Cases
Antle v. The Queen, 2010 DTC 5172 [at 7304], 2010 FCA 280
A purported Barbados trust that was used in connection with a tax plan to avoid Canadian capital gains tax on the disposition of shares of a corporation was found not to exist at the time of a purported sale of shares by the purported trust given that the settler never intended to lose control of the shares to the Barbados trustee, or of the money resulting from their sale, he did not sign the trust deed until after the sale of the shares to the third party, and the shares were not validly transferred to the trust (and, in fact, at the relevant time, they could not be so transferred because they were subject to the security interest of a third party).
In going on to find that the purported trust also was a sham, Noël JA stated (at paras. 19, 20):
The Tax Court judge found as a fact that both the appellant and the trustee knew with absolute certainty that the latter had no discretion or control over the shares. Yet both signed a document saying the opposite. …[T]he Tax Court Judge misconstrued the notion of intentional deception in the context of a sham. …It suffices that parties to a transaction present it as being different from what they know it to be.
2529-1915 Québec Inc. and Faraggi v. The Queen, 2009 DTC 5012, 2009 FCA 398
Overview of facts. The two individual taxpayers devised a scheme to: generate artificial capital gains of $110 million in some home-grown companies; pay the supposedly resulting capital dividend accounts (CDAs) of $55 million to another company (1915); generate artificial capital losses in the home-grown companies to offset their capital gains; effectively sell negotiated portions of the CDA to 3rd-party purchasers by having them subscribe for preferred shares at a 21% premium to their redemption amount with the shares' redemption amounts effectively being flowed out to the 3rd parties as purported capital dividends; and then pocketing such subscription "premiums" as capital dividends paid out to them. A more detailed summary of the facts is under s. 83(2).
Gains generated on income account. After finding that the daylight loan used in the transactions and the promissory notes issued in the transactions issued in the transactions generating capital gains were not shams, and finding that the share premiums generated by 1915 were business income, Noël JA found that the "gainmaking" shares which were acquired for the purpose of their immediate resale so as to give rise to such gains were acquired on income account, given that "property acquired for resale is held on account of revenue" (para. 73).
Elections were shams. Given that these shares were acquired on income account, the subsidiaries in making capital capital dividend elections to flow out their CDAs to 1915 were making a misrepresentation which rendered such elections shams, and similarly the subsequent capital dividend elections by 1915 also were shams.
The Queen v. Nunn, 2007 DTC 5111, 2006 FCA 403
In finding that the trial Judge has erred in finding that the investment of the taxpayer's RRSP in worthless shares as a result of fraudulent misrepresentation represented a sham, Malone J.A. stated, after citing the Snook v. London & West Riding Investments Ltd. case stated (at p. 5114):
"In other words, the elements of a sham require that the parties to a transaction together have deliberately set out to misrepresent the actual state of affairs to a third party ... ."
Ledoux v. The Queen, 2000 DTC 6465, Docket: A-813-97 (FCA)
The Court affirmed (at p. 6466) the findings of the trial judge that a series of complex transactions comprising 43 stages that were completed within a few days, whose apparent purpose was to transmute an income-account gain into a capital gain, "did not reflect the actual transactions completed and did not correspond to the actual relationships formed between the parties: in short, it constituted a deception, a subterfuge, a sham".
McEwen Bros. Ltd. v. The Queen, 99 DTC 5326 (FCA)
In finding that a purported partnership agreement was not a sham, Robertson J.A. stated (at p. 5330):
"In short, to qualify as a sham, the taxpayer must say one thing to the Minister, and do another in an attempt to avoid its tax obligations."
Continental Bank Leasing Corp. v. The Queen, 96 DTC 6355 (FCA), rev'd 98 DTC 6501 (SCC)
Before finding that the taxpayer had failed to accomplish a tax-motivated plan because it had failed, in law, to establish a partnership with two other parties, Linden J.A. quoted a statement of the Tax Court Judge that "if the legal reality that underlies the ostensible legal relationship is the same as that which appears on the surface, there is no sham", and then stated (at p. 6359):
"Absent the essential component of deceit, the present transaction cannot be considered a sham according to current Canadian law."
