T-2940-72
Jean Des Rosiers (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Decary J.—Montreal, May 15 and
16, 1974; February 5, 1975.
Income Tax—Deductions—Plaintiff and others incorporat
ing company to purchase building—Personally leasing build
ing from company, and subsequently subletting under company
name—Operating losses—Whether undue or artificial reduc
tion of income—Income Tax Act, R.S.C. 1952, c. 148, ss. 11,
12, 27(1)(c), 137(1), 138(1), 138 A—Income War Tax Act, S.C.
1932-33, c. 41, s. 6(2), S.C. 1939-40, 2nd Sess., c. 34, s. 6(2)—
Income Tax Act, S.C. 1948, c. 52, ss. 12(2), 125(1)—Interpre-
tation Act, R.S.C. 1952, c. 158, s. 13.
Plaintiff, an employee of a brokerage firm, and two fellow
employees, decided to purchase a building. A company was
incorporated with the three as shareholders, the principal objec
tive of which was ownership of the building. After the pur
chase, the three shareholders personally leased the building
from the corporation under a "net net lease". The joint share
holders then proceeded to sublet the building. As the three were
all brokers, and would have been unable to secure assistance of
other brokers in finding subtenants had it been known that they
were the tenants, the sub-leases were granted under the com
pany name. Difficulty arose in subletting, and in 1968 and
1969, expenses exceeded rental income, and operating losses
were incurred. Each shareholder applied 'h of these losses
against his income from other sources under section 27(1)(e) of
the Income Tax Act. Plaintiff subsequently bought out the
others at a loss. The Tax Review Board found that such
deductions unduly and artificially reduced plaintiffs income
under section 137(1). Plaintiff appealed.
Held, allowing the appeal, for the purposes of section 137(1),
it is the nature of the reason for the expense or disbursement,
i.e., the transaction or operation, that determines whether a
deduction results in an undue or artificial reduction. This
nature, acquired from the transaction or operation, then, is
what must be considered in deciding what is undue or artificial.
It is the transaction or operation which qualifies the deduction,
and this qualification is that resulting from the words "would
unduly or artificially reduce the income". Section 137(1) refers
to a "transaction or operation" as opposed to "transaction or
series of transactions", in section 138(1); in the case at bar,
there was a series of transactions. The facts do not support
characterization of the operation as undue or artificial. There is
no question of sham or deception, nor is there evidence of
"dissimulation" or "evasion".
INCOME tax appeal.
COUNSEL:
H.-P. Lemay, Q.C., and M. Gilbert for
plaintiff.
B. Schneiderman and C. Bonneau for
defendant.
SOLICITORS:
Lemay, Paquin & Gilbert, Montreal, for
plaintiff.
Deputy Attorney General of Canada for
defendant.
The following is the English version of the
reasons for judgment rendered by
DECARY J.: The Court must determine whether
the loss sustained by three shareholders in a com
pany which was the owner of a building, as a
consequence of expenses incurred by them in their
capacity as tenants of the said building, is deduct
ible for the purposes of section 27(1)(e) of the
Income Tax Act.
The Tax Review Board found that deduction of
these expenses had unduly and artificially reduced
the income of plaintiff.
Plaintiff appealed to this Court from this deci
sion of the Tax Review Board. This appeal is a
trial de novo, and is in fact and in law an appeal
from the notification of the Minister.
Plaintiff was the first witness heard. He is a
certified public accountant, not in practice, and is
an officer of the real estate brokerage of Armand
Des Rosiers Inc. The latter firm was authorized to
sell a building owned by Engineering Products of
Canada Limited, and a Mr. Denis of the said
brokerage firm was given the task of selling it,
since he has specialized in the sale of property for
industrial uses for many years.
Armand Des Rosiers Inc. was unable to sell the
building, and so Engineering Products of Canada
Limited reduced its price, and plaintiff, after some
consideration, finally decided to buy the building.
The selling company agreed to a price of $300,001
on the following conditions: the payment of $1.00
in cash and assumption of a mortgage of $300,000
at seven and one half per cent annual interest.
In buying the building plaintiff acted in con
junction with two brokers from the firm of
Armand Des Rosiers Inc., Messrs. Denis and
Lefebvre, who did not have the same financial
resources as those at the disposal of plaintiff.
