Date: 20000207
Docket: T-3466-90
BETWEEN:
SUNSHINE UNIFORM SUPPLY (1983) LTD.
Plaintiff
- and -
HER MAJESTY THE QUEEN
Defendant
REASONS FOR JUDGMENT
EVANS J.
| A. INTRODUCTION |
[1] On February 25, 1986, a series of documents were executed and transactions completed which, if they had their intended legal effect, would result in substantial tax savings for Sunshine Uniform Supply (1983) Ltd. and its parent, Perth Services Ltd.
[2] The Minister of National Revenue disallowed the various deductions claimed by the companies for expenditures made for scientific research and experimental development through the vehicle provided by the elaborate scheme into which they had entered.
[3] The taxpayers have appealed from those decisions. This appeal relates to the deductions claimed by Sunshine for the tax year 1986. The parties agree that the result of this appeal will also effectively dispose of the other five appeals arising from the same transactions.
[4] The disposition of the appeal turns essentially on whether the underlying facts supported the legal form of the documents and on the interpretation of a key element of the provision in the Income Tax Act defining the scope of the scientific research deduction.
| B. FACTUAL BACKGROUND |
(a) the players
| (i) Sunshine and Perth |
[5] Sunshine and Perth are incorporated under the laws of Manitoba and conduct their business in Winnipeg. They rent, deliver, collect, launder and dry clean table linen and the uniforms worn by, for instance, those waiting tables in restaurants and working in hotels,
[6] The companies are now owned by Stewart Leibl, who is also their president. He has been with Perth since 1977 and was the principal witness called on behalf of the taxpayer.
[7] In the mid 1980s, when the events giving rise to this litigation occurred, he was the vice-president of both companies and was solely responsible for the day-to-day running of the rental side of the business. He was also one of the four owners, and a signing officer for the companies. Although Mr. Leibl"s signature does not appear on the documents executed on behalf of Sunshine, he testified that he was familiar with their contents.
[8] During the mid 1980s Sunshine was a successful company with a pre-tax profit in excess of $500,000. In 1985 it had invested in research tax credits to reduce its tax liability, and late in 1985 and early in 1986 Sunshine was actively seeking another tax shelter. Its tax year ended at the end of February.
| (ii) Anaquan Scientific Research Ltd. |
[9] Anaquan, also a Manitoba corporation, was incorporated in 1983. Its business was the conduct of research, particularly in connection with construction. The owner and president of Anaquan was Alexander ("Paddy") McLellan.
[10] In 1984 and 1985 Anaquan had raised approximately $16 million to finance its research activities from investors who were seeking a tax shelter. In return, the company issued the investors with scientific research tax credits which under the law as it then was reduced their tax liability.
[11] These investment funds were taxable in the hands of Anaquan, which could discharge its tax liability by either paying the tax or spending the money on research that qualified for the deduction. Anaquan spent all the money that it raised, but Revenue Canada ruled that $5 million of its expenditure did not qualify for the research deduction.
[12] As a result, by the beginning of 1986 Anaquan was in debt to Revenue Canada for approximately $2.5 million and was in a precarious financial condition. Not surprisingly, Mr. McLellan was very eager to attract new investors in the company to enable it to clear off its debts and to finance further research. He took to Richard Shead the outline of a plan for raising between $500,000 and $1.5 million for Anaquan.
(iii) Richard Shead
[13] The central figure in structuring and designing the tax shelter with which this litigation is concerned was Richard Shead, at that time a senior partner in the Winnipeg law firm of Buchwald Asper Henteleff, where he specialised in the law of taxation and tax planning.
[14] Along with other partners of the Buchwald firm Mr. Shead was a director of Corporate Growth Systems, which was operated in tandem with the law practice and was the vehicle through which they provided business advice to clients. Mr. Shead retired from the law partnership in 1993.
[15] Mr. Shead handled corporate affairs for Sunshine and Perth and suggested to them the tax saving scheme into which they subsequently entered. Mr. Shead acted as their legal adviser in structuring the tax shelter that is the subject of this case. In addition, in 1989 he corresponded on their behalf with Revenue Canada when it disallowed the losses claimed by Sunshine and Perth as their share of the losses of the Anwin Partnership. Mr. Shead was also on the board of directors of Perth.
[16] Mr. Shead"s connections with Anaquan and Mr. McLellan, Anaquan"s first president, go back to 1984 when he incorporated the company and subsequently acted as an adviser to it. In the same year Mr. Shead purchased in his own name scientific research debenture notes from Anaquan Corporation, Anaquan"s parent.
[17] In early February 1986 Mr. McLellan met with Mr. Shead to explain Anaquan"s need to raise capital and outlined a proposal for a tax shelter that might prove attractive to potential investors. The challenge was to find a way to continue to sell Anaquan"s research losses, despite the abolition of the scientific research tax credit. The details of the scheme from which this appeal arises emerged from a series of meetings among Mr. Shead, Mr. McLellan and others, including accountants and representatives of Equion Securities Canada Ltd., another company for whom Mr. Shead had acted. Equion had raised money for other tax shelters and they acted as securities dealers in connection with the Anaquan scheme.
[18] The principal documents comprising the scheme were prepared by Mr. Shead. Despite the obviously conflicting interests of the proponent of the scheme, Anaquan, the investors, Perth and Sunshine, and Equion, the securities dealers, Mr. Shead appears to have acted for them all.
(b) the scheme
[19] The first document, the partnership agreement, contained the terms on which Anaquan, as the general partner, was prepared to enter into a limited partnership to be known as the Anwin Research Partnership. The general partner was authorised to raise capital for the partnership by offering partnership units and admitting subscribers as limited partners.
[20] The business of the partnership is stated to be the development of the "R. & D. Project" and the commercial exploitation of its results. The Project was further defined as research to be carried on at Anaquan"s facility in Winnipeg. The partnership agreement document was signed by Mr. McLellan on behalf of Anaquan, and Messrs. Johnson and Mehkary, two of the other co-owners, on behalf of Sunshine and Perth.