The Queen v. Parsons, 84 DTC 6447, [1984] C.T.C 354 (FCA)
It was found by the trial judge that management companies, which two professional engineers ("Parsons" and "Vivian") had incorporated and interposed between themselves and an engineering firm ("Design") of which they had been employees until that time, "(1) had no bona fide business purpose, (2) had, primarily, the purpose of directly reducing their income tax liabilities [and] (3) had, secondarily, an estate planning purpose which ... must be taken to have also been solely motivated by tax and personal, not business, considerations." Nonetheless, it was held that the arrangements were not a sham and were effective for tax purposes because the legal rights and obligations which the parties purported to create, they had succeeded in actually creating.
The Queen v. Esskay Farms Ltd., 76 DTC 6010, [1976] CTC 24 (FCTD)
The taxpayer, wished to sell land to the City of Calgary in consideration for two annual instalments in order to defer a portion of the gain to its second taxation year, but was informed that the City was precluded by statute from purchasing land over a period of years. As a result: the taxpayer sold the land to a trust company for the same purchase price, but payable in two instalments with the second instalment bearing interest at 7.5% per annum, and with a clause in the purchase agreement that the trust company could elect within 60 days of the date of the agreement of sale to void the agreement; and the trust company sold the land to the City for the same purchase price, paid in cash. Title was transferred directly from the taxpayer to the City.
Cattanach J. found that the transactions were not a sham as the intended legal rights of the three parties were exactly those described in the documents. For example, the Trust Company had the use of the money received on its sale to the City for a protracted period, which it could and did turn to profit on its own account.
Cattanach J., after noting that, in fact, the Trust Company did not pay interest until the time it received money on the sale to the City, rather than from the earlier date provided in the agreement, stated (at p. 6016):
"The delay in payment exceeded the estimated date and there is no impediment to the parties not to strictly comply with the agreement in this respect although the benefiting party is entitled to do so and the party detrimentally affected is bound by the agreement."
After noting that the trust company did not record a liability in its book of account to the taxpayer until the time it receiving payment from the City, Cattanach J. stated (at p. 6016):
"I do not think that bookkeeping entries or the lack of an entry can be accepted as contradicting the clear provisions of a written agreement."
Simard-Beaudry Inc. v. M.N.R., 74 DTC 6552, [1974] CTC 715 (FCTD)
Before concluding (at p. 6557) that "the purchase by the Appellant by means of an option does not constitute a sham in the legal sense," and after quoting the "excellent definition of a financial sham" in Snook, Addy J stated (at p. 6556):
"[I]n order to determine if a document constitutes a sham or not and for this reason must necessarily attract financial consequences, one must not take an exaggerated view of the motives of the parties for the sole purpose of arriving at an interpretation favourable to the taxing authority."
Stubart Investments Ltd. v. The Queen, 84 DTC 6305, [1984] CTC 294, [1984] 1 S.C.R. 536
Before finding that a transfer by the taxpayer of its flavouring business to an affiliated company with a history of losses (coupled with the agreement of the taxpayer to act as the affiliated company's agent respecting that business) was a legally effective transaction and also was effective for tax purposes, Estey J stated:
…This expression [sham] comes to us from decisions in the United Kingdom, and it has been generally taken to mean (but not without ambiguity) a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a façade of reality quite different from the disguised reality.
See Also
Mariano v. The Queen, 2015 TCC 244
The taxpayers were participants in leveraged donation transactions, which were intended to result in a step-up of the adjusted cost base of courseware licences (e.g., on how to use Microsoft products) under ss. 69(1)(c) and 107(2) (apparently with a view to avoiding s. 248(35)) before the licences were donated by them at a higher stipulated value to a registered charity ("CCA").
A Bahamian corporation ("Phoenix') acquired various courseware licenses, at costs of 13.3 to 26.7 cents each from a Florida corporation ("Infosource") which also packaged and sold such licences in the course of its business and gifted most of them to a Canadian–resident Trust (with the balance being sold to raise cash to fund its purchase price). Ostensibly, the licences then were distributed to the program participants such as the taxpayers as capital beneficiaries of the Trust, with the participants then donating them to CCA. The participants also made cash donations to a second registered charity ("Millennium"), which redonated 80% of those amounts to CCA and used the balance to pay fees and other expenses. The participants were issued charitable receipts for three or more times their cash outlay (and perhaps 800 times the cost to Phoenix of the licences (para. 125)).