Accordingly, plaintiff wished to protect himself by
acting in such a manner that he and Messrs. Denis
and Lefebvre would be personally obligated to
make the payments. The following scheme was
agreed on: a company was incorporated, the prin
cipal objective of which was ownership of the
building; plaintiff and Messrs. Denis and Lefebvre
became the shareholders in this company; and they
personally leased the building purchased by the
company, at a rental fixed by a net lease, includ
ing, in common with all leases of this kind, a
number of expenses for which they were to be
responsible.
The company, Placements Ronis Inc., was incor
porated on March 7, 1967; on March 15, 1967 it
bought the building; the agreement of sale con
tained no clause out of the ordinary; plaintiff and
Messrs. Denis and Lefebvre each subscribed for
one hundred and twenty-six ordinary shares in the
company, each with a par value of $1.00, making a
total of $378 of share capital issued and paid up,
in an authorized capital of $40,000; the issued and
paid up capital, and even the authorized capital,
may appear at first glance to be insufficient for the
purchase of a building worth $300,000, but I feel
that the provisions of the lease concluded between
the company and its three shareholders the follow
ing day establish that the capitalization was in fact
sufficient for the purposes intended by the
shareholders.
It is important to note at once that the evidence
shows the rental agreed on between the company
and the shareholders was a normal figure, corre
sponding to the market value of space in the
building. The testimony to this effect by appellant
and Mr. Denis is corroborated by the fact that
rental on leases concluded in the building are only
five or six cents a square foot more than that paid
to the company by appellant and his fellow
shareholders.
In the lease between the company and the joint
shareholders it is stipulated that Placements Ronis
Inc. would be used as a pseudonym in granting
leases. The reason adduced for doing this was that,
as the three shareholders were brokers with the
firm of Des Rosiers, they would have been unable
to secure the assistance of other brokers in obtain
ing subtenants if it had been known that they were
the tenants. In my view, this was a valid reason.
So far as the low capitalization figure of Place
ments Ronis Inc. is concerned, I feel that this state
of affairs is justified by the nature of the lease: the
shareholders leased the entire building at a rental
allowing for the mortgage liabilities of the com
pany, and consequently the latter did not need
capital in order to liquidate its liabilities, since
they were covered by the amount of rental paid by
the three joint shareholders.
The rental which the three joint shareholders
undertook to pay proved to be a burden, because
they were unable to sublet portions of the building
as quickly as they had expected. The reason given
was that the pre-Expo '67 economic activity had
ended.
Placements Ronis Inc. entered into an agree
ment giving Armand Des Rosiers Inc. responsibili
ty for managing the building. No remuneration
was ever paid to the latter firm for the manage
ment duties. Ordinarily, this agreement would
have been between the three tenants and Armand
Des Rosiers Inc. Great emphasis was placed on
this fact during the hearing, but I do not consider
that this agreement is of any significance whatever
in resolving the issue.
For the years 1968 and 1969 the expenses
incurred by the three joint tenants exceeded
income from rentals, and consequently they
incurred an operating loss. Each of the three
shareholders applied one third of these losses
against his income from other sources, pursuant to
the provisions of section 27(1)(e) of the Act.
Learned counsel for the plaintiff argued that the
fact that Placements Ronis Inc. was merely an
owner receiving rentals, which at the outset some
what exceeded its liabilities, did not mean the
company lacked a definite objective, namely that
of being the sole owner of the building, so as to
avoid the inconveniences inherent in co-ownership
and joint ownership, and in a joint and several
mortgage obligation. Consequently, the creation of
the company was not part of a transaction or
operation which, if deduction of disbursements or
expenses relating thereto were allowed, would
unduly or artificially reduce the income of
plaintiff.
Learned counsel for the Minister argued that
the lease to the shareholders was an operation or
transaction resulting in an undue and artificial
deduction from income, and that the expenses paid
by the tenants were expenses which should have
been incurred by the company; consequently, that
if deduction of the expenses were allowed, it would
unduly and artificially reduce their income; and
that those expenses were incurred to protect a
capital asset: the shares of plaintiff.