[21] The second document is an offering memorandum in which 535 units in the Anwin Partnership were offered for sale at $1,000 each, to be paid for by a combination of cash (65%) and promissory notes backed by irrevocable letters of credit (35%). The offering contained a disclaimer about the ability of Anaquan to continue the business of the partnership, and provided that Anaquan"s financial statements would accordingly not be made available to subscribers.
[22] Perth and Sunshine together purchased the 535 units for a total of $535,000. After the payment of professional fees of $37,450, the remaining $497,550 was to be expended by Anwin on the R. & D. Project described in the partnership agreement. As a result of the purchase of these units, Perth and Sunshine owned 99.999% of Anwin, while Anaquan owned 0.001%. There were no other limited partners.
[23] The third document is a joint venture agreement between the Anwin Research Partnership and Anaquan. The agreement provided that between February 25, 1986 and January 31, 1987 Anaquan would incur "current qualifying scientific research expenditures" on the conduct of research at its facility in Winnipeg.
[24] The contract price payable by Anwin comprised a cheque for $310,300 and the assignment of promissory notes payable on January 31, 1987 for $187,250 and 10% interest, secured by an irrevocable letter of credit from a bank. These sums represent the total amount paid by Perth and Sunshine for the units in Anwin, less $37,450 paid in professional fees and commissions to their advisers for arranging the tax shelter.
[25] The agreement also provided that in consideration Anwin was entitled for the first five years of the agreement to receive 10% per year of Anaquan"s gross income from the research facility, up to an annual maximum of 20% of the contract price. In each of the following five years, Anwin would receive 5% of the gross income, up to an annual maximum of 10% of the contract price.
[26] In other words, if Anaquan made substantial profits in each of the ten years of the projected life of the agreement, Anwin could do no better than recover the contract price by the end of the fifth year, and at the end of the tenth year could have made a profit of 50% of the contract price. Needless to say, if this was the maximum return on Anwin"s investment over ten years, under the very best possible conditions, it was very meagre.
[27] Other key documents in the scheme dealt with the cash and notes put up by Perth and Sunshine for the purchase of the units in Anwin. There were three provisions relating to the cash component of the purchase price.
[28] First, $310,300 was to be held in escrow by the Buchwald law firm on trust for Anaquan pending Anaquan"s performance of its obligations under the joint venture agreement. Second, Anaquan authorised itself in its capacity as the general partner of Anwin to lend this sum back to Perth and Sunshine as interest free loans to assist them with the purchase of the Anwin units.
[29] Third, Perth and Sunshine could effectively retire their debt of $310,300 between January and March 1988 by exercising a put option requiring Anaquan to purchase back the 535 limited partnership units in Anwin for 58% of the price at which they had purchased the units: 58% of $535,000 is $310,000. In the event that the results of Anaquan"s research were commercially successful, Perth and Sunshine would presumably elect not to exercise the option, but to retain their Anwin units and repay the "unit purchase assistance loan" out of the income generated from the research
[30] The promissory notes were to be assigned by Anwin to Anaquan and, if Perth and Sunshine did not honour them, Anaquan could look to the bank"s standby letter of credit with which they were secured. As the original issuers of the notes, Perth and Sunshine remained liable on them to the bank if they defaulted.
[31] On March 7, 1986 Perth and Sunshine defaulted on the promissory notes, and Anaquan accordingly received $177,000 from the Continental Bank through the standby letter of credit pursuant to this arrangement. Between March 7 and March 17, Anaquan disbursed this money on the payment of its pre-existing debts.
(c) subsequent events
[32] The research facility in which Anaquan was to conduct the research was never completed. No research was conducted there by Anaquan as it had undertaken in the joint venture agreement that it would. The site of the unfinished research facility was eventually sold in a mortgage sale. Mr. McLellan failed to raise any more capital for Anaquan and in January 1987 the company was petitioned into bankruptcy by its largest single creditor, Revenue Canada. By this time Anaquan owed some $4 million to Revenue Canada.
[33] The Minister of National Revenue ultimately disallowed all the deductions claimed by Perth and Sunshine from their participation in the Anwin partnership. While various provisions of the Income Tax Act govern different aspects of the claims, counsel agreed at the hearing that this appeal turns essentially on the three issues that are considered below in section C of these reasons.
| (d) summary |
[34] Once the dust settled after being stirred up by the flurry of transactions completed on February 25, 1986, the position was as follows. First, of the $535,000 put up by Sunshine and Perth for the acquisition of limited partnership units in Anwin, $37,450 went to transaction costs, $177,000 was paid to Anaquan and the rest was returned to them pursuant to the performance bond, loan and option arrangements.
[35] Second, Sunshine and Perth remained liable to the bank for $187,000 in respect of the bank"s payment on the promissory notes pursuant to the irrevocable standby letters of credit. The remainder of the money, $310,300, had been repaid to the taxpayers as a loan, which was subsequently cancelled. It had never been available in fact to Anaquan.
[36] Third, if the transactions had their intended income tax saving effect, the companies would have a net cash flow gain of $104,634, which was partially offset by a capital gains liability of approximately $83,500 which was deferred until 1989.
[37] Fourth, because of Anaquan"s dire financial straits none of the $177,000 paid to it under the joint venture agreement was in fact spent on research and development but, as already noted, it was used between March 7 and March 17, 1986 to pay Anaquan"s pre-existing debts.
[38] Fifth, if the taxpayers are unsuccessful in their appeal against the notices of assessment, they will be out of pocket by approximately $250,000. They have instituted legal proceedings against the Buchwald firm and Mr. Shead claiming damages as compensation for this loss.
(e) notice of assessment
[39] Revenue Canada disallowed all the losses claimed by Sunshine and Perth arising from this scheme. It took the view that the taxpayers had not laid out their money in order to earn income because there was no possibility that Anwin would derive any profit from Anaquan"s research. It noted that, although research is normally regarded as a long term investment, the joint venture agreement provided that Anwin would receive a higher percentage of any profits in the first five years than in the following five year period, and would receive no profits at all afterwards.
[40] Revenue Canada also took the view that the taxpayers were not entitled to the particularly favourable tax treatment provided at that time by the Income Tax Act for expenditures incurred in respect of scientific research and experimental development because the relevant provision, subparagraph 37(1)(a)(v), only applied if money was actually spent on qualifying research that had been conducted, which was not the case here.
