Continental Bank Leasing Corp. v. Canada

Continental Bank Leasing Corp. v. Canada
Collection
Supreme Court Judgments
Date
1998-09-03
Report
[1998] 2 SCR 298
Case number
25532
Judges
L'Heureux-Dubé, Claire; Gonthier, Charles Doherty; Cory, Peter deCarteret; McLachlin, Beverley; Iacobucci, Frank; Major, John C.; Bastarache, Michel
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
SCC Case Information: 25532
Decision Content
Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298
Continental Bank Leasing Corporation Appellant
v.
Her Majesty The Queen Respondent
and
The Canadian Bankers’ Association Intervener
Indexed as: Continental Bank Leasing Corp. v. Canada
File No.: 25532.
1998: January 26; 1998: September 3.
Present: L’Heureux‑Dubé, Gonthier, Cory, McLachlin, Iacobucci, Major and Bastarache JJ.
on appeal from the federal court of appeal
Income tax -- Depreciable assets -- Recapture of capital cost allowance -- Rollover of assets into partnership -- Bank subsidiary entering into partnership and transferring assets to it pursuant to rollover provision -- Bank Act prohibiting banks from participating in partnerships -- Provincial partnerships legislation providing for dissolution of partnership upon happening of event making it unlawful for business of firm to be carried on or for members of firm to carry it on in partnership -- Whether partnership rendered invalid -- If so, whether subsidiary liable for recapture of capital cost allowance -- Income Tax Act, R.S.C. 1952, c. 148, ss. 13, 97(2) -- Bank Act, R.S.C., 1985, c. B-1, s. 174(2) -- Partnerships Act, R.S.O. 1980, c. 370, s. 34.
In 1986, Continental Bank of Canada (the “Bank”), which had decided to wind up its affairs, invited offers for the purchase of the shares or assets of its wholly owned subsidiary, Continental Bank Leasing Corp. (“Leasing”). Central Capital Leasing (“Central”), which had concerns about the creditworthiness of several of the leases and certain contingent tax liabilities of Leasing, proposed a transaction whereby Leasing would form a partnership with several Central subsidiaries to carry on the same business as Leasing, transfer its assets other than the excluded leases to the partnership using an election under s. 97(2) of the Income Tax Act, a rollover provision, distribute its partnership interest to the Bank at its cost base as part of its winding-up, and then have the Bank sell its interest to Central or its subsidiaries. A master agreement was signed setting out the various steps to be executed by the parties. The partnership was formed on December 24, 1986; all partners, except Leasing, gave representations and warranties that they were and would remain duly registered and qualified to carry on the business of the partnership. On December 27, Leasing and the Bank signed an indenture providing for the transfer of Leasing’s partnership interest to the Bank. On December 29, 1986, the Bank sold the interest in the partnership to subsidiaries of Central. Leasing filed its income tax return for 1987 based on these transfers. The Minister of National Revenue reassessed Leasing on the basis that the partnership transaction was invalid and that the true nature of the transaction was a disposition by Leasing of its leasing assets to Central, making the s. 97(2) election invalid and giving rise to recaptured capital cost allowance in the hands of Leasing. Under s. 174(2) of the Bank Act , a bank may not, directly or indirectly, participate in a partnership in Canada. Section 34 of the Ontario Partnerships Act provides that a partnership is “dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership”. The Tax Court of Canada allowed Leasing’s appeal of the reassessment. The Federal Court of Appeal reversed that decision.
Held (L’Heureux-Dubé and Bastarache JJ. dissenting): The appeal should be allowed.