In order to decide whether a deduction unduly
and artificially reduces income, I feel it is impor
tant to survey the facts which appear to me to be
relevant: the testimony of the three plaintiffs is
substantially identical; it proved impossible for
Armand Des Rosiers Inc. to carry out the task
entrusted to it by Engineering Products of Canada
Limited, of selling the building; plaintiff and
Messrs. Denis and Lefebvre considered the possi
bility of buying the building; they examined the
premises but, because of the presence of heavy
machinery, they were unable to discover the true
state of the building and they did not call in
engineers to do this; the condition of the premises
was not what they thought, and required repairs
and renovations, as transpired subsequently; plain
tiff and Messrs. Lefebvre and Denis thought the
entire building could easily be leased, and that this
would be a profitable undertaking, which proved to
be a second error on their part, because the build
ing was not completely leased before the end of
1968; before making the purchase plaintiff and
Messrs. Denis and Lefebvre arranged for a com
pany to be incorporated, in which they each sub
scribed for one hundred and twenty-six shares
having a par value of $1 each, which gave Place
ments Ronis Inc. an issued and paid up capital of
$378, in an authorized capital of $40,000; this
represented a thin issued capitalization; the role
that the company was to play: to be the owner of
the building, and lease it to the shareholders under
a "net net lease", in order that the company might
meet its mortgage debts; the building was pur
chased on March 15, 1967 for $300,001 payable
on the following conditions: the payment of $1.00
in cash and assumption of the obligations of a
mortgage debt of $300,000; the day following the
purchase, Placements Ronis Inc. leased the entire
building to its three shareholders at a rental fixed
under the usual terms of a "net net lease",
amounting to $1.00 a square foot; this rental
amount was the going rate, as was proven by leases
granted by the company, since the same premises
were re-leased for five or six cents more a square
foot; the company acted as a pseudonym for the
three shareholders, the reason being that the latter
were all real estate brokers working for the same
firm, Armand Des Rosiers Inc., and did not want
this fact known, in order to be able to obtain the
services of brokers outside Armand Des Rosiers
Inc.; indeed, the first rental was due to the efforts
of another real estate brokerage; the entire build
ing was not leased until the end of 1968; renova
tions and repairs cost much more than $50,000,
the amount anticipated by plaintiff and Messrs.
Denis and Lefebvre; bank loans and advances
made by the shareholders to the company became
too burdensome for two of the shareholders, who
had to sell their shares to plaintiff at a loss,
because they were in debt beyond their ability to
repay.
The French version of section 137(1) reads:
137. (1) Dans le calcul du revenu aux fins de la présente loi,
aucune déduction ne peut être faite à l'égard d'un déboursé fait
ou d'une dépense contractée, relativement à une affaire ou
opération qui, si elle était permise, réduirait indûment ou de
façon factice le revenu.
In my opinion, the subject of the verb "rédui-
rait" (would reduce) is the pronoun "qui" (that).
Although the phrase "affaire ou opération"
(transaction or operation) immediately precedes
the pronoun "qui", the latter pronoun substitutes
for "déduction" (deduction), because it is the
"déduction" that reduces income, not the "affaire
ou opération". In an income statement there are
entries for deductions, but none for transactions or
operations. The deduction consists of one or more
items of expense or disbursement; the expenses or
disbursements are designated by reference to the
type of transaction or operation in which they were
made. An expense or disbursement will be deduct-
ible depending on the type of transaction or opera
tion in which it is made: an expense or disburse
ment of a current nature, in accordance with
recognized accounting principles; one made
deductible in accordance with a statutory provi
sion; one of a capital nature, in accordance with
recognized accounting principles; and one disal
lowed under an express provision of the Act, as a
deduction in computing income. In each case it is
the reason for the expense or disbursement,
namely the operation or transaction, that deter
mines whether the expense or disbursement can be
allowed as a deduction in computing income.
For the purposes of section 137(1), therefore, it
is the nature of the reason for the expense or
disbursement, namely the transaction or the opera
tion, that determines whether a deduction results
in an undue or artificial reduction. It follows that
this nature, acquired from the transaction or oper
ation by the disbursement or expense, is what must
be considered in deciding what is undue or artifi
cial, since the fact of the transaction or operation
being undue or artificial is the primary reason for
the disbursement or expense, which is the basis for
the deduction, and the deduction is in turn the
reason for the reduction.