[41] Finally, Revenue Canada was of the view that disallowance was justified under the anti-avoidance provision of the Income Tax Act, subsection 245(1), principally on the ground that most of the money allegedly expended by the taxpayers on research was in fact recycled back to them in the form of loans that would never have to be repaid out of Sunshine and Perth"s general resources.
| C. ISSUES AND ANALYSIS |
| Issue 1: Did the Anwin Research Partnership comprise "persons carrying on a business in common with a view of profit" within the definition of a partnership contained in The Partnership Act , R.S.M. 1970, c. P-30, section 4? |
[42] It was conceded by counsel for Sunshine that, for the following reasons, the taxpayer"s appeal must fail if the parties to the Anwin partnership agreement failed in law to create a valid partnership.
[43] First, in the absence of a partnership no expenditures were incurred by Anwin that could be allocated to the individual partners as losses for tax purposes. Second, in order to qualify for a scientific research and development deduction under subparagraph 37(1)(a)(v), an expenditure must be in respect of research that is related to the business of the taxpayer. If the Anwin Research Partnership was a partnership in law, Perth and Sunshine could claim that as limited partners in Anwin their business included the business of the partnership, which was the development and funding of the research to be undertaken by Anaquan as prescribed in the partnership agreement.
[44] However, if there was no partnership, then since the only business in which Perth and Sunshine were engaged was dry cleaning, laundry and uniform rental, their expenditures under the joint venture agreement for research into concrete by Anaquan would not qualify for the scientific research and development deduction, because the research for which they had contracted with Anaquan was not related to their business.
[45] This first issue can be broken into two questions: was the partnership in fact "carrying on a business" and, if it was, was it "with a view of profit"? It was agreed that these questions could not be answered simply by an examination of the documents; it was also necessary to consider the evidence as a whole to determine whether their assertions were consistent with the facts.
[46] It was also agreed that the fact that the Anwin Partnership was created primarily for the purpose of tax avoidance was in itself insufficient to establish that it was "carrying on a business", or that it was so doing "with a view of profit" so as to qualify as a partnership within the definition contained in the Partnership Act . On the other hand, if this was the sole purpose for its creation, it was not valid. As was said in Moloney v. The Queen 92 DTC 6570, 6570 (F.C.A.), "reduction of his own tax cannot by itself be a taxpayer"s business for the purpose of the Income Tax Act ."
[47] However, because there was no allegation that the parties had a deceptive intention, the Crown did not contend that the documentation was a "sham" in the rather narrow sense in which that term has come to be understood in tax law: Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, 545-73.
(a) "carrying on a business"
(i) plaintiff"s argument
[48] The argument advanced by counsel for Sunshine was that three transactions by Anwin on February 25 constituted the carrying on of a business within the statutory definition of a partnership. The first was the signing of the joint venture agreement with Anaquan, which was referred to in the partnership agreement.
[49] Anwin entered into the other two transactions pursuant to the joint venture agreement: the assignment to Anaquan of the promissory notes issued by the taxpayers, and the payment to Anaquan of the cash component of the research contract price. This latter sum, it will be recalled, was to be held in escrow by the Buchwald firm under the performance bond provision of the scheme, to be returned subsequently to Sunshine and Perth as a loan.
[50] Mr. Pustogorodsky relied on Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298 as authority for the proposition that very little is required by way of business activity in order to satisfy this element of the definition of a partnership. In that case the partnership had existed for a matter of days and entered into no new transactions. However, as Bastarache J, observed (at paragraph 33):
| It is common that partnerships are formed when two parties agree to carry on the existing business of one of them, while the other contributes capital. |
[51] This, counsel contended, was precisely the situation in our case. Anaquan had raised and spent $16 million in the previous two years, was in operation on February 25, 1986 and continued until it went into bankruptcy in September 1987. Perth and Sunshine contributed capital through Anwin to an ongoing business.
[52] It was also said in Continental Bank (at paragraph 34) that the fact that the partners had delegated to one of their number responsibility for the management of the partnership was not inconsistent with their carrying on a business in common. Thus, the fact that Anaquan, as the general partner, managed the affairs of the Anwin Research Partnership, to the exclusion of the limited partners, Sunshine and Perth, did not preclude the existence of a valid partnership.
(ii) defendant"s argument
[53] Counsel for the Crown, Mr. Gibson, sought to distinguish Continental Bank on its facts by pointing out that the partnership in that case took over and continued to operate an active business formerly owned by one of the partners. Accordingly, the existing contracts with lessees remained in place, and as far as these third persons were concerned, the business continued as normal.
[54] In contrast, he submitted, the business of the Anwin Research Partnership never got under way. It will be recalled that Anwin"s business was defined very precisely in the partnership agreement as the development of, and the contribution of funds to the current expenditures connected with, the R. & D. Project described in Schedule "A" to the agreement: namely, research and development in a facility owned and operated in Winnipeg by Anaquan. Since Anaquan lacked the financial means to complete the construction of this facility, the partnership"s business could not be conducted.
(iii) discussion
[55] I agree with counsel for the defendant that the facts of this case are less favourable to the taxpayer than those in Continental Bank, supra. However, in my opinion this is not dispositive of the issue. The question is whether Anwin"s entering into the partnership agreement, the assignment to Anaquan of the promissory notes, and its disposition of the cash component of the research contract price pursuant to the agreements were sufficiently closely related to the development of the R. & D. Project, and the contribution of funds to it, to constitute the carrying on by Anwin of its business.
[56] As the division of opinion on a similar question in Spire Freezers Limited v. Canada, [1999] 4 F.C. 381 (F.C.A) illustrates, this can be difficult to answer on any given set of facts. However, in my view, Anwin"s part in the flurry of signing that took place on February 25, 1986 did not constitute the carrying on of a business.
[57] First, having laid off its staff in December 1985, and otherwise being desperately short of funds, Anaquan was not engaging in any research activities in February 1986. Indeed, since the designated research facility was still under construction when the parties executed the documents, and never was constructed, it was unable to embark on the R. & D. Project described in the partnership and joint venture agreements.