Per Gonthier, Cory, McLachlin, Iacobucci and Major JJ.: While the other aspects of Bastarache J.’s reasons were agreed with, s. 34 of the Ontario Partnerships Act did not render the partnership between Leasing and its partners void. The business of a partnership is not rendered illegal merely because an investor holds shares in a corporate partner in the partnership when the law says it should not. The partnership must be distinguished from those who may invest in or support the partners that make it up. Prior to December 27, 1986, the Bank was not a partner. It merely held shares in one of the partners, Leasing, which was a separate and legally distinct corporation. Section 174 of the Bank Act accordingly did not make it unlawful for the partnership to carry on its business, or for Leasing to be a partner, prior to December 27. The partnership was not dissolved under s. 34 of the Partnerships Act simply because the Bank should not have held shares in one of the partners. Nor can Leasing’s participation in the partnership be considered unlawful within the meaning of s. 34 of the Partnerships Act by reason of the public policy component of the common law doctrine of illegality. A finding that Leasing’s participation should be void or unenforceable for public policy reasons does not necessarily mean that its participation was illegal or unlawful in the traditional sense of either term. Moreover, public policy requires that breaches of the Bank Act should not lead to the invalidation of contracts and other transactions. More importantly, s. 20(1) of the Bank Act , which stipulates that no act of a bank is invalid by reason only of a contravention of that Act, supports the view that Parliament never intended breaches of the Bank Act to render bank transactions null and void. Since the partnership was valid between December 24 and December 27, the election under s. 97(2) of the Income Tax Act was also valid.
Per L’Heureux-Dubé and Bastarache JJ. (dissenting): In cases such as this, where the parties have entered into a formal written agreement to govern their relationship and hold themselves out as partners, the courts should determine whether the agreement contains the type of provisions typically found in a partnership agreement, whether the agreement was acted upon and whether it actually governed the affairs of the parties. On the face of the agreements entered into, the parties created a valid partnership within the meaning of s. 2 of the Partnerships Act, which provides that partnership is the relation that subsists between persons carrying on a business in common with a view to profit. Moreover, the parties acted upon the agreements and the agreements governed their affairs. While it is true that between December 24 and December 27, 1986, no meetings were held, no new transactions were entered into by the parties and no decisions were made, there was no termination of Leasing’s contracts with its customers when Leasing’s business and assets were transferred to the partnership and the contracts continued during this period. The fact that no new business was created during the period of Leasing’s and the Bank’s involvement in the partnership does not negate the effect of the existing business that was continued during this time. As well, the business that was carried on was carried on by the partners in common. Leasing and the Bank held themselves out as partners, and conducted themselves as partners for the duration of their memberships in the partnership. The business was also carried on with a view to profit. The partnership agreement provided for the distribution of the profits from the leasing business being operated by the partnership and the partnership continued to carry on the business operated for profit by Leasing.
While the Bank contravened s. 174(2) (i) of the Bank Act by entering into a partnership, the prohibition in that provision does not make partnerships ultra vires the Bank. Under s. 18(1) of the Act, a bank has the “capacity and . . . the rights, powers and privileges of a natural person”. Section 20(1) states that “[n]o act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act”. While s. 20(1) is not a complete bar to the application of the doctrine of illegality in the appropriate case, the doctrine does not apply in the present circumstances. Section 20(1) is not in conflict with s. 34 of the Ontario Partnerships Act, however, which has the effect of dissolving the unlawfully formed partnership ab initio. Payment of the penalties set out in s. 174(16) of the Bank Act does not render lawful what the Bank Act prohibits. Any indirect participation by a bank, through a subsidiary company, for example, makes the carrying on of business in the partnership “unlawful” within the meaning of s. 34 of the Partnerships Act. Leasing’s participation in the partnership can also be considered “unlawful” by reason of the public policy component of the common law doctrine of illegality. While it may not be strictly contrary to the Bank Act for Leasing to enter into a partnership, in all of the circumstances it is contrary to public policy to allow the parties to benefit from their deliberate breach of the Act’s prohibitions. The collapse of the partnership scheme vis-à-vis Leasing does not change the fact that Leasing’s assets were transferred to Central’s subsidiaries on December 24, 1986. Because these assets were not transferred to a partnership pursuant to s. 97(2) of the Income Tax Act, Leasing cannot take advantage of that rollover provision and is therefore liable for the recapture of capital cost allowance on its depreciable assets pursuant to s. 13 of the Income Tax Act.
Cases Cited
By McLachlin J.
Referred to: Salomon v. A. Salomon and Co., [1897] A.C. 22.
