Oryx Realty Corporation (Appellant)
v.
Minister of National Revenue (Respondent)
and
Shofar Investment Corporation (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Heald J.—Montreal, November
24, 1971; Ottawa, January 4, 1972.
Income Tax—Land dealing company—Non-arm's length
purchase of land—Price payable over ten years—Income
Tax Act (1960) s. 12(3)—Whether price "an otherwise
deductible outlay or expense"—Subsequent sale of land—
Whether sale at arm's length.
In 1959 the O company, a dealer in land, bought a parcel
of land in a non-arm's length transaction from the L compa
ny whose shares were held by the same shareholders. The
purchase price was payable $1,000 down and the balance of
$173,000 in eight annual instalments. On July 21, 1960, all
of the shares in the O company were sold for $151,000 to
another company which guaranteed payment of the $173,-
000 owing on the land purchase. On the same day the O
company sold the land to the S company for $373,000,
payable $38,000 in 1960 and the balance over eight years.
For its 1960 taxation year the O company included in its
income the selling price of the land, $373,000, and was
allowed a reserve of $172,726 for unrealized profit under
section 85B. The O company also sought to deduct the
unpaid cost of the land, viz $173,000, but the Minister
disallowed the deduction of $155,500 of that amount under
section 12(3) of the Income Tax Act, which as it stood in
1960 prohibited the deduction of "an otherwise deductible
outlay or expense payable by a taxpayer to a person with
whom he was not dealing at arm's length if the amount
thereof has not been paid before the day one year after the
end of the taxation year".
Held, the assessment should be affirmed.
1. The Minister was right in disallowing the deduction of
$155,500 under section 12(3). The cost price of the land
sold would ordinarily be deductible in computing the O
company's income for the year of sale and it was thus an
"otherwise deductible outlay or expense" within the mean
ing of section 12(3).
2. Section 12(3) continued to apply notwithstanding the
sale of the O company's shares to another company on July
21, 1960. Looked at as a whole in the light of all the
circumstances the relevant transactions were not arm's
length transactions.
INCOME tax appeal.
P. F. Vineberg, Q.C. for appellant.
G. Drolet and Roger Roy for respondent.
HEALD J.—These cases are appeals from
assessments made by the respondent against the
appellant corporations. It was agreed by coun
sel that the two cases should be heard at the
same time since they are closely related
matters.
The appeal of Oryx Realty Corporation (here-
after Oryx) is against the respondent's assess
ment for the taxation year 1960. The appeal of
Shofar Investment Corp. (hereafter Shofar) is
against the respondent's assessments for the
taxation years 1960, 1961 and 1962.
Both appellants appealed the said assess
ments to the Income Tax Appeal Board which
Board dismissed the appeal in each case. The
said assessments now come before this Court
by way of appeal from the Tax Appeal Board. I
will deal first with the Oryx appeal.
The essential facts are as follows:
1. Oryx was incorporated under the laws of
the Province of Quebec on May 7, 1958.
2. On April 20, 1959, Oryx purchased a
parcel of land from Lanber Investment Cor
poration (hereafter Lanber). Said parcel of
land was a portion of Lot 95, Cote St., Parish
of Montreal and comprised 299,851 square
feet. The purchase price of said parcel was
$174,000 payable as follows: (a) $1,000 in
cash; and (b) the balance of $173,000 in nine
instalments of $17,500 each on September
1st in each of the years 1961 to 1969 inclu
sive with the final payment of $15,500 pay
able on September 1, 1970. No interest was
chargeable on the unpaid balance.
3. Counsel for the appellant admits that on
April 20, 1959, the date of purchase, Oryx
was not dealing at arm's length with Lanber.
Lanber, as of April 20, 1959 was owned as
follows:
(a) The Berman Family-68%
(b) The Miller Family-25%
(c) The Zukierman Family-7%
There is no blood relationship between
these three families. Oryx, as of April 20,
1959, had the same ownership and in the
same proportions as Lanber—that is to say, it
was owned 68% by the Berman family, 25%
by the Miller family and 7% by the Zukier-
man family.
