T-2659-81
Frederick G. Vivian (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Mahoney J.—Toronto, February
24; Ottawa, March 23, 1983.
Income tax — Income calculation — Assessments — Man
agement companies — No bona fide business purpose — Tax
reduction primary purpose — Estate planning secondary pur
pose, motivated solely by tax and personal, not business,
considerations — Interposition of management companies not
"sham" within generally accepted definition in Snook v.
London & West Riding Investments Ltd., [1967] 1 All E.R.
518 (C.A.) nor within wider definition in Minister of National
Revenue v. Leon, [1977] 1 F.C. 249 (C.A.) — Federal Court of
Appeal later disagreeing with definition in Leon case — Valid
ity of Leon not settled, as leave to appeal to Supreme Court of
Canada refused — Court satisfied that what was done to
achieve desired result—reduction of tax—valid, complete
transaction — Appeals allowed.
Plaintiffs appeal assessments of their personal income tax
returns. The Minister of National Revenue included in their
respective incomes amounts paid by Newfoundland Design
Association Limited ("Design") to their management compa
nies who reported the payments as income. The plaintiffs are
professional engineers and Design is an engineering firm whose
entire capital stock is equally owned by plaintiffs and their
wives. According to plaintiffs, the management companies were
created not only to reduce their income tax liability, but also to
permit them to pursue their professional interests, to slow down
the growth in equity value of Design, and to dissolve tensions
between them. Estate-planning considerations was another ele
ment of the reorganization. The issue is whether the reorgani
zation was made for a bona fide business purpose and whether
it constituted a "sham" within the meaning given to that word
by Lord Diplock in Snook v. London & West Riding Invest
ments Ltd., [1967] 1 All E.R. 518 (C.A.): "for acts or docu
ments to be a `sham' ... all the parties thereto must have a
common intention that the acts or documents are not to create
the legal rights and obligations which they give the appearance
of creating", or within the wider definition given by the Federal
Court of Appeal in Minister of National Revenue v. Leon,
[1977] 1 F.C. 249 (C.A.): "If the agreement or transaction
lacks a bona fide business purpose, it is a sham."
Held, the appeals are allowed. The interposition of the
management companies have no bona fide business purpose: its
primary purpose was the reduction of plaintiffs' income tax
liabilities; its secondary purpose was estate planning which, in
the absence of credible evidence to the contrary, was solely
motivated by tax and personal considerations. Furthermore, the
interposition did not constitute a "sham" within the meaning
given to that word in the Snook and Leon decisions. Only if the
definition of "sham" adopted in Leon remains valid can the
plaintiffs fail. However, leave to appeal that decision was
refused by the Supreme Court of Canada, and it is apparent
from the Federal Court of Appeal's later judgments that it has
not taken the refusal as an approval of the definition in the
Leon case. In Massey Ferguson Limited v. The Queen, [1977]
1 F.C. 760 (C.A.), the Court of Appeal confined the definition
in Leon to the facts of that case—which facts are not different
from those in the case at bar. In Stubart Investments Limited
v. Her Majesty The Queen (198 I ), 81 DTC 5120 (F.C.A.), the
Federal Court of Appeal, while holding that the transactions in
question were not a "sham", added that in any event, the Court
had to be satisfied that what the appellant purported to do was
accomplished. In the case at bar, what was purported to be
done was done; what was done to achieve the desired result—
the reduction of tax—was a valid, complete transaction, noth
ing less.
The law is not clear, and while the burden of the proof of
facts rests generally upon the taxpayer, the burden of establish
ing that the law clearly imposes the tax sought to be levied
invariably rests upon the taxation authorities.
CASES JUDICIALLY CONSIDERED
APPLIED:
Snook v. London & West Riding Investments Ltd.,
[1967] 1 All E.R. 518 (C.A.).
NOT FOLLOWED:
Minister of National Revenue v. Leon, [1977] 1 F.C. 249
(C.A.).
DISTINGUISHED:
Massey Ferguson Limited v. The Queen, [1977] 1 F.C.
760 (C.A.); Stubart Investments Limited v. Her Majesty
The Queen (1981), 81 DTC 5120 (F.C.A.); Atinco Paper
Products Limited v. Her Majesty The Queen (1978), 78
DTC 6387 (F.C.A.).
REFERRED TO:
Spur Oil Ltd. v. The Queen, [1982] 2 F.C. 113 (C.A.).
COUNSEL:
Donald Bowman, Q.C. and M. A. Monteith
for plaintiffs.
John R. Power, Q.C. and Deen Olsen for
defendant.
SOLICITORS:
Stikeman, Elliott, Robarts & Bowman,
Toronto, for plaintiffs.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
MAHONEY J.: This is a management company
case. It was tried together on common evidence
with Rex T. Parsons v. The Queen, Court file no.