With regard to the use of the phrase "si elle
était permise" (if allowed), it should be noted that
in sections 11 and 12 of the Act, when reference is
made to a "déduction", the words "déduction
admise" (deduction allowed) and "déduction non
admise" (deduction not allowed) are used, not
"déduction permise" or "non permise". The
meaning of "permettre" (allow), which is to let
happen, not to prevent, applies to a deduction
rather than to an operation or transaction. In my
view, the verb "permettre" cannot be applied to a
transaction or operation, since the Minister has no
powers to allow or not allow a transaction or
operation, but he does have powers to allow or
disallow the deduction of a disbursement or
expense.
We must examine more closely the meaning of
the key words "indûment" (unduly) and "de façon
factice" (artificially), which give to the transaction
or operation the nature that will in turn affect the
question of reduction.
In Robert, Dictionnaire de la langue française:
INDÛMENT, adv... D'une manière indue .. .
INDU, UE: adj.... Qui va à l'encontre des exigences de la
raison, de la règle, de l'usage .. .
FACTICE: adj... 1° Vx. Qui n'est pas de création naturelle. V.
Artificiel, .. .
... 2° Mod. Qui est fait artificiellement, à l'imitation de la
nature ...
... 3° Fig. Qui n'est pas naturel
"Indu" (undue) suggests the idea of being con
trary to reason, practice or custom; "factice"
(artificial) suggests the idea of falsity.
Let us now consider the English version of sec
tion 137(1):
137. (1) In computing income for the purposes of this Act,
no deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or opera
tion that, if allowed, would unduly or artificially reduce the
income.
The English version of section 137(1) uses the
words "if allowed", words which were also used in
sections 11 and 12 of the Act. The verb "to allow"
is defined in the Shorter Oxford English Diction
ary on Historical Principles as:
Allow: v... 2. To accept as true or valid, to admit 1548 ... 3.
trans. To concede, permit (an action, etc.) 1558... II. Fr.
allouer .. .
1. To assign as a right or due-1596; to give, or let any one
have, as his share, or as what he needs ME; to portion,
endow-1712.
2. To place to one's credit, count to one-1667; hence, to
deduct from the debit, to abate-1530; gen. to add or deduct
(so much) on account of 'something not formally appearing
1663....
I feel there is some disparity between the two
versions: the _ French version used the word "per-
mise", although in sections 11 and 12, which deal
with deductions, the word "admettre" was used.
The English version, by using the verb "allowed",
which comes from the French "allouer", in section
137(1) and sections 11 and 12, leaves no doubt
that the reference is to "deduction". I conclude,
therefore, that the two versions must be interpret
ed as meaning that "permise" refers to "déduc-
tion", just as "allowed" refers to "deduction".
In the English version, the key words "unduly"
and "artificially" are defined in the Shorter
Oxford English Dictionary on Historical Princi
ples as:
Artificially: Adv. artificial.
Artificial: ... adj. 1. Opp. to natural. l.made by or resulting
from art or artifice; not natural. 2. Made by art in imitation of,
or as substitute for, what is natural or real 1577. 3. Factitious;
hence, feigned, fictitious 1650. 4. Affected 1598.. .
Unduly: ... adv. late ME ... 1. Without due cause or justifi
cation; unrightfully, undeservedly. 2. To excess; beyond the due
degree 1779... .
So far as the definition of "artificially" is con
cerned, I do not think it can reasonably be said
that expenses are not natural, or that they are
"feigned", but this can be said of an operation or
transaction. "Unduly" suggests the idea of a lack
of justification, or the idea of excess. The second
meaning, of excess, does not appear in the French
definition of "indûment"; that meaning corre
sponds to the idea contained in section 12(2) of the
Act, namely the reasonableness of the quantum of
an expense or disbursement. In the English version
as in the French, the words "indûment" and "de
façon factice", and the words "unduly" and
"artificially", attribute these characteristics to the
operation or transaction, the source of the dis
bursements or expenses, and the operation or
transaction communicates these same characteris
tics to these disbursements and expenses; the
expenses and disbursements communicate these
characteristics to the deduction, which in turn
communicates to the reduction the same
characteristics.
I feel it is impossible to interpret this section
other than by determining the nature of the trans
action or operation which gave rise to the expense
or disbursement: the expense or disbursement will
have this nature, as will the deduction claimed. I
therefore agree with the interpretation of section
137(1) to the effect that it is the transaction or
operation which qualifies the deduction, and this
qualification is that resulting from the words
"would unduly or artificially reduce the income".
I think section 137(1) justifies reference to the
same dictionary, Robert, Dictionnaire de la langue
française, for a definition of the words "affaire",
"opération" and "permettre".