Lanber had owned since 1955, a part of
Lot 95, on Cote St., Parish of Montreal com
prising 1,109,860 square feet. In 1959 this
property was subdivided into six separate
parcels and five of these parcels were sold in
1959 to five separate corporations, one of
which was Oryx. None of the purchaser com
panies was at arm's length with the vendor,
Lanber, at the sale date in 1959. As a matter
of fact, they were all owned by the same
parties in the same proportions as Lanber—
i.e., 68% by the Berman family; 25% by the
Miller family; and 7% by the Zukierman
family. These were certainly attractive pur
chases from the point of view of the purchas
er corporations in that they purchased realty
valued at $544,000 for down payments totall
ing only $4,000, with ten years to pay the
balance, and with no interest charged on the
unpaid balance.
4. Nothing transpired to change the share-
holdings of either Oryx or Lanber until July
21, 1960.
On the morning of July 21, 1960, the
Berman family, the Miller family and the
Zukierman family sold all of their shares in
Oryx to a Quebec Corporation known and
described as The Golden Woolstock Co. Ltd.
(hereafter Golden Woolstock). At all relevant
times, Golden Woolstock was owned, one-
half by Benny Zukierman and one-half by his
father, Zelman Zukierman. Said agreement
recites that Oryx's only liability was the bal
ance of $173,000 owing on the land pur-
chased, which outstanding balance was guar
anteed by the purchaser company, Golden
Woolstock. The agreement further provides
that the purchase price for all of the Oryx
shares shall be $151,000, payable as follows:
(a) cash in the sum of $16,000;
(b) the balance of $135,000 by three equal
annual instalments of $43,750 payable July
21, 1961; July 21, 1962; and July 21, 1963;
and
(c) the unpaid balance to carry interest at
the rate of 6% per annum.
It is clear at this point that the sale price of
the Oryx shares on July 21, 1960 was in
reality $324,000 because $151,000 was pay
able to the shareholders and $173,000, the
balance owing on the land, was assumed by
the purchaser of the shares. Thus it is evident
that in arriving at a value for the Oryx shares,
the proposed sale of the land the same day
for $373,000 was taken into consideration.
The evidence establishes that the two sale
transactions on July 21, 1960, that is, the sale
of the shares in the morning and the sale of
the land in the afternoon, were made in the
light of each other.
5. On the afternoon of July 21, 1960, the
appellant Oryx (now beneficially owned
entirely by the Zukierman family through its
ownership of Golden Woolstock) sold the
parcel of land in question to another Quebec
Corporation called Sweet Realties Limited
(hereafter Sweet) for $373,000 payable as
follows:
(a) the sum of $3,000 in cash;
(b) the sum of $35,000 on December 31,
1960;
(c) the sum of $300,000 by way of eight
annual, equal consecutive instalments of
$37,500, the first thereof to be due and
payable on December 29, 1961;
(d) the balance in the sum of $35,000 to be
due and payable on December 29, 1969.
It was a further term in said agreement for
sale that the unpaid balance of purchase price
would bear no interest.
At all relevant times the shares in Sweet
were owned one-half by Benny Zukierman,
and one-half by a partner of his, one Morris
McDowell, not related to any of the Zukier-
mans, the Bermans or the Millers.
In filing its income tax return for 1960, Oryx
acknowledged that it was a trading company
and subject to tax on trading operations in
respect of the sale of land above referred to. It
claims, however, to be entitled to deduct from
its income for 1960, the unpaid cost of said land
in the sum of $173,000. The respondent chal
lenges the said deduction under the authority of
section 12(3) of the Income Tax Act. Said sec
tion applied to the 1960 income tax year, but
has since been repealed and re-embodied with
somewhat altered provisions into the present
section 18. Said section 12(3) read as follows:
In computing a taxpayer's income for a taxation year, no
deduction shall be made in respect of an otherwise deduct
ible outlay or expense payable by the taxpayer to a person
with whom he was not dealing at arm's length if the amount
thereof has not been paid before the day one year after the
end of the taxation year; but, if an amount that was not
deductible in computing the income of one taxation year by
virtue of this subsection was subsequently paid, it may be
deducted in computing the taxpayer's income for the taxa
tion year in which it was paid.