[58] Second, although the transactions by Anwin on which the taxpayer relies were payments for research by Anaquan pursuant to the joint venture agreement, in fact the proceeds of the promissory notes were used by Anaquan to discharge existing debts. Anaquan, of course, was also the general partner of Anwin, and as such responsible for its management, and must therefore have known how the funds would be used.
[59] Third, since the cash component of the contract price was never in any practical sense available to Anaquan as a result of the performance bond, loan back and put option agreements, Anwin"s transactions with respect to the $310,300 were even more peripheral to the business of the partnership.
[60] Accordingly, the taxpayer has failed to satisfy me that in all the circumstances of this case the participants were carrying on a business through the Anwin Research Partnership. The financial transactions in which Anwin participated were no more than merely preparatory to the conduct of the partnership business, and were not sufficiently closely connected to it to constitute the carrying on of the partnership business.
[61] Although the partnership continued, in form at least, until September 1987, counsel conceded that there was no business activity subsequent to the execution of the various documents on February 25, 1986. In the absence of evidence by Mr. McLellan, who was not called as a witness, I cannot attach much weight to the suggestion that he was still actively seeking funding for Anaquan from banks as late as July 1986.
[62] It is relevant here to emphasise again the very narrow and specific definition of the business of the partnership: the development of the R. & D. Project at Anaquan"s partially constructed research facility, and "specifically to contribute funds towards the current scientific research expenditures incurred in connection therewith." Neither on February 25, nor subsequently, were there any research activities as specified in the partnership agreement, and, consequently, no current research activities to which Anwin could contribute.
[63] However, in case I am wrong to conclude that the plaintiff has not established that the participants were "carrying on a business", I shall consider the second of the requirements of a valid partnership in dispute in this case.
(b) "with a view of profit"
(i) plaintiff"s argument
[64] In order to establish that the Anwin Partnership was carrying on a business "with a view of profit", the taxpayer pointed to the partnership and joint venture agreements, both of which envisaged that the results of the research would be commercially exploited and that Anwin would receive defined percentages of the gross income arising from it.
[65] Counsel submitted that the jurisprudence indicated that this took his clients very far down the road to establishing that the definition of the Partnership Act had been satisfied. He relied particularly on Continental Bank Leasing Corp. v. Canada, supra, to support this proposition.
[66] Turning to the evidence, counsel argued that, in view of the great weight to be given to the documentation, which the Crown did not allege was a sham, the evidence was sufficient to establish the necessary facts. However, he also conceded that, since Anaquan went into bankruptcy in 1987, and its corporate records had been destroyed, the evidential problems facing the taxpayer in this appeal had been formidable.
[67] Moreover, he emphasised that the factual issues had to be determined on the basis of the facts as they were, and were known by the parties to be, on February 25, 1986. That Anaquan never was able to extricate itself from its financial woes and was petitioned into bankruptcy less than a year after the execution of the documents with which this appeal is concerned is of no direct relevance.
[68] The Court should not approach an assessment of the evidence with the benefit of hindsight, but should put itself in the position of an entrepreneur who was prepared to take considerable financial risks in the pursuit of a vision. The Court should not substitute its view that there was no realistic possibility of profit for that of the business people involved who thought that there was.
[69] Moreover, the requirement that the business be carried on "with a view of profit" may be satisfied even though it is understood that profit is not imminently forthcoming from the activity. The law permits partnerships to be formed by persons who expect that it will take some time for their business activities to realise profits.
[70] Counsel submitted that the test to be applied was whether on February 25, 1986 Anaquan, as the general partner of the Anwin Research Partnership, had an expectation that its expenditures under the joint venture agreement would lead to the making of a profit from Anaquan"s research activities.
[71] In support of a positive answer to this question Mr. Pustogorodsky noted that Anaquan had raised $16 million in the previous two years, most of which had been spent on research that qualified under the scientific research tax credit scheme then in place. Anaquan was thus not a "sham" company, but had a business plan and, since its reported losses were not disallowed when its tax liability was assessed, it had been treated by Revenue Canada as doing business with a view to making profits.
[72] In addition, the construction of the facility at which the research was to be conducted was nearing completion, and Mr. McLellan continued to seek research funding as late as July 1986, well after the execution of the documents on February 25 of that year. Indeed, the company continued in business until September 1987.
[73] Counsel also relied on the fact that it appeared from a contemporaneous note made by Mr. Shead that, when sketching out the scheme at a meeting with Mr. Shead prior to February 25, Mr. McLellan apparently reduced the percentage of gross income payable to the limited partners from the proceeds generated by the research. Counsel submitted that this could only have been because Mr. McLellan believed that there would be profits from Anaquan"s research.
[74] Moreover, before committing themselves to this venture Sunshine and Perth had relied on the advice of reputable accountants, a professor at the University of Manitoba and Mr. Shead. Further, Mr. Leibl stated in his evidence that, while tax avoidance had been the primary reason for entering into the scheme, he expected research to be done and regarded the possibility of profit as a "bonus".
(ii) The legal principles
[75] Two questions need to be addressed before the ultimate finding can be made as to whether the business was being carried on "with a view of profit". The first is the material that the Court may consider when deciding what the parties" intention was. The second is whether the test requires a determination of their actual, subjective intention or whether that intention must, in some minimal way at least, be realistic.
(a) evidence of intention
[76] The starting point for this inquiry must be the judgment by Bastarache J. in Continental Bank Leasing Corp. v. Canada, supra. Although his was a dissenting judgment, McLachlin J. (as she then was), who wrote for the majority of the Court, expressly agreed with this part of Bastarache J."s analysis.
[77] Bastarache J. stated that, if the documents constituting the alleged partnership were not a sham, the fact that the parties" primary motive in forming it was tax avoidance did not prevent legal effect from being given to the language of the documents, properly construed. Adopting the statement of the law in Lindley & Banks on Partnership 17th edn. (London: Sweet & Maxwell, 1995), pp. 10-11, Bastarache J. held (at paragraph 43) that a partnership existed if "profit-making and profit-sharing was an ancillary purpose."