AFFAIRE: sens (II)
1 ° Convention, marché, négociation, tractation, traité, tran
saction. Entreprise, opération commerciale, spéculation. Une
bonne (elliptiqt. une "affaire": un marché avantageux) affaire,
une affaire d'or. Une mauvaise affaire. Une grosse, une petite
affaire. Proposer une affaire à quelqu'un. S'intéresser, prendre
part à une affaire. Entreprendre, lancer une affaire. Prendre
une affaire en main. Etre à la tête d'une affaire. Administrer,
conduire, diriger, gérer une affaire. S'occuper d'une affaire.
Conclure, régler, terminer une affaire. L'affaire est dans le sac.
V. Sac. Réussir, manquer, rater, une affaire. Se retirer de son
affaire. Son affaire va bien, va mal, marche bien, marche mal.
Entendre son affaire, connaître son métier.
I think that this definition suggests the idea of
different stages in a plan as making up an
"affaire". Ibid:
OPERATION: sens (II) est ainsi défini.—
Démarche de l'esprit, acte ou série d'actes, supposant
réflexion et combinaison de moyens* en vue d'obtenir un
résultat déterminé. V. Accomplissement, entreprise, exécution,
travail. Les opérations essentielles de la médecine (cit. 7)
clinique. La première opération en histoire consiste à se mettre
à la place des hommes que l'on veut juger (Cf. Entrer, cit. 50).
L'analyse est l'opération qui ramène l'objet à des éléments
déjà connus (Cf. Intuition, cit. 2). Opérations industrielles,
chimiques, pharmaceutiques, techniques. V. Manipulation,
traitement. Les opérations qui conduisent de l'obtention de la
matière première à la fabrication du produit fini (Cf. Intégra-
tion, cit. 1). Machine (cit. 15) qui se charge de la plupart des
opérations.
OPERATION: sens (VI) est ainsi défini.—
(XVIII* s.) V. Affaire (II, 1°), spéculation. Opération com-
merciale (Cf. Courtier, cit. 4; effet, cit. 40), financière, immo-
bilière (Cf. Idéal 2, cit. 23). Opérations de bourse, ventes et
achats réalisés dans une bourse* de marchandises ou de
valeurs. Opération au comptant, à court terme, à long terme.
Combiner une opération. Opération d'envergure (cit. 6), auda-
cieuse (Cf. Marché, cit. 28), imprudente, malhonnête. Opéra-
tion avantageuse, désastreuse.—Fam. Vous n'avez pas fait lÃ
une belle opération!—Par anal. La guerre, mauvaise opération
et qui ne rapporte rien (Cf. Dommage, cit. 6).—Opération de
banque: ensemble des actes juridiques accomplis à l'occasion du
commerce des banques.—Opérations comptables, de comptabi-
lité. Opérations de dépenses et de recettes (Cf. Exercise, cit. 22;
et aussi Journal, cit. 1).
The phrases "acte ou série d'actes" (action or
series of actions) in sense (II), and "l'ensemble des
actes juridiques" (group of actions with legal
consequences) in sense (VI) should be noted, as
each phrase suggests the idea of a plan and the
stages of an operation. Ibid:
PERMETTRE:
Laisser* faire quelque chose, accepter qu'une chose soit, se
produise ... , ne pas l'empêcher.
PERMETTRE DE ... :
Suivi de l'infinitif. Donner le droit*, la liberté, le pouvoir de ...
As between allowing something to be done, and
conferring a right to do something, I adopt the
meaning of "conferring a right to" for purposes of
interpretation of the section. Nothing in the Act
permits the Minister to disregard the legal exist
ence of a transaction or operation, but expenses
and disbursements incurred as a consequence may
or may not be allowed in computing income.
In the Shorter Oxford Dictionary the word
"transaction" is defined as:
Transaction:
[ad. L. transactionem, f. transigere; see prec.] 1. Roman and
Civil Law. The adjustment of a dispute between parties by
mutual concession; compromise; hence gen. an arrangement, an
agreement, a covenant. Now Hist. exc. as in 3b. 2. The action
of transacting or fact of being transacted-1655. 3. That which
is or has been transacted; a piece of business; in pl. doings,
proceedings, dealings-1647. b. Theo!. In ref. to the Atone
ment, `transaction' has senses ranging from 1 to 3. (In sense 1
chiefly in deprecation.) 1861. 4. The action of passing or
making over a thing from one person, thing, or state to anoth-
er-1691. 5. pl. The record of its proceedings published by a
learned society. Rarely in sing.—l665.