The respondent says that under said section
12(3) it was entitled to disallow in 1960 the sum
of $155,500 out of the total land cost of $174,-
000. It arrives at said figure of $155,500 as
follows:
Total price $ 174,000
Less $1,000 paid in 1960 18,500
Less $17,500 paid in 1961
Balance $ 155,500
On the other hand, counsel for Oryx submits
that said section 12(3) has no application to this
assessment for two reasons:
(1) the cost of inventory (land) herein is not
"an otherwise deductible outlay or expense"
within the meaning of section 12(3); and
(2) the transaction in question is an arm's
length transaction and therefore section 12(3)
has no application.
I will deal firstly with the meaning of the
words "an otherwise deductible outlay or
expense" as they appear in section 12(3).
In support of its argument that the cost of
inventory is not "an otherwise deductible outlay
or expense" under section 12(3), Oryx submits
an example of a company with $100,000 of
manufacturing net profit in the course of a year
and on the last day of the year venturing into a
new trading enterprise and disbursing $100,000
for new inventory, none of which was sold in
that year. Oryx argues that if the cost of inven
tory of $100,000 was "expense" and thus
deductible, the company's taxable income
would be zero. Oryx says that the Income Tax
Department would be quick to disallow such an
expense. Oryx further submits that section 14
deals with inventory and that under the
respondent's interpretation, section 12(3)
cannot be reconciled with section 14'.
With deference, I do not agree with this sub
mission. Section 14 relates only to unsold
inventory while section 12(3) relates only to
goods sold which are thus an otherwise deduct
ible "outlay" or "expense". The facts in the
above example are not the same as in the case
at bar. In the example, the goods were not sold
at year end and were thus inventory. In the case
at bar, the goods (land) were sold in the taxation
year 1960 and the item in dispute is the unpaid
cost of the goods sold. I believe most account
ants would agree that the cost price of an asset
cannot be applied against revenue until the
asset has been resold in normal trading
operations.
Because the asset in question, i.e., the parcel
of land, was resold in the taxation year it would
surely be "otherwise deductible".
Counsel for Oryx submitted several defini
tions in support of his argument that cost of
inventory was not an "expense or outlay".
Unfortunately, most of his definitions dealt
with "operating expenses". I would probably
agree that "operating expenses" would exclude
cost of inventory. However, section 12(3) does
not have in it the word "operating" which is
most certainly a limiting and a restrictive word.
The Shorter Oxford English Dictionary defines
"outlay" as "The act or fact of laying out or
expending; expenditure (of money upon some
thing)". The same dictionary defines "expense"
as "money or a sum expended".
Cost of inventory is surely included in the
term "expenditure (of money upon some
thing)". Surely it is also included in the term
"money expended".
I have no difficulty in concluding that the
cost of inventory, in this case, would come
within the ordinary meaning of the words "out-
lay or expense".
Oryx introduced evidence at the trial by Mr.
Stanley Hitzig, a well qualified chartered
accountant associated with the auditing firm
employed by Oryx as its auditor who testified
that in normal auditing practice, the consump
tion of inventory is not recognized as an
expense. I gathered from his testimony that the
practice tends more toward treating expenses as
operating expenses, and thus cost of inventory
would be excluded. Mr. Hitzig was asked for
his opinion, as an accountant, as to whether
cost of inventory was a deductible outlay or
expense in computing income.
In making his answer, he prefaced his opinion
with the following observation: "Well, I would
first have to say that the term "outlay" is not a
commonly used term in accounting". He then
went on to express his opinion, as an account-
ant, not without some hesitation, that the acqui
sition of inventory would not be a deductible
outlay in determining income. However, I am
satisfied that giving the words in section 12(3)
their ordinary meaning, they are certainly wide
enough to include cost of inventory.