[78] Bastarache J. emphasised (at paragraphs 45-6) the documentation as the primary basis for determining whether the parties had an intention to carry on a business in common with a view to profit. However, in concluding that the documentation sufficed in that case to create a partnership, he also noted (at paragraph 44) that it was not "a case where no profits were anticipated during the term of a partner"s involvement." Indeed, profits were in fact made by the partnership in that case and distributed to the partners.
[79] Accordingly, in my view Continental Bank, supra, is not authority for the proposition that, absent an element of deceit, a court is precluded from considering the facts of the case as a whole in order to determine whether the parties had as an ancillary objective the making of profit. Indeed, Bastarache J. cited with approval (at paragraph 23) another passage from Lindley & Banks, supra, to the effect that "in determining the existence of a partnership ... regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case ." [emphasis added]
[80] This was the view of Continental Bank, supra, taken by the Federal Court of Appeal in Spire Freezers Limited v. Canada, supra, where the Court held that, while the documentation was consistent with the creation of a partnership, the surrounding facts made it impossible to conclude that the parties had entered the partnership with any intention other than that of acquiring a tax loss. As Linden J.A. put it (at paragraph 17):
| One cannot insist in writing that a partnership has been created when the objective facts do not support that conclusion. It is similarly trite law that one cannot on paper deny the existence of a partnership when the objective facts demonstrate that a partnership has in fact been formed. The paperwork is very important but it is not the whole story. Thus, a partnership in law requires a partnership in life. |
[81] In another case decided after Continental Bank, Backman v. The Queen, 99 DTC 5602, the Federal Court of Appeal held that, despite the existence of documents that had been carefully prepared with the intention of creating a partnership, no partnership had been created in fact because the sole objective of some of the partners was the acquisition of a tax loss. The so-called partnership was "an empty shell that did not actually carry on a business" (paragraph 24). It is plain that the Court in this case looked beyond the documentation in order to determine whether the requisite intention for a valid partnership was in fact present.
[82] Accordingly, after giving due weight to the evidence of intention found in the documents signed by the parties, I must nonetheless also consider all the circumstances of the case.
(b) intention: subjective or objective?
[83] It would seem that the intention of all the participants in the Anwin Research Partnership, Sunshine, Perth and Anaquan, should be considered: Spire Freezers Limited v. Canada, supra, paragraph 40. It is thus not enough that Anaquan alone intended to carry on a business in common with Sunshine and Perth "with a view of profit."
[84] Second, since the ultimate question is the subjective intention of the parties. It is not for the Court to consider whether it was reasonable or even realistic for them to believe that the business that they were carrying on in common would yield a return. This is a case where the overwhelming intention of the limited partners at least was to acquire a tax loss in order to reduce their tax liability. The question is whether they also had a subsidiary intention of making a profit through Anwin from Anaquan"s research activities. If they did, then that suffices to create a valid partnership.
[85] However, in order to determine what intention can be imputed to the parties, the Court must look in an objective manner at the evidence before it, particularly at the facts as they were known to be when the relevant documents were executed. Evidence given by a participant, such as Mr. Leibl, that profit was a reason for entering into the relationship cannot necessarily be accepted as proving the true intention of the parties. And, to reach such a conclusion does not require, or imply, a finding that the witness meant to be anything other than truthful.
[86] Similar sentiments were expressed in Backman, supra, where, in view of other evidence, the Court attached little weight (at paragraph 20) to "vague oral evidence from the appellant that the Canadians expected to earn a profit of $1,000 to $1,500 per year from the oil and gas investment." And, in Spire Freezers, supra, at p. 413, paragraph 56 of his reasons for judgment, Robertson J.A. was similarly sceptical about the value of oral testimony in tax cases:
| Clear, objective evidence as to intention always trumps the subjective ruminations of witnesses who are naturally reticent to offer testimony which may be prejudicial to their interests. Moreover, the influence which legal and tax advisors exercise over their clients cannot be ignored when assessing the parties" intentions. |
[87] Finally, in Symes v. Canada, [1993] 4 S.C.R. 695, 736, Iacobucci J. said this in respect of proof that expenditures were incurred for the purpose of producing income from a business within the meaning of the Income Tax Act, paragraph 18(1)(a):
| As in other areas of the law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will be guided only by a taxpayer"s statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard to all of the circumstances. |
(c) application of the test
1. Documentary evidence
[88] To turn now to the evidence, I shall consider first the documents that are alleged to indicate that the taxpayers had a "view of profit" when they entered with Anaquan into the Anwin Research Partnership. The partnership agreement itself would certainly support a finding that the participants "had a view of profit". Thus, article 2.03(b) describes the objectives of the partnership as including the commercial exploitation of the results of the R. & D. Project through licensing, production and marketing. In addition, article 4.05-08 provides for the determination, and allocation among the partners, of the net income or losses of the partnership.
[89] On the other hand, the joint venture agreement provides somewhat more equivocal evidence of whether the parties had "a view of profit". In particular, clause 7 of the agreement caps the sum payable to Anwin from the gross income generated by Anaquan from the R. & D. Project at 20% of the contract price in each of the first five years of the agreement. Thus, regardless of the commercial success of Anaquan"s research, Anwin would make no profit in the first five years; the partnership would simply recover the money that it had paid to Anaquan for the research. Admittedly, in the next five years the agreement caps Anwin"s share of the gross income at an annual maximum of 10% of the contract price, so that a profit, albeit a small one, was at least possible in theory.
[90] If I were to confine my search for the parties" intention or purpose to an examination of the documents, I would be prepared to conclude that the participants in the Anwin Partnership were carrying on a business "with a view of profit". However, given that no profit, in the sense of a return on the purchase of Anwin units, could arise until the sixth year of the joint venture with Anaquan, and given also the narrowness of the definition of the R. & D. Project, I cannot regard the documentary evidence as providing particularly cogent proof of the requisite intention..