3. Discoursing of the Court of France, and the transactions
there Clarendon. Hence Transactional a., ly adv.
Ibid.
Transact:
v. 1584. [f. L. transact—, transigere to drive through,
accomplish, f. TRANS — t agere to drive, do, act.] 1. intr. To
carry through negotiations; to have dealings, do business; to
treat; also, to manage or settle affairs. Now rare. b. fig. (usu.
dyslogistic.) To have to do, to compromise 1888. 2. trans. To
carry through, perform (an action, etc.); to manage (an affair);
now esp. to carry on, do (business) 1635. 3. To deal in or with;
to traffic in, negotiate about; to handle, treat; to discuss. arch.
1654. 4. To transfer-1889. l.b. In his criticism .: he seems to
us a little to 't.' with cant 1890. 2. A country fully stocked in
proportion to all the business it had to t. Adam Smith.
I think the second sense of "transaction", "the
action of transacting", and the third sense, "that
which has been transacted; a piece of business",
correspond to section 137(1), though it would
appear that the choice of this word was not as
fortunate as "affaire" or "opération".
Consideration of the origins of section 137(1)
and section 12(2) may be helpful in determining
the scope of section 137(1).
Section 12(2) of the 1948 Act is derived from
section 6(2) of the Income War Tax Act. This
section, 6(2), is taken from c. 41 of the Statutes,
23-24 Geo. V, and reads as follows:
(2) Le ministre peut rejeter comme dépense la totalité ou
toute fraction de traitement, gratification, commission ou d'ho-
noraires d'administrateur qui, à son avis, excède ce qui est
raisonnable pour les services rendus.
The English version is worded as follows:
(2) The Minister may disallow as an expense the whole or
any portion of any salary, bonus, commission or director's fee
which in his opinion is in excess of what is reasonable for the
services performed.
It is clear that the purpose of these two versions
was to determine the reasonableness of the quan
tum of an expense, which may be all or a part of
the amount of the expense, having regard to the
services rendered, but not the expense itself,
because of its character or nature. Thus, it is the
quantum that is in question, not the expense.
By c. 34 of S.C. 1939-40, 2nd session, namely 4
Geo. VI, s. 17, section 6(2) was repealed and
replaced by the following:
(2) Le ministre est autorisé à rejeter toute dépense qu'il peut
discrétionnairement déterminer comme excédant ce qui est
raisonnable ou normal en ce qui concerne l'entreprise du contri-
buable, ou faite relativement à une opération ou affaire qui, Ã
son avis, a indüment ou artificiellement réduit le revenu.
The English version reads:
(2) The Minister may disallow any expense which he in his
discretion may determine to be in excess of what is reasonable
or normal for the business carried on by the taxpayer, or which
was incurred in respect of any transaction or operation which in
his opinion has unduly or artificially reduced the income.
It may be noted, first of all, that the section no
longer relates to specific expenses: salaries and so
on; it applies to any expense; it no longer mentions
disallowance of the whole of a specific expense; it
permits the disallowance of anything in excess of
what is reasonable or normal; and it uses "normal"
in addition to "reasonable", creating a choice be
tween two standards: reasonableness or normality,
two complementary concepts. The new concept of
normality undoubtedly referred to the practices
and customs applicable to the business.
However, a new and much more significant
concept appears in the Act—and this is the genesis
of section 137(1): disallowance of any expense
incurred in respect of any transaction, if such
expense in the Minister's opinion has unduly or
artificially reduced income.
It may be noted that the right to disallow the
whole of the quantum of an expense or disburse-
ment under what was formerly section 6(2) now
depends on whether an operation or transaction is
undue or artificial; that the right to disallow a
portion of an expense or disbursement depends on
the reasonableness or normality of that expense;
and that only what is in excess of such reasonable
ness or normality may be disallowed.
In my view, these provisions of section 6(2) of
chapter 34 clearly indicate that it is the transac
tion or operation which, because of its undue or
artificial nature, attaches this characteristic to the
expense or disbursement, which may be disallowed
in its entirety, at the Minister's discretion.