T-2660-81. Parsons testified first; the plaintiff,
Frederick G. Vivian, was excluded from the court
room during his cross-examination. In issue are the
assessments of their personal income tax returns
for 1975, 1976, 1977 and 1978. The Minister has
included in their respective incomes amounts paid
by Newfoundland Design Associates Limited,
hereinafter "Design", to Frederick G. Vivian
Management Limited and Rex T. Parsons Man
agement Limited, hereinafter the "management
companies". The management companies reported
the payments as their income.
At all material times, all of the shares in Design
were owned equally by Vivian, Parsons and their
wives, or by two holding companies, whose voting
shares were entirely owned by them respectively.
They are professional engineers. Design is an engi
neering firm offering its services in the Province of
Newfoundland. The management companies, as
well as Vivian, Parsons and, presumably, Design,
were, at all material times, duly licensed to prac
tice the profession of engineering in Newfound-
land.
Vivian and Parsons each owned all 500 issued
voting preference shares of his management com
pany and each was sole trustee of the trust that
owned all of the issued common shares for the
benefit of his children. There were 200 issued
common shares of F.G. Vivian Management Lim
ited and 201 of Rex T. Parsons Management
Limited. Each share, common and preference, car
ried one vote.
There is no point in a detailed review of the
extensive documentary evidence, all admitted by
agreement. Suffice it to say, the plaintiffs and the
companies took and meticulously followed com
petent professional advice. Every move is properly
documented and, in the documentation, every "i"
is dotted and "t" crossed. Vivian and Parsons
resigned their employment by Design and were
employed by their respective management compa
nies. The arrangements were undoubtedly made
with a view to an overall reduction of income tax.
That said, they were precisely what they purported
to be: all services theretofore rendered to Design
by Vivian and Parsons as employees were, as of
and after October 1, 1975, rendered by the respec
tive management companies. Vivian and Parsons
were no longer paid salaries by Design; they were
paid by the management companies. They
remained directors and corporate officers of
Design. The management companies each
employed the wife of its respective controlling
shareholder at a nominal salary to perform ser
vices for the management company; however, the
services rendered to Design by each management
company were, in fact, entirely performed by
Vivian or Parsons personally. The services per
formed for Design by the management companies
were the services called for under the management
contracts and the management companies were
paid therefor by Design in strict compliance with
the terms of those contracts. The services called
for by the contracts were the identical services
previously performed in their employment and
there was no apparent change in their relationships
with Design's staff as a result of the interposition
of the management companies. In short, the rela
tionships among Design, the management compa
nies, the trusts and Vivian and Parsons, were
entirely legal, precisely defined in writing and, in
fact, observed by each and all of them.
The management companies each maintained
an office in the residence of its controlling share
holder. There were separate telephone listings and
they offered engineering services to others than
Design. Aside from Vivian and Parsons and their
wives, they had no employees. With one exception,
when the services of others were required, they
were provided by Design's staff and Design was
reimbursed therefor at the rates published from
time to time by the Association of Professional
Engineers of Newfoundland. That exception was
in the case of the $5,080 billing by Vivian's man
agement company in 1979, as set out below. It
paid $2,080 to a third party in respect thereof.
I do not accept Parsons' evidence that he would
not have entered into the transactions in issue only
because of the tax advantages on account of them
being too cumbersome. Neither do I accept as
well-founded, Vivian's doubt that there was really
any tax advantage. Vivian's personal income tax,
as reported, for 1974, the last full year prior to the
reorganization, was $48,623 on a taxable income
of $91,260. The combined personal and corpora
tion income taxes, as reported by Vivian and his
management company for 1976, the first full year
in which the reorganization was in effect was
$67,639 on combined taxable incomes of $174,528.
Comparable figures for Parsons were, for 1974,
$48,378 tax on $93,026 taxable income and, com
bined for 1976, $63,886 tax on $167,558 taxable
income.
One of the reasons, aside from income tax con
siderations, for the reorganization was to permit
Vivian and Parsons, individually, to pursue their
particular professional interests and establish per
sonal identities in the practice of their profession
independent of Design and their association with
each other. In the last quarter of 1975, the Vivian
management company received $30,525 from
Design under the management contract and noth
ing from others. Thereafter, the pertinent amounts
were:
1976 1977 1978 1979
From Design $139,056 $120,510 $142,492 $162,450
From Others 3,574 1,945 2,248 5,080
Payments to Design 2,823 1,038 296 Nil
Likewise, the Parsons management company
received $29,726 from Design, and nothing from
others, in the last quarter of 1975 and thereafter,
the following:
1976 1977 1978 1979
From Design $140,131 $123,410 $146,682 $159,173
From Others 4,285 5,891 3,185 420
Payments to Design 2,944 58 3,109 Nil
The amounts received from others, as set out
above, are gross receipts. The payments to Design
are the amounts paid each year by each manage
ment company for the services of Design's
employees in the performance of their independent
work for others. Over the four years, Vivian's
management company received 98.5% of its net
revenue for services from Design and Parsons'
received 98.6% from that source.