2. Anaquan"s financial position
[91] If the surrounding evidence indicates that Anaquan lacked the financial capacity or potential to carry out its obligations under the joint venture agreement and realise a profit from the research that it had contracted to do, and that the parties either knew of or closed their eyes to Anaquan"s inability to obtain the funds necessary for it to conduct research and make a profit, Sunshine and Perth cannot plausibly claim that they entered the Anwin Research Partnership "with a view of profit."
[92] A somewhat similar point was made in Moloney v. The Queen, supra, at page 6571, where Hugessen J.A. upheld the trial judge"s conclusion that the taxpayer did not intend to carry on a business because it lacked the means or ability to market the product that was allegedly the object of the business.
[93] It does not require the perspicacity bestowed by hindsight to appreciate the seriousness of Anaquan"s financial position on February 25, 1986. It owed $2.5 million to Revenue Canada, and was substantially in debt to the suppliers of computer equipment essential for the continuation of its research. Its research facility was not finished and approximately another $1 million was required for completion of the construction. Anaquan had had to lay off its staff in December 1985.
[94] While the company had succeeded in raising substantial capital in the previous two years, it had done so when scientific research tax credits were still available. Their abolition seriously weakened Anaquan"s ability to raise sufficient capital to satisfy its existing debts and to fund new research. In addition, in early 1986 it was widely expected by tax planners, including Mr. Shead, that changes would be made on February 26, 1986 to the Income Tax Act that would affect the tax treatment of partnerships, and make less attractive the kind of tax shelter with which this litigation is concerned.
[95] Indeed, the only funds that Anaquan succeeded in raising through the tax shelter scheme designed by Mr. McLellan and Mr. Shead in 1986 were the $177,000 provided by Perth and Sunshine through the promissory notes. Other potential sources of finance explored by Mr. McLellan came up dry.
[96] There was no suggestion anywhere in the evidence that Anaquan was on the brink of making a profit. No evidence was led that indicated that its research had produced results that could be exploited commercially.
3. Knowledge of the participants
[97] What the participants knew at the relevant time is germane to their intention or purpose in entering into the Anwin scheme. As of February 25, 1986 all the facts described above were within the knowledge of Mr. McLellan, the president of Anaquan, the general partner of the Anwin Partnership. In light of the evidence before me about Anaquan"s financial situation in 1986, which deteriorated sharply after February, any expectation on the part of Mr. McLellan that a bank would advance funds to Anaquan would have been purely quixotic.
[98] It would have been helpful to have heard evidence from Mr. McLellan explaining why, during the discussions that he had with Mr. Shead about the partnership scheme, he seems to have decided to reduce the percentage of gross income to be paid to Sunshine and Perth in the first five years after the signing of the joint venture agreement. However, in the absence of this evidence, I am not prepared to infer from Mr. McLellan"s apparent desire to limit Sunshine"s financial reward from the research, that there were facts on which he based a genuine belief in the profitability of the enterprise.
[99] I do not regard it as particularly significant that Revenue Canada apparently accepted that Anaquan"s losses were incurred in the course of seeking income or profit. There is no evidence that this was a matter that had been the subject of an audit or investigation by officials, and consequently Anaquan"s claimed business losses were simply accepted at face value.
[100] I infer that Mr. Shead must also have been aware of Anaquan"s parlous state from the meetings and discussions that occurred early in 1986 between Mr. McLellan and Mr. Shead to discuss Anaquan"s urgent need for capital and Mr. McLellan"s idea for offering a tax shelter to attract investors, and from Mr. Shead"s long standing connection with Anaquan and Mr. McLellan. Indeed, Mr. Shead testified that he was aware that Anaquan had no money on hand for its research purposes, and that of the $500,000 to $1.5 million that Mr. McLellan was seeking, he had only raised the $177,000 provided by Perth and Sunshine.
[101] Mr. Shead also testified that he knew that the facility in which Anaquan had undertaken in the joint venture agreement to conduct the research was still under construction on February 25. He conceded that he had no reason to believe that it would be completed in the following few weeks.
[102] In view of these facts, and of the interest that he has in the outcome of this litigation as a defendant in the proceeding instituted against him by Perth and Sunshine, I cannot accept Mr. Shead"s evidence that in February 1986 he was unaware of Anaquan"s financial difficulties.
[103] For two reasons I regard as unpersuasive Sunshine"s allegation that it had no knowledge of the likely financial inability of Anaquan to conduct potentially profitable research. First, since Mr. Shead appears to have acted for all parties to the various transactions under consideration here, despite the fact that they had different and competing interests, it would not be inappropriate to impute to Sunshine the knowledge possessed by Mr. Shead, regardless of the capacity in which he acquired it.
[104] Second, it is clear from the evidence that Sunshine entered the transaction with no real thought to the possibility of profit from Anaquan"s research. In my view, the evidence does not show that Sunshine was merely careless in failing to make the enquiries that any prudent business person would have made who was embarking on a business venture with a view of profit. Rather, judged by any reasonable business practice, Sunshine was reckless as to Anaquan"s ability to conduct research which, if successful, might then have been turned into profit for Anwin.
[105] Thus, Mr. Leibl testified that Sunshine did not ask to see Anaquan"s financial statements: indeed, he was aware from the terms of the offering memorandum that limited partners were not entitled to financial information about Anaquan and contained disclaimers of Anaquan"s ability to satisfy the option agreement or to continue to carry on the business of the partnership. The memorandum also drew investors" attention to the risk factors inherent in this type of investment and advised that they consult their own advisers.
[106] Mr. Leibl made no inquiries about other sources of finance available to Anaquan, and did not inform himself at the time about the amount that Anaquan would receive as a result of the transactions from which this litigation arises. Indeed, as he frankly said in his testimony, this was not a matter about which he cared.
[107] Mr. Leibl seems to have known nothing about the nature or progress of the research to be conducted by Anaquan, beyond the fact that it had to do with concrete, and that the company had a track record in this area. He conducted no study to assess the feasibility of Anwin"s making a profit from Anaquan"s research activities. However, having visited Anaquan"s research site, he did know that the facility where the research was to be conducted was not complete and would not be operational in the weeks following February 25, 1986.