No change was made in the Act until 1948,
when the Income War Tax Act was repealed, and
replaced by the Income Tax Act, c. 52 of the 1948
Statutes.
The two concepts which were contained in one
section, section 6(2), became the subject of two
separate sections: section 12(2) and section
125(1).
Section 12(2) read, in French:
(2) Dans le calcul du revenu, il n'est opéré aucune déduction
à l'égard d'une mise de fonds ou d'une dépense autrement
déductible, sauf dans la mesure où la mise de fonds ou la
dépense était raisonnable dans les circonstances.
The English version was:
(2) In computing income, no deduction shall be made in
respect of an outlay or expense otherwise deductible except to
the extent that the outlay or expense was reasonable in the
circumstances.
This section preserves the standard of reason
ableness, but abandons that of normality; permits
disallowance of the amount of an expense which
exceeds what is reasonable; and widens the ambit
of the standard by referring to the circumstances
rather than to the taxpayer's business.
In my opinion the section has a wider scope as a
result of elimination of the standards of normality
and the type of business, because the standard of
reasonableness is qualified by the circumstances,
which makes it subjective.
The use of the phrase "mise de fonds" for
"outlay" in French should be noted. This error was
to be corrected in 1952.
The concept of what is undue br artificial is now
the subject of section 125(1) of the Act:
125. (1) Dans le calcul du revenu aux fins de la présente loi,
aucune déduction ne peut être faite à l'égard d'un déboursé fait
ou d'une dépense subie, relativement à une transaction ou
opération qui, si elle était permise, réduirait indûment ou de
façon factice le revenu.
The English version reads:
125. (1) In computing income for the purposes of this Act,
no deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or opera
tion that, if allowed, would unduly or artificially reduce the
income.
In my view, the fact that both concepts were
contained in the same section, 6(2), indicates that
there was, and still is, some relationship between
section 12(2) and section 125(1), which became
137(1), if only their common origin.
Section 12(2) limits its application to reason
ableness in relation to the circumstances, and iden
tifies its object: disallowance of a portion of a
disbursement or expense; its ambit is clearly
circumscribed.
Section 137(1) limits its application to what is
undue and artificial, and identifies its object: disal-
lowance of any disbursement or expense incurred
in respect of an operation or transaction deemed to
be undue or artificial; its ambit cannot be easily
circumscribed. Indeed, these standards, of what is
undue and artificial, are standards of morality
which necessarily vary.
The fact that in a transaction or operation there
are certain aspects less well-advised than others
should not result in making the entire operation or
transaction artificial or undue, and all the
expenses incurred in respect of it non-deductible.
The provisions of section 137(1) are very wide,
and confer on the Minister a power that enables
him to abolish the specific provisions of sections 11
and 12 of the Act for all practical purposes, since
any disbursement or expense deemed to be non
deductible is undue, and its deduction is unfound
ed, which is one of the meanings of undue.
In my view section 137(1) is the section with the
widest scope in all of Part VI of the Act, for its
boundaries are more imprecise than all the others,
which provide either for a decision of the Treasury
Board or evidentiary requirements, if the section is
to apply. There is nothing of this kind in section
137(1).
Under section 13 of the Interpretation Act, ref
erence may not be made to the marginal note of
section 137(1), but judicial authority exists for
referring to the heading, which in this instance is
"Tax evasion" for Part VI of the Act, and also for
referring to the context of section 137(1).
The heading of Part VI, "Dissimulation de
matière imposable", by its use of the word "dis-
simulation", emphasizes a deliberate act by the
taxpayer intended to defraud the treasury. More
over, in English this title is rendered by "Tax
evasion", which leaves no doubt that it refers to a
deliberate act.
So far as the context is concerned, in particular
section 138 (1) of the Act, it is interesting to note
that if "one of the main purposes for a transaction
or transactions ... was improper avoidance or
reduction of taxes ... the Treasury Board may
give such directions as it considers appropriate to
counteract the avoidance or reduction."
The purpose of section 138(1) is essentially the
same as that of section 137(1), except that the
power to act resides not with the Minister but with
the Treasury Board; section 138(1) is a less dan
gerous weapon than that contained in section
137(1), since Treasury Board approval is required,
though the provision in section 138(1) has the
same objective, namely that of reversing the reduc
tion or avoidance of tax.