The reorganization was also expected to slow,
stop or reverse the growth in the equity value of
Design thereby permitting equity participation by
employees. Since 1975, no one, other than the
plaintiffs, their wives and holding companies, have
participated in Design's equity. There is no evi
dence that the opportunity of such participation
has yet been offered.
Vivian and Parsons testified to tensions between
them under the old regime that, almost magically
it seems, dissolved with the reorganization. Nei
ther articulated a rational theory to explain the
phenomenon.
One area of tension was described as arising out
of the "Siamese twins" style leadership extant
before the advent of the management companies.
While the problems were described with some
specificity, the manner of their resolution as an
objective rather than a result of the reorganization
was not even alluded to. It is surprising that an
organizational set-up described as too cumbersome
to be justified by its substantial tax savings alone
had so beneficial a result.
Another area was embraced in the term "funds
in jeopardy". They were concerned with Design's
built-up worth being available to satisfy potentially
enormous damages founded in professional liabili
ty claims. I can appreciate the reality of such a
concern but, again, fail to understand how interpo
sition of the management companies was proposed
to, or did in fact, resolve it. There was no distribu
tion of surplus involved in the transaction in issue.
That occurred with the later interposition of the
holding companies.
A third area identified was the conflicting views
between Vivian and Parsons as to the investment
of Design's surplus funds. Again, since there was
no distribution of surplus, it is not apparent how
interposition of the management companies could
have, in fact, or was intended, to resolve that
conflict. There was no evidence as to how those
funds were invested prior to October 1, 1975, and
how they were invested after. The witnesses both
asserted the existence of the disagreement but I do
note, from a perusal of their personal income tax
returns, that they do share a rather special invest
ment interest: Canadian film production. Perhaps
that is rooted in a common cultural concern.
There was, of course an element of estate plan
ning. The only reason advanced, by Parsons, was
his guilt at being kept away from his children by
pressures of business and, as a result, wanting to
do something for them. That, praiseworthy as it is,
is not a business purpose. I should not wish to close
the door to the possibility that estate planning may
have a bona fide business purpose in some circum
stances as well as tax and personal purposes. If it is
possible, it has not been proved here.
If I have not mentioned other alleged business
purposes asserted in evidence, it is because I found
them even more far-fetched than those I have dealt
with. I find that the interposition of the manage
ment companies (1) had no bona fide business
purpose, (2) had, primarily, the purpose of directly
reducing their income tax liabilities, (3) had,
secondarily, an estate-planning purpose which, in
the absence of credible evidence to the contrary,
must be taken to have also been solely motivated
by tax and personal, not business, considerations
and (4) was not a sham in the generally accepted
legal sense of that word. I understand that to be
the frequently cited opinion of Lord Diplock in
Snook v. London & West Riding Investments Ltd.
[at page 528]:'
I apprehend that, if it [sham] has any meaning in law, it means
acts done or documents executed by the parties to the "sham"
which are intended by them to give to third parties or to the
court the appearance of creating between the parties legal
rights and obligations different from the actual legal rights and
obligations (if any) which the parties intend to create. One
thing I think, however, is clear in legal principle, morality and
the authorities ... that for acts or documents to be a "sham",
' [1967] 1 All E.R. 518 (C.A.).
with whatever legal consequences follow from this, all the
parties thereto must have a common intention that the acts or
documents are not to create the legal rights and obligations
which they give the appearance of creating. No unexpressed
intentions of a "shammer" affect the rights of a party whom he
deceived.
That definition appears recently to have been
adopted in a number of judgments, in the context
of the Income Tax Act [R.S.C. 1952, c. 148 (as
am. by S.C. 1970-71-72, c. 63, s. 1)], by the
Federal Court of Appeal. 2
The definition of "sham" in the context of the
Income Tax Act was, however, considerably
broadened by the Federal Court of Appeal in
Minister of National Revenue v. Leon, 3 where it
was held:
If the agreement or transaction lacks a bona fide business
purpose, it is a sham .... In the case at bar, there is no bona
fide business reason for the agreements and the sole purpose of
the agreements is the savings in income tax.