[108] All of this is consistent with the clear impression that I had from Mr. Leibl"s testimony: Sunshine"s interest in the scheme was in the cash flow benefit that would accrue from the tax shelter, and that if there were profits from the research they would be a "bonus". In these circumstances I do not think that the objective evidence establishes that Sunshine entered into the Anwin agreement with any genuine "view of profit", even as an ancillary objective.
[109] Nor am I satisfied that Sunshine"s apparent lack of concern about either the financial viability of Anaquan, or the state of its research, can be explained away on the basis of the confidence that the taxpayer reposed in its professional advisers.
[110] For one thing, as I have already noted, Sunshine is deemed to have had the extensive knowledge of Anaquan"s affairs possessed by its solicitor, Mr. Shead. For another, the income tax opinion, dated February 24, 1986, that Sunshine was given by the firm of accountants did not address the possibility of profit from Anaquan"s research activities.
[111] The opinion clearly stated at the beginning that it was based on certain information, including the fact that Anwin was a limited partnership, "duly constituted under the laws of Manitoba". For the most part, the tax opinion simply explained the various components of the scheme and their effect, assuming that the relevant tax deductions were allowed by Revenue Canada.
[112] As for the opinion from Professor Wedepohl addressed to Anwin, it merely gave the author"s view that the proposed research to be conducted by Anaquan at its Winnipeg facility would qualify as "scientific research" for income tax purposes. Again, nothing is said in the report about Anaquan"s financial ability to conduct any research or its potential profitability.
| (d) conclusion |
[113] Applying the law to the facts as I have found them to be I conclude that neither Mr. McLellan"s apparent belief in the viability of his research project in the face of the hard evidence of Anaquan"s financial plight, nor Sunshine"s uninformed and speculative hope that there might be a profit from Anaquan"s research, something that it regarded as little more than a windfall or "bonus", is sufficient, whether considered individually or together, and put in the context of all the other evidence, to bring Anwin within the statutory definition of a partnership.
[114] On the facts as they were, and were known to be, on February 25, 1986 I am not satisfied that on the balance of probabilities the parties agreed to carry on a business through the Anwin Research Partnership "with a view of profit", even as an ancillary objective.
[115] Since the determination of the true intention of the parties depends on the evidence before the Court in the particular case, other cases can provide only limited assistance. Nonetheless, words used in the Backman case, supra, seem apt here: in particular, the characterisation of the arrangement as "window dressing" (paragraph 20) and "an empty shell" (paragraph 24).
[116] Although my conclusions on the first issue are sufficient to dismiss the appeal, in the event that I am wrong in finding that there was no partnership in existence, I shall address the second issue. However, counsel agreed that since the relevant provisions of the Income Tax Act have been repealed, my judgment is likely to be of very limited application beyond this case.
| Issue 2: Assuming that the Anwin Research Partnership was valid, did its expenditures pursuant to the joint venture agreement qualify for the special treatment afforded to payments falling within subparagraph 37(1)(a)(v) of the Income Tax Act? |
[117] The provision of the Income Tax Act in force in 1986, and which is in question in this appeal, is as follows:
| 37.(1) Scientific research and experimental development. - Where a taxpayer files with his return of income under this Part for a taxation year a prescribed form containing prescribed information, carried on a business in Canada and made expenditures in respect of scientific research and experimental development in the year, there may be deducted in computing his income for the year the amount, if any, by which the aggregate of (a) such amounts as may be claimed by the taxpayer not exceeding all expenditures of a current nature made in Canada by the taxpayer in the year or in any previous taxation year ending after 1973 (i) on scientific research and experimental development related to the business and directly undertaken by or on behalf of the taxpayer, (ii) by payments to an approved association that undertakes scientific research and experimental development related to the class of business of the taxpayer, (iii) by payments to an approved university, college, research institute or other similar institution to be used for scientific research and experimental development related to the class of business of the taxpayer, ... (v) by payments to a corporation resident in Canada for scientific research and experimental development related to the business of the taxpayer; |
| 37.(1) Recherches scientifiques et développement expérimental. Lorsqu"un contribuable produit avec sa déclaration de revenu en vertu de la présente partie pour une année d"imposition un formulaire prescrit contenant les renseignements prescrits et qu"il a exploité une entreprise au Canada et a fait des dépenses pour des recherches scientifiques et du développement expérimental dans l"année, est déductible dans le calcul de son revenu pour l"année la fraction éventuelle du total (a) toute somme que peut réclamer le contribuable et qui ne dépasse pas le total des dépenses de nature courante faites au Canada par le contribuable durant l"année ou toute année d"imposition antérieure se terminant après 1973 (i) pour recherches scientifiques et développement expérimental se rapportant à l"entreprise du contribuable et effectués directement par lui ou pour son compte, (ii) sous forme de paiements à une association agréée qui entreprend des recherches scientifiques et du développement expérimental en rapport avec la catégorie d"entreprise du contribuable, (iii) sous forme de paiements à quelque université, collège, institut de recherches ou autre établissement semblable agréés, lesquels paiements doivent servir à des recherches scientifiques et à du développement expérimental en rapport avec la catégorie d"entreprise du contribuable, ... (v) sous forme de paiements à une corporation résidant au Canada, à des fins de recherches scientifiques et de développement expérimental en rapport avec l"entreprise du contribuable;
|
[118] The principal issue in contention between the parties is whether, as a matter of interpretation, subparagraph 37(1)(a)(v) only applies if the expenditure was actually used for the conduct of research.
(a) plaintiff"s position
[119] Counsel for the taxpayer submitted that there was no such requirement; it was sufficient if the expenditure had been incurred pursuant to a contract as a payment for the purpose of research, whether or not any research was in fact conducted.
[120] Mr. Pustogorodsky noted that subparagraph (v) speaks of an expenditure "for" scientific and experimental research, whereas subparagraph (i) uses the word "on". He argued that in using different prepositions Parliament should be taken to have intended the subparagraphs to have different meanings.
[121] Thus, he suggested, in order to qualify for a deduction under subsection 37(1), "expenditures ....on scientific research..." in subparagraph (i) must be expenditures on research that was in fact conducted. On the other hand "... payments ... for scientific research ...." can include payments made for the purpose of research which are deductible under subsection 37(1), regardless of whether the research was actually conducted.