The respondent also called a chartered
accountant to testify, Mr. Ernest J. Guignard,
one of the respondent's senior assessors, with
much experience in these matters. He was just
as adamant in his opinion that cost of inventory
in these circumstances would normally be con
sidered as "an otherwise deductible outlay or
expense". He quoted from Canadian Account
ing Practice 1956 by Leonard and Beard at page
218 as follows: "The sale of goods is regarded
as revenue earned. The cost of acquiring the
goods sold and the cost of incidental supplies
and services are expenses of earning the reve
nue". This witness also cited two other account
ing authorities in support of his position: (1)
Edwards, Hermanson and Salmonson—
Accounting—A programmed Text-1967, vol.
2, page 167, "The cost of inventory, like any
other asset, includes all outlays necessary to
acquire the goods."; and (2) Black, Champion
and Brown—Accounting in Business Decisions,
2nd ed., 1967, page 185, land is defined "items
comprising the cost of land are all of the outlays
necessary to obtain legal title and to prepare it
for use as a location for the business".
Mr. Guignard testified as did Mr. Hitzig, that
there are two main methods employed in filing
income tax returns, the cash method and the
accrual method. On the cash method, the tax
payer is required to show all cash income
received, and can only deduct expenses actually
paid out in the taxation year.
On the accrual method, income is reported in
the year when earned, and expenses are allowed
as deductions in the year when they are
incurred and not necessarily paid.
In a trading operation such as this, the accru
al method is used. However, Mr. Guignard says
that section 12(3) represents a statutory depar
ture from the general practice in that it puts the
taxpayer on a cash basis for the purchase of
this land. Mr. Guignard says further that section
85B also puts a taxpayer in these circumstances
on a cash basis for purposes of profit calcula
tions. In this assessment, Oryx was given the
benefit of section 85B in deferring the profit.
The assessment shows that Oryx was allowed
as a deduction from the sale price of the land,
the sum of $172,726 shown as deferred income
reserve pursuant to section 85B of the Income
Tax Act.
The relevant portions of section 85B(1) appli
cable to the 1960 taxation year were as follows:
85a. (1) In computing the income of a taxpayer for a
taxation year,
(b) every amount receivable in respect of property sold
or services rendered in the course of the business in the
year shall be included notwithstanding that the amount is
not receivable until a subsequent year unless the method
adopted by the taxpayer for computing income from the
business and accepted for the purpose of this Part does
not require him to include any amount receivable in
computing his income for a taxation year unless it has
been received in the year;
(d) where an amount has been included in computing the
taxpayer's income from the business for the year or for a
previous year in respect of property sold in the course of
the business and that amount or a part thereof is not
receivable until a day
(i) more than two years after the day on which the
property was sold, and
(ii) after the end of the taxation year,
there may be deducted a reasonable amount as a reserve
in respect of that part of the amount so included in
computing the income that can reasonably be regarded as
a portion of the profit from the sale; and
(2) Paragraphs (a) and (b) of subsection (1) are enacted
for greater certainty and shall not be construed as implying
that any amount not referred to therein is not to be included
in computing the income from a business for a taxation year
whether it is received or receivable in the year or not.
Thus, under paragraph (b) of subsection (1),
the entire sale price of the subject properties,
that is, $373,000 must be included in Oryx's
income for 1960, the year of sale unless Oryx is
filing on a cash basis. As stated above, there is
no argument in this connection. Oryx agrees
that it has to file on an accrual basis and did as
a matter of fact file on an accrual basis and take
the entire sale price in the sum of $373,000 into
income in its return.
However, under paragraph (d) of subsection
(1), provision is made by which the taxpayer
may deduct a reasonable amount as a reserve in
respect of that part of the amount so included in
computing the income that can reasonably be
regarded as a portion of the profit from the sale
(italics mine). And in filing its 1960 tax return,
Oryx did take advantage of this provision and
deducted from its 1960 income the sum of
$172,726 which was allowed by the respondent
as a deduction in its assessment.