In my opinion, "dissimulation" implies camou
flaging or disguising an act in order to lend it an
appearance not its own, while "avoidance" sug
gests the idea of avoiding by legal, or at least
legalistic, means a heavier tax burden. There is
undoubtedly a difference between the two versions.
It should also be emphasized that in section
138(1) the legislator used the words "irrégulière-
ment éviter ou réduire les impôts" (improper
avoidance or reduction of taxes). If it is bad form
to avoid taxes improperly, that implies, ipso facto,
that it is good form to avoid or reduce taxes
property. "Régulier" and "irrégulier" must be
understood not as meaning in a continuing or
intermittent manner, but by following, or not fol
lowing, the rules of the game.
It is surprising that section 138(1), the applica
tion of which is exceptional, since it requires refer
ence to the Treasury Board, should have a narrow
er scope than section 137(1), because reduction or
avoidance in accordance with the rules does not
fall within its purview. The reference in section
138(1) to "irrégulièrement" (improperly) implies
that the action in question is contrary to the rules,
is not within the accepted standard. In Robert,
Dictionnaire de la langue française, we find the
following definition:
RÉGULIER:
Qui est conforme aux règles, ne fait pas exception à la
norme....
Ibid.
IRRÉGULIER:
2° (Abstrait). Qui n'est pas conforme à la règle établie, Ã
l'usage commun ... .
This reference to accepted standards, practice,
rules, must be taken into account. I think section
138(1) throws great light on the interpretation
that must be placed on section 137(1).
Section 138A also requires study. This section
confers discretion on the Minister in two cases: the
reduction or disappearance of the assets of a cor
poration where one of the purposes is to avoid tax,
or the existence of corporations having the reduc
tion of tax as one reason for their existence.
Under section 138A(3) the Tax Review Board or
the Federal Court may conclude that, in the first
case, the transaction or series of transactions did
not have the effect attributed to it by the Minister,
and in the second case, that none of the main
reasons for the existence of the corporations was to
reduce tax. Clearly defined standards are provided
in this section.
In my opinion what is noticeable in the provi
sions of this section is that the legislator took pains
to use, in the first case, the phrase "transaction or
series of transactions". In section 137(1) the
phrase used is "transaction or operation", not
"transaction or series of transactions". A transac-
tion and a series of transactions are two different
things.
In the case at bar, there was a series of transac
tions, not a transaction, and section 137(1) refers
only to a transaction. Furthermore, section 138(1),
which is the reference to the Treasury Board,
requires that there must have been an improper
reduction or avoidance of taxes, that is to say, by
means contrary to accepted standards, rules and
practice, by legalistic rather than legal means.
In my view it is necessary to refer to this
accepted standard, these rules and practices, to
decide whether the operation or transaction in
question was undue or artificial.
In my opinion, the facts in evidence do not
support characterization of the operation as undue
or artificial. Plaintiff and his fellow tenants acted
in a manner appropriate to real estate agents
joining together to purchase a building, and in so
doing they acted in conformity with the rules,
accepted standards and practice. When we speak
of an undue or artificial operation or transaction
we refer, in my view, to a sham, a deception. There
was nothing of that nature in the case at bar.
Plaintiff and his fellow tenants chose from among
several methods the one that would entail the least
tax burden, but there was nothing undue or artifi
cial about the method chosen.
To my mind, the concept of what is undue or
artificial is another way of stating the well-known
principle of form and substance, a principle which
is not referred to in every situation, but only when
the nature of a transaction, though designated as
"A", is in law and in fact "B".
Learned counsel for the Crown adduced another
argument, namely that plaintiff and his fellow
tenants incurred these expenses not qua tenants
but qua shareholders. I cannot subscribe to this
proposition of law, since it might be applied to any
person who is a shareholder in a private company
who incurs expenses and acts in some other capaci
ty than that of a shareholder.
It would certainly be surprising if the provisions
of section 137(1), implementation of which is left
in the discretion of the Minister alone, were to be
interpreted more strictly than those of section
138(1), which are entrusted, not to the unaided
discretion of the Minister, but to the decision of
the Treasury Board, or than those of section 138A,
in which the evidentiary requirements are clearly
stated.
The heading of Part VI, to which we may refer,
reads "dissimulation" and "evasion". In the case
at bar there is no evidence of either "dissimula-
tion" or "evasion".
The appeal is allowed with costs.
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.