By Bastarache J. (dissenting)
Continental Bank of Canada v. Canada, [1998] 2 S.C.R. 358; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Orion Finance Ltd. v. Crown Financial Management Ltd., [1996] 2 B.C.L.C. 78; Mahon v. Minister of National Revenue, 91 D.T.C. 878; Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336; Canada v. Antosko, [1994] 2 S.C.R. 312; Ashbury Railway Carriage and Iron Co. v. Riche (1875), L.R. 7 H.L. 653; Communities Economic Development Fund v. Canadian Pickles Corp., [1991] 3 S.C.R. 388; Cope v. Rowlands (1836), 2 M. & W. 149, 150 E.R. 707; Sidmay Ltd. v. Wehttam Investments Ltd. (1967), 61 D.L.R. (2d) 358, aff’d on other grounds, [1968] S.C.R. 828; Royal Bank of Canada v. Grobman (1977), 18 O.R. (2d) 636; Still v. Minister of National Revenue (1997), 221 N.R. 127; Neider v. Carda of Peace River District Ltd., [1972] S.C.R. 678; Menard v. Genereux (1982), 39 O.R. (2d) 55; Holman v. Johnson (1775), 1 Cowp. 341, 98 E.R. 1120; Hudgell Yeates & Co. v. Watson, [1978] 2 All E.R. 363.
Statutes and Regulations Cited
Bank Act, R.S.C., 1985, c. B-1, ss. 18(1), 20(1), 174(2)(i), (16), 246.
Canada Business Corporations Act , S.C. 1974-75-76, c. 33, ss. 15(1), 16(3).
Income Tax Act, R.S.C. 1952, c. 148 [am. 1970-71-72, c. 63], ss. 13 [am. 1976-77, c. 4, s. 3; am. 1980-81-82-83, c. 48. s. 5], 56(4), 85(1) [am. 1974-75-76, c. 26, s. 48; am. 1980-81-82-83, c. 48, s. 45; am. 1985, c. 45, s. 41], 88(1) [am. 1974-75-76, c. 26, s. 52; am. 1979, c. 5, s. 29; am. 1980-81-82-83, c. 48, s. 48], 97(1), (2) [am. 1974-75-76, c. 26, s. 61; am. 1980-81-82-83, c. 140, s. 58; am. 1985, c. 45, s. 49].
Partnerships Act, R.S.O. 1980, c. 370, ss. 1(1)(a) “business”, 2, 15, 34.
Authors Cited
Black’s Law Dictionary, 6th ed. St. Paul, Minn.: West Publishing Co., 1990, “unlawful”.
Cheshire, Fifoot and Furmston’s Law of Contract, 13th ed. London: Butterworths, 1996.
Contracts: Cases and Commentaries, 5th ed. Edited by Christine Boyle and David R. Percy. Scarborough, Ont.: Carswell, 1994.
Crawford and Falconbridge, Banking and Bills of Exchange: A Treatise on the Law of Banks, Banking, Bills of Exchange and the Payment System in Canada, vol. 1, 8th ed. Toronto: Canada Law Book, 1986.
Fridman, G. H. L. The Law of Contract in Canada, 3rd ed. Scarborough, Ont.: Carswell, 1994.
Lindley & Banks on Partnership, 17th ed. London: Sweet & Maxwell, 1995.
Manzer, Alison R. A Practical Guide to Canadian Partnership Law. Aurora, Ont.: Canada Law Book, 1994 (loose-leaf updated October 1997, release No. 3).
Manzer, Alison R. The Bank Act Annotated. Toronto: Butterworths, 1993.
Ogilvie, M. H. Canadian Banking Law. Scarborough, Ont.: Carswell, 1991.
Treitel, G. H. The Law of Contract, 9th ed. London: Sweet & Maxwell, 1995.
Wegenast, F. W. The Law of Canadian Companies. Toronto: Carswell, 1979.
APPEAL from a judgment of the Federal Court of Appeal, [1996] 3 F.C. 713, 199 N.R. 9, 25 B.L.R. (2d) 149, 96 D.T.C. 6355, [1997] 1 C.T.C. 13, [1996] F.C.J. No. 710 (QL), allowing the Crown’s appeal from a decision of the Tax Court of Canada, [1995] 1 C.T.C. 2135, 94 D.T.C. 1858, [1994] T.C.J. No. 585 (QL), allowing the taxpayer’s appeal from a reassessment. Appeal allowed, L’Heureux-Dubé and Bastarache JJ. dissenting.
H. Lorne Morphy and Kent E. Thomson, for the appellant.
Larry R. Olsson, Q.C., and S. Patricia Lee, for the respondent.
Harry Underwood and Ira Nishisato, for the intervener.