Computation of this figure is as follows:
Sale of land $ 373,000
Less cost of land sold 180,650
Gross profit on sale (51.56%) $ 192,350
Deferred Income as follows:
51.56% of $335,000 (Deferred
portion of sale price) $ 172,726
Where the dispute arises is when Oryx
attempts to also deduct the cost of land in the
sum of $173,000 which is resisted by the
respondent under the authority of section 12(3)
of the Act.
I agree with Mr. Guignard when he says that
the resultant situation is equitable to the taxpay
er in that the departure from the accrual method
in section 12(3) is offset by the deferred income
credit allowed the taxpayer under section 85B
which can also be considered a departure from
the accrual method.
Counsel for Oryx also argues that section
12(3) is only intended to apply to cover abuses
that might arise when non-arm's length taxpay
ers are following alternative systems of report
ing income—that is to say, when one taxpayer
is on a cash basis and another non-arm's length
taxpayer is on an accrual basis; an example
would be an agreement by an accrual taxpayer
to pay a salary to a cash taxpayer, and then not
pay it in a particular year—the accrual taxpayer
could claim the salary as a deduction because it
is payable in the taxation year; and yet the cash
taxpayer would not have to show it as income
because he did not receive the cash in the
taxation year. Thus, by indefinitely postponing
payment to the cash taxpayer from year to year,
a deductible expense has been created without a
corresponding taxable income item.
Counsel for Oryx concedes that section 12(3)
is available to the Income Tax Department and
is necessary to prevent abuse in the kind of
situation described above. However, counsel
says that section 12(3) is not necessary to cover
a case such as we have here where both taxpay
ers are on an accrual basis, that where the
vendor and the purchaser are both on an accru
al basis, there is no great evil to be remedied
and accordingly there is no need for section
12(3).
I do not agree that section 12(3) is intended
to apply only when non-arm's length taxpayers
follow alternative methods of income reporting.
Even where both vendor and purchaser are on
an accrual basis, as is the case here, the vendor
could still benefit under section 85B while the
purchaser could deduct the unpaid full purchase
price of the property were section 12(3) or its
equivalent not in the Act.
The case of Gatineau Westgate Inc. v.
M.N.R. [1966] DTC 560, is a decision of the
Tax Appeal Board in which it was held that
section 12(3) applied to the purchase of real
estate. In that case, the appellant, a real estate
company, bought real estate from its directors
with whom it was not dealing at arm's length.
By the agreement for sale, the purchase price
was payable over a 30 year period with a provi
sion for prepayment. In 1962, $37,935.34 was
paid off and was allowed as a deduction by the
Minister. However, the unpaid balance of $40,-
343.61 was disallowed as a 1962 deduction
applying section 12(3). Mr. Boisvert, for the
Board, held that because of the provisions of
section 12(3), the unpaid balance was not
deductible in the 1962 taxation year.
Then Oryx says that the effect of the
respondent's method of assessment would
result in the imposition of a rate of tax which
would run up to 200% which would, of course,
be harsh and unreasonable. I cannot agree that
this would be the result of the respondent's
application of section 12(3) to this assessment.
Looking at these transactions in their simp
lest form, Oryx bought a parcel of land in 1959
for $174,000 and sold it in 1960 for $373,000.
If Oryx were filing income tax on a cash basis,
and this were a cash transaction, it would pay
tax on the net profit of $199,000 in one year.
However, Oryx has to file and does file on an
accrual basis. Accordingly, the respondent has
adopted the following method of assessment:
1960 — Sale of land $ 373,000
Less—Deferred income reserve
—See s. 85B
51.56% (profit ratio) of
$335,000 (unpaid balance of
agreement for sale at end of
1960) 172,726
$ 200,274
Less cost of land actually paid
in 1960 and in 1961 as per sec
tion 12 (3) $ 18,500
Net profit $ 181,774
NOTE: The figure of $181,774 is larger than
the amount in the actual assessment because of
other allowable charges which are here omitted
for purposes of simplification.