[122] This textual conclusion may be supported by two further arguments. First, expenditures under subparagraph (i) concern research conducted by the taxpayer herself, or by someone engaged by the taxpayer to conduct the research. In both instances the research is directly under the control of the taxpayer who could thus ensure that the research was indeed conducted. It makes sense, therefore, to limit the deduction to money spent on research that has in fact been conducted.
[123] In contrast, when a taxpayer makes payments "to a corporation resident in Canada for research ...", which is the situation described in subparagraph (v), the interposition of the corporation, which the taxpayer may not control, means that the taxpayer has no way of ensuring that payments made for research will in fact be used in that way.
[124] Thus, if subparagraph (v) were interpreted to require that the deduction could be claimed only if the research were conducted, the taxpayer could never be sure that he would be entitled to receive the deduction. This element of uncertainty would unfairly limit taxpayers" ability to arrange their affairs so as to minimise their tax liability.
[125] In addition, it would thwart Parliament"s policy of increasing research and development in Canada by offering tax incentives to those willing to provide funding that more traditional sources of finance, such as the banks, are reluctant to advance to those whose principal assets are an inventive mind, or a good idea.
(b) defendant"s position
[126] Mr. Gibson"s response to the textual argument was that if Parliament had meant the word "for" in subparagraph (v) to mean "for the purpose of", it would have said so. This latter phrase is found throughout the Income Tax Act , such as in subparagraphs 20(1)(c)(i) and (ii) (borrowed money used or amounts payable for property acquired "for the purpose of" earning, gaining or producing income).
[127] Although not mentioned by counsel, I should note here that the French text also lends some support to this contention. In subparagraphs 20(1)(c)(i) and (ii) the phrase used is "en vue de", whereas in subparagraph 37(1)(a)(v) it is "à des fins de". The French text also mirrors the English by using a different preposition in subparagraph 37(1)(a )(i), "pour recherches".
[128] Counsel for the Crown also submitted that the plaintiff"s position was that a taxpayer was entitled to a deduction merely by writing a cheque to a corporation resident in Canada and specifying that it was for the purposes of research related to the business of the taxpayer.
[129] He suggested that this was inconsistent with the detailed provisions in the Act and Regulations governing the scientific research deductions, which were intended to prevent the kind of abuse that had occurred under the former scientific research tax credit regime, and to ensure that the statutory scheme was more carefully tailored to serve the public interest in the encouragement of research.
(c) conclusion
[130] While acknowledging the force of Mr. Pustogorodsky"s argument on the difference between payments made "on" and "for" research, I have concluded that Mr. Gibson"s interpretation is a better fit with other clauses in paragraph 37(1)(a ).
[131] In particular, subparagraph 37(1)(a)(iii) includes within the research deduction payments made to "approved" universities and other specified institutions "to be used for scientific research and experimental development". It would seem clear from this provision that the deduction may be claimed even if the taxpayer cannot establish that the money has in fact been spent on research. Hence, if Parliament intended subparagraph (v) of the same paragraph to have the same meaning, why would it not use the same words?
[132] Subparagraph (ii) is also relevant. It applies to "payments made to an approved association that undertakes scientific research and experimental development". Again, it would seem clear that the deduction can be claimed under subparagraph (ii) even though the payment has not in fact been spent by the "approved"association on research. If Parliament intended a similar meaning in subparagraph (v) it could have stipulated simply that a taxpayer was eligible for the deduction who made "a payment to a corporation resident in Canada that conducts scientific research and experimental development".
[133] In fact, there is a good reason why Parliament would have framed the deduction more narrowly in subparagraph (v) than in either subparagraph (ii) or subparagraph (iii): the identity of the recipients of the payments. Only payments to "approved" associations or "approved" universities, research institutes or similar institutions qualify for deductions under subparagraphs (ii) and (iii). "Approved" is defined in paragraph 37(7)(a ) as meaning
| approved by the Minister after he has, if he considers it necessary, obtained the advice of the Department of Regional Industrial Expansion or the National Research Council of Canada; |
[134] The inclusion of a requirement of ministerial approval serves as an assurance that recipients of payments for which deductions were claimed had research capacity and were likely to spend the payments on research, or on defraying other expenses which would release other resources for research. Hence, it was unnecessary for Parliament to require that, before being entitled under subsection 37(1) to a deduction for a payment made, the taxpayer must establish that research had in fact been conducted with the money.
[135] The additional incentive to investors provided by the more liberal rule in subparagraphs (ii) and (iii) would also have the effect of advancing the public policy underlying this section by attracting additional funding to established and reputable bodies with research programmes that have won them a ministerial seal of approval.
[136] Accordingly, since Anwin"s payment to Anaquan resulted in no research, the Minister did not err in disallowing the deduction claimed by Sunshine under subparagraph 37(1)(a )(v).
| D. CONCLUSIONS |
[137] Having decided in favour of the Crown on each of the three principal issues argued in this appeal, it is unnecessary to consider the issues that are of less significance, and irrelevant given my other conclusions. That these issues concern provisions of the Income Tax Act that have been repealed is another justification for not pursuing in these reasons every last issue raised by the parties.
[138] The fact that Sunshine and Perth were led to believe by their advisers that participation in the elaborate Anwin scheme would significantly reduce their tax liability is no reason why other taxpayers should have to take up the slack. The plaintiffs must look elsewhere for possible redress, as apparently they are already doing.
[139] For these reasons the appeal will be dismissed with costs.
OTTAWA, ONTARIO "John M. Evans"
February 7, 2000 J.F.C.C.
Date: 20000207
Docket: T-3466-90
OTTAWA, ONTARIO, THIS 7TH DAY OF FEBRUARY, 2000.
PRESENT: THE HONOURABLE MR. JUSTICE EVANS
BETWEEN:
SUNSHINE UNIFORM SUPPLY (1983) LTD.
Plaintiff
- and -
HER MAJESTY THE QUEEN
Defendant
JUDGMENT
The appeal is dismissed with costs.
"John M. Evans"
J.F.C.C.