//Bastarache J.//
The reasons of L’Heureux-Dubé and Bastarache JJ. were delivered by
Bastarache J. (dissenting) --
I. Introduction
1 This appeal and a related appeal (Continental Bank of Canada v. Canada, [1998] 2 S.C.R. 358) concern events arising out of the winding-up of Continental Bank of Canada (the “Bank”) and its subsidiary, Continental Bank Leasing Corporation (“Leasing”). The broad issue is the validity of a transaction by which Central Capital Leasing (“Central”) ultimately became the owner of leasing assets formerly held by the Bank and Leasing. The transaction involved the formation of a partnership into which Leasing transferred its leasing assets in return for a 99 percent interest in a partnership. Leasing transferred that partnership interest to the Bank, which subsequently sold it to Central’s subsidiaries. These transactions ultimately permitted Leasing to file an election pursuant to s. 97(2) of the Income Tax Act, R.S.C. 1952, c. 148, as amended; this election was rejected by the Minister of National Revenue.
II. Factual Background
2 The Bank was incorporated by an Act of Parliament in 1977 and commenced operations in 1979. In October 1981, the Bank amalgamated with IAC Limited (“IAC”) and became the successor corporation to IAC. Prior to the amalgamation, IAC carried on a sales finance and leasing business which involved, among other things, the purchase of depreciable assets by IAC, including heavy equipment and aircraft, which were then leased for a term of years to corporations that required the use of the assets in their businesses. In 1981, Leasing was incorporated as a subsidiary of the Bank pursuant to amendments to the Bank Act in 1980 which permitted chartered banks to carry on leasing businesses through wholly owned subsidiaries. In 1986, the Bank, no longer being viable, made a decision to wind up its affairs. On October 31, 1986, the Bank entered into an asset purchase agreement with Lloyds Bank plc of London (“Lloyds”) whereby Lloyds agreed to purchase all of the Bank’s assets except the shares of Leasing, the remaining leases still held directly by the Bank and its international loan portfolio. The Bank invited offers for the purchase of either the assets of Leasing or its shares.
3 Pursuant to an agreement accepted by the Bank on October 15, 1986, Central agreed to purchase the shares of Leasing from the Bank. The October 15th agreement was made on the understanding that any leasing assets held directly by the Bank would be transferred to Leasing prior to the completion of the sale of the shares of Leasing. The October 15th agreement was conditional on certain due diligence to be conducted by Central.
4 On November 1, 1986, the Bank transferred the leasing assets held directly by it to Leasing, in contemplation of the share sale. The share sale transaction, however, was never completed. After conducting due diligence in respect of the October 15th agreement, Central expressed concern with regard to certain tax liabilities of Leasing and the creditworthiness of seven lessees. Given that the Bank was in the process of winding-up, it was not prepared to assume the contingent tax liabilities and the parties were at an impasse.
5 In December 1986, Central proposed an alternative transaction which was structured to replicate the economic consequences of the October 15th agreement, but would exclude the seven leases about which Central had expressed concern and would avoid the contingent tax liabilities. This transaction is the one giving rise to this appeal. In essence, Central proposed that Leasing form a partnership with several Central subsidiaries to carry on the same business as Leasing, transfer its assets into the partnership using an election under s. 97(2) of the Income Tax Act, distribute its partnership interest to the Bank at its cost base pursuant to s. 88 of the Income Tax Act, and then have the Bank sell its interest to Central or its subsidiaries.
6 The transaction was governed by the provisions of a Master Agreement that was signed on December 23, 1986 by the Bank, Leasing, Central, Central Capital Management Inc. (“CCMI”), 693396 Ontario Limited (“693396”), 693397 Ontario Limited (“693397”) and 153587 Canada Limited (“153587”). CCMI, 693396 and 693397 were wholly owned subsidiaries of Central. 153587 was a shelf company. The Master Agreement set out the following steps that were executed by the parties:
(a) On December 23, 1986, Leasing acquired certain additional leasing assets that were to be included at the request of Central in the agreement.
(b) On December 24, 1986, Leasing and 153587 amalgamated and continued as one corporation under the name Continental Bank Leasing Corporation (“Leasing”). The Bank was the sole shareholder of the corporation. This created a new year end for Leasing on December 23, 1986.