1961—
Income earned-51.56% (profit
ratio) of $37,500 (payable by
Sweet to Oryx in 1961 as per
agreement for sale) $ 19,335
Less cost of land paid in 1962 as
per section 12 (3) 17,500
Net profit $ 1,835
The assessment would be the same for the
years 1962, 1963, 1964, 1965, 1966, 1967 and
1968 because in each of those years, Sweet is
obligated to pay Oryx $37,500 per year and
Oryx is obligated to pay $17,500 on its pur
chase agreement with Lanber.
In 1969, Sweet's payment to Oryx is $35,000
while Oryx's 1970 payment to Lanber is
$15,500 and is deductible in the 1969 return
under section 12(3). Thus, the respondent's
assessment of Oryx through the years would
appear as follows:
Net profit 1960 $ 181,774
Net profit 1961-1968 inclusive
8 x $1,835 14,680
Net profit 1969 2,546
Total net profit assessed to Oryx $ 199,000
From the above calculations, I am satisfied
that there is nothing inequitable about the
respondent's assessment.
If the respondent were not allowed to use
section 12(3) in these circumstances, Oryx
could deduct the entire cost of the land in 1960
($173,000), would still be entitled to the benefit
of section 85B while Sweet could deduct its full
purchase price of the property in filing its tax
returns.
A calculation of the tax payable under Oryx's
proposed method would have the following
result:
Net profit 1960 $ 26,274
Net profit 1961-1968 inclusive
8 years @ $19,335
per year 154,680
Net profit 1969 18,046
Total $ 199,000
By comparing the two methods, it will be
seen that if the Oryx method were allowed, the
incidence of tax is amortized over ten years
rather than being mostly payable in one year as
is the result under the respondent's method.
Thus, the rationale for the application of sec
tion 12(3) to land transactions where the parties
are not at arm's length becomes apparent. If
Oryx is correct in its proposed method of
assessment, it would be possible for non-arm's
length taxpayers to amortize the payment of tax
over even longer periods, say 20, 30 or 50 years
by simply extending the time for payment in the
agreements over a lengthy period. Thus, section
12(3) protects the Department against undue
delay in payment of the income tax which is
properly payable on a transaction.
Oryx made a net profit of $199,000 in this
one land transaction. Surely it would not be
reasonable or equitable that Oryx be allowed to
amortize this profit over a 50 year period and
yet this would be possible and permissible
under Oryx's construction of section 12(3).
Learned counsel for Oryx cited a number of
authorities dealing with the rules to be followed
in interpreting statutes. He quoted from Beal's
Cardinal Rule of Legal Interpretation and Max-
well on Interpretation of Statutes to the effect
that where a statute is capable of two possible
constructions, the Court should give the words
in question that interpretation which appears to
be most in accord with convenience, reason,
justice and legal principles.
In holding that the respondent was entitled to
apply the provisions of section 12(3) to the
assessment in question, I believe that I am
following said rules of interpretation.
To hold otherwise, would be to distort the
provisions of the Act and would allow taxpay
ers to circumvent or at least unreasonably delay
the payment of proper tax on income.
The appellant's second argument in the Oryx
case was that even if section 12(3) could be
applied to cost of land in these circumstances,
that it should not have been applied to the facts
in this case because, when the share ownership
of Oryx changed under the agreement for the
sale of its shares on the morning of July 21,
1960, from and after that time, Oryx was deal
ing at arm's length with its vendor, Lanber. It is
admitted that on April 20, 1959, when Oryx
purchased the land from Lanber, the two com
panies were not at arm's length—they were
owned by exactly the same family groups and in
exactly the same proportions-68% by the Ber -
mans, 25% by the Millers and 7% by the Zuki-
ermans. This ownership remained the same
until the morning of July 21, 1960. On the
morning of July 21, 1960, the Zukiermans
bought out the Bermans and the Millers so that
after the morning of July 21, 1960, Oryx was
owned solely by the Zukiermans and Lanber
continued to be owned 68% by the Bermans,
25% by the Millers and 7% by the Zukiermans.