Pizzitelli J agreed with the Minister that the transactions were a sham. The trust and escrow agent were operated, either directly or indirectly, by the Promoter, so that any purported independent exercise of discretion or judgment was a fabrication. There were numerous other examples of deceit, including concealing the fact that 90% of the total cash donated did not stay with any charities, and the creation of fraudulent invoices and a backdated inventory of courseware CDs.
Before stating (at para. 89) "the deceit…need not be perpetrated by the Appellants in order to find a sham, as their participation in the sham is sufficient to invalidate their purported gifts of cash and property to the charities," Pizzitelli J noted that their execution of Deeds of Gifts referencing the gifted licences as described in "Schedule A" which, in fact had not yet been completed, amounted to, if not complicity, at least wilful blindness (para. 88).
See summaries under s. 118.1 – total charitable gifts and s. 104(1).
Birchcliff Energy Ltd. v. The Queen, 2015 TCC 232
A predecessor ("Birchcliff") of the taxpayer negotiated a plan to merge with a corporation ("Veracel"), which had discontinued its medical equipment business, in order to access Veracel's non-capital losses and credits. Investors subscribed for subscription receipts of Veracel and received voting common shares of Veracel therefor under a Plan of Arrangement, and Veracel and Birchcliff amalgamated immediately thereafter under the Plan. The voting common shares received by the investors on the amalgamation represented a majority of the voting shares of the amalgamated corporation, so that no acquisition of control of Veracel occurred under s. 256(7)(b)(iii)(B), and the loss-streaming rules under ss. 111(5)(a) and 87(2.1) were avoided.
Although he proceeded to find that GAAR applied to extinguish the losses, Hogan J rejected the Minister's argument that the investors' "would not enjoy the rights and privileges attached to [their] shares" (para. 45) so that their acquisition was a sham, stating (at para. 52) that there was no evidence "that the New Investors were engaged in deceit."
See summary under s. 245(4).
Coast Capital Savings Credit Union v. The Queen, 2015 TCC 195
On the basis of allegations accepted in the pleadings, the applicant, which was the trustee of RRSPs and RRIFs, purchased shares (that were taxable Canadian property) of Canadian companies from non-resident vendors at prices which (unbeknownst to it) were substantially in excess of those shares' fair market value, with the result that the RRSPs and RRIFs were stripped of funds which ended up in offshore accounts or were applied to pay the fees of the "promoters." The applicant was assessed under s. 116(5) for failure to withhold.
V. Miller J. denied a requested amendment to the applicant's Notice of Appeal asserting that the sale transactions were a sham (intended to deceive the applicant), stating (at paras. 22, 24, 27):
[I]n a tax case, a court will make a finding of "sham", only when it is the Minister who is deceived… . [I]t is only the Minister who can plead "sham" and rely on the "sham" argument to have the courts disregard a transaction. …
It is clear that both the Annuitants and the Promoters intended the purchase price for the shares be the stated purchase price. … They misled the Applicant with respect to the value of the shares purchased by the RRSPs but this is not a "sham." It is fraud.
See summary under s. 116(5).
Dimane Enterprises Ltd. v. The Queen, 2015 DTC 1013 [at 64], 2014 TCC 334
The taxpayer's sole director ("Richard"), who ran the taxpayer's business out of his home office, employed his four children, aged 23, 21, 14 and 13, for annual salaries of $1200 each (or $600 for the two younger children) to perform tasks such as maintaining the lawn or sorting mail. The taxpayer set up an "employee profit-sharing plan" with Richard and his wife as trustees, with a "committee" of the taxpayer (i.e., Richard) to determine the taxpayer's contributions to the plan and the participants, and with distributions to the participants determined by the trustees (i.e., Richard). The taxpayer elected under s. 144(10).
D'Arcy J found that the taxpayer could not deduct its contributions to the plan, as the plan was a sham. What in fact occurred was that the purported distributions out of the fund were to a bank account controlled by Richard, so that the participants "never had control of these funds" (para. 40), and so that the "real transactions" were "the payment of amounts by the Appellant to Richard" (para. 42). Moreover, the small portion of the funds received out of the "EPSP" which were applied to expenses represented payment simply of "family expenses that a father and mother incur for their children" (para. 41).