(c) On December 24, 1986, Leasing formed a partnership, known as Central Capital Leasing (the “Partnership”), with 693396 and CCMI. Leasing contributed its leasing business to the Partnership in return for a 99 percent interest in the Partnership, and filed an election pursuant to s. 97(2) of the Income Tax Act. 693396 and CCMI each contributed $656,929 to the Partnership and each received one-half of a 1 percent interest. Under the Partnership Agreement, 693396 and CCMI gave representations and warranties that they were and would remain duly registered and qualified to carry on the business of the Partnership and enable it to own or lease property, that they could fulfill their partnership obligations without violating the terms of their constating documents or other agreements, and that their forming the Partnership would not result in the breach of any law or agreement. Leasing declined to give such representations.
(d) The first fiscal period for the Partnership ended on December 27, 1986.
(e) On December 27, 1986, as part of its winding-up, Leasing and the Bank signed an indenture providing for the transfer of Leasing’s 99 percent partnership interest to the Bank pursuant to s. 88 of the Income Tax Act.
(f) On December 29, 1986, the Bank purchased secured notes and subordinated convertible debentures of Central for a total amount of $130,071,985. This amount was credited to Central on the books of the Bank.
(g) On December 29, 1986, the Bank sold the interest in the Partnership to 693396 and 693397 for a total purchase price of $130,071,985. Pursuant to the Partnership Interest Purchase Agreement and Assignment Agreement, 693396 purchased 1/11 of the partnership interest and 693397 purchased 10/11 of the partnership interest. The agreements were signed on December 24, 1986 and were effective December 29, 1986.
7 On February 4, 1987, 693397 sent a cheque to Leasing from the Partnership in the amount of $130,726 in respect of Leasing’s net earnings as the 99 percent partner of Central Leasing for the fiscal year December 24 to 27, 1986.
8 Leasing filed its income tax return for 1987 on the basis that pursuant to s. 97(2) of the Income Tax Act, it transferred all of its leasing assets, with the exception of the seven excluded leases, to the Partnership on December 24, 1986 in return for its interest in the Partnership and that it transferred its interest in the Partnership to the Bank as part of its winding-up pursuant to s. 88(1) of the Income Tax Act.
9 On October 12, 1989, the Minister of National Revenue issued a Notice of Reassessment for the 1987 taxation year. Revenue Canada reassessed Leasing on the basis that the partnership transaction was invalid and that the true nature of the transaction was a disposition by Leasing of its leasing assets to Central, making the s. 97(2) election invalid and giving rise to recaptured capital cost allowance in the hands of Leasing.
III. Relevant Statutory Provisions
10 The following statutory provisions are relevant to this appeal:
Bank Act, R.S.C., 1985, c. B-1
18. (1) A bank has the capacity and, subject to this Act, the rights, powers and privileges of a natural person.
20. (1) No act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act.
174. . . .
(2) Except as authorized by or under this Act and in accordance with such terms and conditions, if any, as are prescribed by the regulations, a bank shall not, directly or indirectly,
. . .
(i) acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or limited partnership;
. . .
(16) A bank that contravenes any of paragraphs (2)(a), (c), (f), (h), (i) or (j) is guilty of an offence and liable on summary conviction to a fine not exceeding five hundred dollars in respect of each contravention.
Partnerships Act, R.S.O. 1980, c. 370
2. Partnership is the relation that subsists between persons carrying on a business in common with a view to profit. . . .
34. A partnership is in every case dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.
Income Tax Act, R.S.C. 1952, c. 148, as amended
85. (1) Where a taxpayer has after May 6, 1974 disposed of any of his property that was a capital property (other than real property, an interest therein or an option in respect thereof, owned by a non-resident person), a Canadian resource property, a foreign resource property, an eligible capital property or an inventory (other than real property) to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation, if the taxpayer and the corporation have jointly so elected in prescribed form and within the time referred to in subsection (6), the following rules apply:
(a) the amount that the taxpayer and the corporation have agreed upon in their election in respect of the property shall be deemed to be the taxpayer’s proceeds of disposition of the property and the corporation’s cost of the property;
88. (1) Where a taxable Canadian corporation (in this subsection referred to as the “subsidiary”) has been wound up after May 6, 1974 and not less than 90% of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another taxable Canadian corporation (in this subsection referred to as the “parent”) and all of the shares of the subsidiary that were not owned by the parent immediately before the winding-up were owned at that time by persons with whom the parent was dealing at arm’s length, notwithstanding any other provision of this Act, the following rules apply:
(a) . . . each property of the subsidiary that was distributed to the parent on the winding-up shall be deemed to have been disposed of by the subsidiary for proceeds equal to,
. . .