The appellant submits that the cost of the
land becomes deductible only when it ceases to
become inventory, therefore it only becomes
deductible at the moment of sale by Oryx which
was the afternoon of July 21, 1960 and that by
that time, and at all times thereafter, Lanber
and Oryx were at arm's length. A necessary
inference from the appellant's argument is that
it does not matter what the situation was prior
to the moment of sale or moment of
deductibility.
My brother Cattanach J. discussed in some
detail the concept involved in the expression
"dealing at arm's length" as used in the Income
Tax Act and the Estate Tax Act in the case of
M.N.R. v. Merritt Estate [1969] C.T.C. 207. At
pages 216-17 he said:
In M.N.R. v. Sheldon's Engineering Limited, [1955]
S.C.R. 637; [1955] C.T.C. 174, Locke J., delivering the
judgment of the Supreme Court of Canada, had occasion to
comment upon the expression "deadline at arm's length" as
it appeared in a provision in the Income Tax Act. He said at
page 643 [p. 179]:
The expression is one which is usually employed in
cases in which transactions between trustees and cestuis
que trust, guardians and wards, principals and agents or
solicitors and clients are called into question. The reasons
why transactions between persons standing in these rela
tions to each other may be impeached are pointed out in
the judgments of the Lord Chancellor and of Lord Black-
burn in McPherson v. Watts (1877), 3 App. Cas. 254.
He went on to say, however, that "These considera-
tions"—i.e., the reasons why transactions between persons
standing in such relations as trustee and cestuis que trust
may be impeached—"have no application in considering the
meaning to be assigned to the expression in Section 20(2)".
Having thus put aside the principles that had been devel
oped concerning transactions between persons standing in
the relationship of trustee and cestuis que trust and other
relationships giving rise to an implication of undue influ
ence, Locke J. went on to reject the argument that the
provision in the Income Tax Act at that time whereby
certain defined classes of persons were deemed not to deal
with each other at arm's length was exhaustive of the
classes of persons who could be regarded as not dealing
with each other at arm's length for the purposes of that Act.
He said:
I think the language of Section 127(5) [now 139(5)],
though in some respects obscure, is intended to indicate
that, in dealings between corporations, the meaning to be
assigned to the expression elsewhere in the statute is not
confined to that expressed in that section.
While, therefore, the facts in the Sheldon's Engineering
(supra) case did not fall within any of the specially enume
rated classes of cases where persons were deemed not to
deal with each other at arm's length, Locke, J. concluded
that it was still necessary to consider whether, as a matter
of fact, the circumstances of the case fell within the mean
ing of the expression "not dealing at arm's length" within
whatever meaning those words have apart from any special
deeming provision.
In this appeal, the question is whether the circumstances
are such as to fall within the words "persons dealing with
each other at arm's length" in Section 29(1) of the Estate
Tax Act. In my view, these words in the Estate Tax Act
have the same meaning as they had in the income tax
provision with which Locke, J. was dealing in Sheldon's
Engineering when those words were considered, as Locke,
J. had to do, apart from any special "deeming" provision.
It becomes important, therefore, to consider what help
can be obtained from the judgment in Sheldon's Engineering
as to the meaning of the words "persons dealing at arm's
length" when taken by themselves. The passage in that
judgment from which, in my view, such help can be
obtained, is that reading as follows:
Where corporations are controlled directly or indirectly
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 Section 20(2) was
inapplicable.
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 are 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.
Mr. Justice Cattanach held that where the
"mind" by which the bargaining (italics mine) is
directed on behalf of one party to a contract is
the same "mind" that directs the bargaining
(italics mine) on behalf of the other party, it
cannot be said that the parties were dealing at
arm's length.
Following the reasoning used in the Dworkin
case (M.N.R. v. Dworkin Furs [1967] C.T.C. 50)
and in the Buckerfield case (Buckerfield's Ltd. v.
M.N.R. [1964] C.T.C. 504 at p. 507), the
Berman family was the "mind" directing the
bargaining on behalf of the vendor Lanber. The
Berman family was also the "mind" directing
the bargaining on behalf of the purchaser Oryx.