Although these findings were sufficient grounds for "sham," he went on to note that the children did not make any contribution to the taxpayer's profits, as the chores performed were services for their parents, not the taxpayer (para. 45).
Bessette v. ARC (Quebec Revenue Agency), 2014 QCCQ 4329
The dental practice of the taxpayer paid fees of approximately 70% of its revenues to a services company (which was wholly-owned by the dentist through a holding company) pursuant to annual contracts which (in an apparently back-dated Appendix) provided for the provision of management and health services to the practice by the services company. Gouin JCQ stated (at para. 34, TaxInterpretations translation) that "the evidence…demonstrates clearly that [the services company] had no employees and did not purchase any supplies for eventual use in management or health services."
Before denying the deduction of the fees in toto, Gouin JCQ stated (at para. 30) that "it is necessary to prove that the management expenses constitute genuine expenses and not a sham in the sense that the concluded agreements represented genuine transactions between the parties," and then quoted with approval the statement in Fillion v. The Queen, 2004 FCA 135, at para. 72 [clumsy official translation below] that:
In order to claim an expense, it is not enough to make an accounting entry backed by a vague invoice [and]… it must be established that the evidence was real, fully supported and justified and, moreover, that the expenditure was incurred in order to produce business income… .
McLarty v. The Queen, 2014 DTC 1162 [at 3556], 2014 TCC 30
The taxpayer, as a member of a joint venture, bought an undivided interest in seismic data for $20,000 cash and an $85,000 limited-recourse promissory note. The Minister limited the taxpayer's deductions in connection with the note portion to the amount of licensing revenues ultimately received. After finding that the expenses connected with the note were reasonable (see summary under s. 67), Favreau J stated (at para. 78):
In my opinion, the Crown cannot apply the doctrine of sham to only a part of a particular transaction while considering another part of the same transaction as being legally valid and effective. For example, I have difficulty with the Crown being permitted to apply the doctrine of sham to only that part of the acquisition by the appellant of an undivided interest in the Seismic Data that was paid for by the appellant's Promissory Note.
Foresbec Inc. v. The Queen, 2002 DTC 1786, Docket: 98-2034-IT-G (TCC), aff'd 2003 DTC 5455, 2002 FCA 186
A consulting contract did not reflect the legal reality of the parties' rights and obligations (it was never contemplated that consulting services would be provided and the payments were to be made irrespective of the level of services to be provided) and, accordingly, the contract was found to be a sham for purposes of the Act.
Articles
Glen Loutzenhiser, "Sham in the Canadian Courts", Sham Transactions (Edwin Simpson and Miranda Stewart, editors), Oxford University Press, 2014.
Sham formulation in Snook
(pp. 244-5)
The classic Snook-inspired Canadian formulation of sham has three main components. First, there must be a deceit of third parties, which in tax cases are the Canadian tax authorities, i.e. the CRA…. Second, there must be an apparent transaction or arrangement, and an actual but concealed one. Third, there must be a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. Importantly, and as will be discussed in more detail later in this chapter, a "common intention" to deceive may not necessarily be required in the tax context; if a single deceitful taxpayer advances an apparent position as a façade for another, concealed one that could be enough to satisfy the Canadian tax law test for sham.
Relationship to legal substance doctrine (pp. 245-6)
The sham and the legally ineffective doctrines are both subsets of an important, over-arching principle in Canadian tax law—derived from the famous 1936 UK tax case IRC v Duke of Westminster [fn 20: [1936] AC 1 (HL.)]—that tax consequences are to depend on the legal substance actually created by the parties rather than the form or descriptions employed or the economic substance. [fn 21: David Duff et al. (eds), Canadian Income Tax Law, 4th edn (LexisNexis Canada, 2012) 156-8.] It follows that if the legal rights reflected in the transaction documents (e.g. the contracts, the (p.246) trust deeds) do not reflect the actual legal rights the parties created, either because the parties intended it that way in an attempt to deceive the tax authorities (i.e. a sham) or because the transaction was not legally effective in the way the parties intended, the apparent rights will be ignored and tax computed in accordance with the actual legal rights.