(iii) in the case of any other property, the cost amount to the subsidiary of the property immediately before the winding-up;
. . .
(f) where property that was depreciable property of a prescribed class of the subsidiary has been distributed to the parent on the winding-up and the capital cost to the subsidiary of the property exceeds the amount deemed by paragraph (a) to be the subsidiary’s proceeds of disposition thereof, for the purposes of sections 13 and 20 and any regulations made under paragraph 20(1)(a),
(i) notwithstanding paragraph (c) the capital cost to the parent of the property shall be deemed to be the amount that was the capital cost thereof to the subsidiary, and
(ii) the excess shall be deemed to have been allowed to the parent in respect of the property under regulations made under paragraph 20(1)(a) in computing income for taxation years before the acquisition by the parent of the property.
97. (1) Where at any time after 1971 a partnership has acquired property from a taxpayer who was, immediately after that time, a member of the partnership, the partnership shall be deemed to have acquired the property at an amount equal to its fair market value at that time and the taxpayer shall be deemed to have disposed of the property for proceeds equal to that fair market value.
(2) Notwithstanding any other provision of this Act, other than subsection 85(5.1), where at any time after November 12, 1981 a taxpayer has disposed of any capital property, a Canadian resource property, a foreign resource property, an eligible capital property or an inventory to a partnership that immediately after that time was a Canadian partnership of which the taxpayer was a member, if the taxpayer and all the other members of the partnership have jointly so elected in prescribed form and within the time referred to in subsection 96(4), the following rules apply:
(a) the provisions of paragraphs 85(1)(a) to (f) apply to the disposition as if
(i) the reference therein to “corporation's cost” were read as a reference to “partnership’s cost”,
(ii) the references therein to “other than any shares of the capital stock of the corporation or a right to receive any such shares” and to “other than shares of the capital stock of the corporation or a right to receive any such shares” were read as references to “other than an interest in the partnership”,
(iii) the references therein to “shareholder of the corporation” were read as references to “member of the partnership”,
(iv) the references therein to “the corporation” were read as references to “all the other members of the partnership”, and
(v) the references therein to “to the corporation” were read as references to “to the partnership”;
(b) in computing, at any time after the disposition, the adjusted cost base to the taxpayer of his interest in the partnership immediately after the disposition,
(i) there shall be added the amount, if any, by which the taxpayer’s proceeds of disposition of the property exceed the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property, and
(ii) there shall be deducted the amount, if any, by which the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property so disposed of by him exceeds the fair market value of the property at the time of the disposition; and
(c) where the property so disposed of by the taxpayer to the partnership is taxable Canadian property of the taxpayer, the interest in the partnership received by him as consideration therefor shall be deemed to be taxable Canadian property of the taxpayer.
IV. Judicial History
Tax Court of Canada, [1995] 1 C.T.C. 2135
11 Bowman J.T.C.C. allowed Leasing’s appeal of the reassessment. Dealing first with illegality under s. 174(2) (i) of the Bank Act , Bowman J.T.C.C. recognized that Leasing’s entering into the Partnership was a breach of the Bank Act , given that this resulted in indirect participation of the Bank in a partnership. Bowman J.T.C.C. held, however, that the breach of the Bank Act was not sufficient to invalidate the scheme because the Bank Act provides a penalty for the breach and because s. 20(1) preserves the validity of the impugned act.
12 Bowman J.T.C.C. concluded that the scheme, in substance, was a single transaction designed to sell Leasing’s assets and that the Partnership was merely a means to an end. He held that neither the Bank nor Leasing had intended to enter into a long‑term partnership with Central. In his opinion, the scheme had been designed to enable the Bank to divest the leasing assets at a tax cost roughly equivalent to the cost of a share transaction. However, in his opinion, the scheme was not a sham. He held that the Bank and Central had been at arm’s length and that their legal relationships had been real and binding. He held that the parties would not have been able to tell a third party that they were not partners and had not disguised another type of legal relationship. In his opinion, a sham requires a different, real, legal relationship behind a legal facade. Bowman J.T.C.C. concluded that the legal reality was the same as the apparent legal relationships; therefore, there had been no sham.