The cost of the land inventory became payable
by the agreement to purchase on April 20,
1959. Nothing changed until the morning of
July 21, 1960 when Oryx and Lanber probably
became arm's length corporations. All the dis
cussions, all the negotiations and all the bar
gaining took place when the vendor and pur
chaser corporations were not at arm's length.
To give effect to Oryx's submission, I would
have to disregard everything that happened
before the afternoon of July 21, 1960; to ignore
the fact that there is a direct relationship
between the sale price of the land and the sale
price of the shares; to ignore the plan conceived
whereby Lanber in effect amortized its profits
on land sales 50 times by selling the land to 5
different non-arm's length companies with ten
years to pay; to ignore the unrealistic terms of
the land sale agreements (property valued at
$544,000 sold for only $4,000 down with 10
years to pay the balance and with no interest).
This question of material times for consider
ing the arm's length situation was discussed by
Thurlow J., in Swiss Bank v. M.N.R. [1971]
C.T.C. 427. At page 438, he said:
... It also appears to me that while the transactions here in
question are the payments of interest and the times at which
they were made are the times when the power to influence
or control must be considered, evidence of a situation that
was initiated and existed before the material times and
continued through and after them may be considered in
determining whether the parties dealt at arm's length at the
material times.
That is to say, even accepting Oryx's argu
ment that the material time, and the only
material time is the moment of sale by Oryx to
Sweet on July 21, 1960, the Court is entitled to
look at what went on before the material time.
I agree with this view of the law that I am
entitled to look at these transactions as a whole
and having done so, I am satisfied that they are
not arm's length transactions.
Having decided that the Court is entitled to
look at the transactions in question as a whole,
it becomes unnecessary to deal with the argu
ment of counsel for Oryx that the only "mo-
ment" that matters is the "moment" of
deductibility.
However, without deciding the matter, I
express the opinion that if the Court were to be
restricted to a particular "moment" in determin
ing the arm's length question, I would find that
the relevant "moment" for the purposes of sec
tion 12(3) would be the "moment" when the
outlay or expense became "payable". Section
12(3) uses the words "outlay or expense pay
able by the taxpayer to a person with whom he
was not dealing at arm's length". I think there is
a very good argument for holding that the cru
cial moment would be the moment when the
obligation to pay was created and this moment
would be on April 20, 1959 at the time the
agreement for sale between Lanber as vendor
and Oryx as purchaser was executed by both
corporations. I hold this opinion because sec
tion 12(3) says "payable", not "due and pay
able". Therefore all of the instalment payments
became "payable" when the agreement for sale
was completed on April 20, 1959, although not
due until later. The legal obligation to pay was
incurred or created on April 20, 1959, and if
there is a crucial point in time, that point would,
on the facts of this case, be on April 20, 1959,
when it is conceded the purchaser, Oryx, was
not at arm's length with the vendor, Lanber.
I accordingly hold that the respondent prop
erly applied the provisions of section 12(3) to
the assessment of Oryx for the 1960 taxation
year. The appeal of Oryx is therefore dismissed
with costs.
So far as the appeal of Shofar is concerned,
counsel for the appellant conceded that the
transactions in the Shofar case were not at
arm's length which left him with one argument,
namely the first argument advanced in the Oryx
case, that the cost of inventory (land) is not "an
otherwise deductible outlay or expense" within
the meaning of section 12(3).
For the same reasons as I expressed when
dealing with the Oryx appeal, I am of the opin
ion that the respondent properly applied the
provisions of section 12(3) in assessing Shofar
for the taxation years under review.
The appeal of Shofar is accordingly dismissed
with costs.
1 14. (2) For the purpose of computing income, the prop
erty described in an inventory shall be valued at its cost to
the taxpayer or its fair market value, whichever is lower, or
in such other manner as may be permitted by regulation.
(3) Notwithstanding subsection (2), for the purpose of
computing income for a taxation year the property
described in an inventory at the commencement of the year
shall be valued at the same amount as the amount at which
it was valued at the end of the immediately preceding year
for the purpose of computing income for that preceding
year.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.