styled actions to produce and show to counsel for the plaintiff in each action the income tax returns for the fiscal years ending in 1964, 1965 and 1966 of Pelon Holdings Limited. Costs in the cause.