Stubart (p. 248)
[S]tubart involved the transfer of a business from a profit-making company (Stubart) to a loss-making sister company (Grover) in the same group. Grover appointed Stubart to run the business as agent for Grover, and Stubart paid over the profits of the business to Grover and offset against those profits accumulated loss carry-forwards. … [T]he court held the transaction was not a sham because it was not constructed to create a false impression-the appearance created by the documentation was the reality….
No requirement for common intention to deceive (pp. 249-250)
[E]stey J also outlined a new, tax specific formulation of sham:
- …This expression [sham] comes to us from decisions in the United Kingdom, and it has been generally taken to mean (but not without ambiguity) a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a façade of reality quite different from the disguised reality.
…Estey J goes further than simply re-affirming the Snook formulation of sham. Noticeably absent from Estey J's formulation is any reference to common intention to deceive by the parties to the sham….Thus, on the Estey J formulation, if the taxpayer alone has created a façade to disguise the reality of the situation, this could, it appears, constitute a sham….
Classic doctrine reaffirmed in Singleton (p. 252)
The Supreme Court decision in Singleton appeared to dash any hope that the sham doctrine would have a significant role to play in Canadian tax law. To that point, all judicial attempts to push the boundaries of sham outwards were quickly challenged and ultimately rejected….
Sham elections in Faraggi (p. 254)
What then was the sham in Faraggi?...Noël JA concluded that the taxpayers' actions suggested that they were aware of the flaw in their plan–that the shares were not capital property. Despite this knowledge, the subsidiaries controlled by the taxpayers represented in filings to the tax authorities and in their elections, which were relied upon by the third party purchasers, that they had generated capital gains. Noël JA concluded that on that basis the filings were a sham. …
The classic Snook formulation of a sham requires a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. In this case, the taxpayers and the companies that they controlled could be said to have that intention, but the third-party purchasers were apparently unaware of the source of the CDAs they were purchasing (and CDAs clearly could legitimately arise by other means). On this reading, the deceit in this case lies solely with the taxpayers. As the Tax Court judge put it:…'To have made an election pursuant to section 83(2) in these circumstances is, to put it mildly, dishonest…'….
Antle in Tax Court (p. 255)
[I]n [Antle]an attempt to shelter the gain from tax, Mr A's [fn 64: Antle v R 2010 FCA 280; 2010 DTC 7304] tax advisors came up with a plan under which Mr A would settle a Barbados trust in favour of his wife, and convey his shares to the trust. The trust would then sell the shares to Mrs A at fair market value, and Mrs A would sell the shares (now with a cost base 'stepped-up' to market value) to the arm's length purchaser….
[I]n obiter remarks, Miller J went on to discuss his findings on the question of sham:
…I do not accept that [the Barbadian trustee] had any real discretion….The pretence of discretion was critical to make the strategy work, but I entertain no doubt whatsoever in this situation, it was a preference….
Despite this finding, Miller J ruled that there was no intentional deception and therefore no sham.
Antle in FCA (p. 256)
[I]n Noël JA's view, the Tax Court judge's findings that both the appellant and the trustee gave a 'false impression of the rights and obligations created between them' was sufficient to justify a holding of sham….
Sham after Faraggi and Antle (pp. 256-7)
Whilst Faraggi arguably could be confined to its unusual facts, in Antle the Federal Court of Appeal sent a clear warning to taxpayers and their advisors that the sham doctrine is alive and well in Canadian tax law….
[I]t is not entirely clear what Noël JA meant when in Antle he described the level of deceit necessary to establish a sham as merely a false impression that can fall short of the level of deceit required in the criminal or tort law context. This appears to be intended to 'lower the bar' and make it easier for a court to find a sham exists, possibly by signalling to judges that they should not be unduly troubled about the level of proof required to establish the necessary deceit. In fact, there is some anecdotal evidence that the CRA has begun to issue more assessments alleging sham since Antle. [fn 71: Statement by an unnamed tax practitioner at the University of British Columbia tax workshop held in Vancouver at Thorsteinssons LLP (March 19, 2013).]…