By that definition, the interposition of the manage
ment companies was a sham. Leave to appeal that
decision was refused by the Supreme Court of
Canada. 4
In Massey Ferguson Limited v. The Queen,' a
different panel of the Federal Court of Appeal,
considering the Leon judgment, said:
I am not at all sure that I would have agreed with the broad
principles relating to a finding of sham as enunciated in that
case, and, I think, that the principle so stated should perhaps be
confined to the facts of that case.
The facts in Massey Ferguson were very different
from those in Leon. Those here are not.
Again, dealing with facts very different from
here, another panel of the Court of Appeal, includ
ing, coincidentally the authors of both the Leon
and Massey Ferguson judgments, in Stubart
Investments Limited v. Her Majesty The Queen, 6
after accepting Lord Diplock's definition of
"sham", had this to say:
2 Stubart Investments Limited v. Her Majesty The Queen,
infra, at p. 5123; Spur Oil Ltd. v. The Queen, [1982] 2 F.C.
113 [C.A.], at p. 126.
3 [1977] 1 F.C. 249 [C.A.], at pp. 256 and 257.
4 [1976] 2 S.C.R. ix.
5 [1977] 1 F.C. 760 [C.A.], at p. 772.
6 (1981), 81 DTC 5120 [F.C.A.], at pp. 5124 ff.
It was admitted that the transactions were entered into for
the purpose of utilizing the tax losses accumulated by Grover.
That in itself is not a reprehensible, let alone an illegal, act
since every person is entitled to organize his affairs in such a
manner as to minimize or eliminate taxes so long as he does so
within the limitations imposed by the law. To attach to those
transactions the pejorative term "sham", in the circumstances
of this case, it seems to me may be unnecessary, unfair and,
perhaps unwarranted although it must be said that the evidence
certainly points in that direction. However, even if they did not
comprise a sham, that conclusion does not necessarily permit
the appellant to claim that the Minister's reassessments were
invalid. As I see it, it must, in any event, satisfy the Court that
what it purported to do, namely to transfer its assets and
undertakings to Grover, was in fact accomplished. Since the
acknowledged purpose of the transactions was to reduce the tax
consequences arising out of the profits of the flavourings busi
ness by applying Grover's tax losses thereto, the Court is
entitled, indeed obliged, to examine all of the evidence relating
to the transactions to ensure that what was done for the
purpose of achieving the desired result in fact was sufficient to
enable the Court to conclude that there had been a valid,
completed transaction.
In Stubart, the Court of Appeal also took the
opportunity to reiterate what it had said earlier in
Atinco Paper Products Limited v. Her Majesty
The Queen.'
I do not think that I should leave this appeal without
expressing my views on the general question of transactions
undertaken purportedly for the purpose of estate planning and
tax avoidance. It is trite law to say that every taxpayer is
entitled to so arrange his affairs as to minimize his tax liability.
No one has ever suggested that this is contrary to public policy.
It is equally true that this Court is not the watch-dog of the
Minister of National Revenue. Nonetheless, it is the duty of the
Court to carefully scrutinize everything that a taxpayer has
done to ensure that everything which appears to have been
done, in fact, has been done in accordance with applicable law.
It is not sufficient to employ devices to achieve a desired result
without ensuring that those devices are not simply cosmetically
correct, that is correct in form, but, in fact, are in all respects
legally correct, real transactions. If this Court, or any other
Court, were to fail to carry out its elementary duty to examine
with care all aspects of the transactions in issue, it would not
only be derelict in carrying out its judicial duties, but in its duty
to the public at large. It is for this reason that I cannot accede
to the suggestion, sometimes expressed, that there can be a
strict or liberal view taken of a transaction, or series of transac
tions which it is hoped by the taxpayer will result in a minimi
zation of tax. The only course for the Court to take is to apply
the law as the Court sees it to the facts as found in the
particular transaction. If the transaction can withstand that
scrutiny, then it will, of course, be supported. If it cannot, it
will fall.
7 (1978), 78 DTC 6387 [F.C.A.], at p. 6395.
In both Stubart and Atinco, it was found that
the transaction, or series of transactions, could not
withstand scrutiny. Here, it is otherwise. What
was purported to be done was, in fact, done; what
was done to achieve the desired result, the reduc
tion of tax, was a valid, complete transaction, or
series of transactions, and nothing less. Only if the
definition of "sham" adopted in Leon remains
valid can the plaintiffs fail. It is apparent from its
later judgments that the Court of Appeal has not
taken the refusal of leave to appeal by the
Supreme Court of Canada as approving that defi
nition. Those later judgments raise doubts as to its
validity.
The law is not clear. In tax matters, while the
burden of proof of facts rests generally upon the
taxpayer, the burden of demonstrating that the
law clearly imposes the tax sought to be levied
invariably rests upon the fisc. The appeals from
the assessments are allowed with costs.
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