13 Bowman J.T.C.C. held that the requirement to consider “substance over form” in income tax law does not mean that the legal effect of a transaction is irrelevant, nor does it mean that one is entitled to treat substance as synonymous with economic effect. He held that he could not ignore the form of the legally binding relations in this case because the essential nature of a transaction cannot be altered for income tax purposes by nomenclature. Bowman J.T.C.C. concluded that the ultimate purpose of the transactions did not warrant a disregard of the legal relations created by the scheme; therefore, the parties had formed a valid partnership.
14 With respect to the sale of the partnership interest in the final step of the scheme, Bowman J.T.C.C. held that the Bank had not traded its partnership interest in the same way that a speculator or trader would trade land or securities. He held that the Bank’s partnership interest had been a capital asset and that any characterization of the disposition of the partnership interest had to consider the context in which the transaction had occurred. The reasons for disposing of the partnership interest, in the context of a composite transaction forming an integral part of the winding up of Leasing, were sufficient to dispel any inference that the Bank had been engaged in a profit-making scheme. He noted that when subsidiaries are wound up, their assets are often transferred at cost to their parents to be immediately resold. He also noted that under s. 85 of the Income Tax Act, assets that are not inventory may be rolled into a corporation at their cost amount and immediately resold by the corporation at a profit without becoming inventory, because of the rapidity of the resale. Bowman J. rejected the Crown's argument that the Bank's gain on the sale of its partnership interest was income from an adventure in the nature of trade.
15 Bowman J. rejected the Crown's argument that the transactions violated the object and spirit of s. 97(2) of the Income Tax Act. He held that the words of a statute are of primary importance when determining the statute's “object and spirit”, but that any interpretation of a provision inconsistent with the obvious purpose of the provision should be avoided. He held that s. 97(2) is intended to defer tax by permitting an asset transfer without triggering an immediate tax result when the transfer is to a partnership. He held that the premise underlying s. 97(2) is that a taxpayer's real economic position is not enhanced because the assets are merely being held in a different vehicle. He held that a taxpayer does not contravene s. 97(2) by taking advantage of it.
Federal Court of Appeal, [1996] 3 F.C. 713
16 The Court of Appeal rendered two separate judgments. The judgment relevant to this appeal is that dealing with the liability of Leasing for the recapture of the capital cost allowance. In this judgment, Linden J.A. for the court concluded that no valid partnership had been created or, if one had been created, that it was void or ultra vires the Bank. Linden J.A. held that Leasing had sold its assets to Central and had recaptured capital cost allowance; therefore, it had to pay tax on the recapture.
17 Linden J.A. agreed that the transaction had not been a sham because no element of deceit had been involved and because the scheme had formed legally binding relationships. However, he held that to achieve the desired tax results the substance of the tax transaction must be considered, the partnership scheme must be real, and its form must not be fanciful. Linden J.A. reviewed the evidence and held that the parties had not intended to carry on business with a view to profit; therefore, s. 97(2) could not be relied upon by the parties.
18 Linden J.A. held that any involvement by the Bank in a partnership through Leasing would have been legally invalid, void and illegal because it would have contravened s. 174(2) (i) of the Bank Act , which prohibits banks from indirectly participating in partnerships through subsidiaries. He also held that s. 34 of the Partnerships Act would have dissolved any partnership that might have been established because a violation of s. 174(2) (i) of the Bank Act would be illegal and criminal within the meaning of s. 34. He also held that a partnership was ultra vires the Bank. He rejected arguments that ss. 18(1) and 20(1) of the Bank Act offset the ultra vires doctrine. He held that the parties had been advised by counsel that signing the Partnership Agreement was a violation of the Bank Act , that flagrant violations of the Bank Act will not be ignored and that this is not a circumstance for which the Court of Appeal should grant relief under s. 20(1) . He held the Court of Appeal was obliged to apply the doctrine of ultra vires and to view the scheme as invalid.
V. Issues
19 The following issues must be addressed to determine this appeal.
1. Was Leasing a member of a valid partnership with the subsidiaries of Central in December 1986 within the meaning of s. 2 of the Partnerships Act?
2. If Leasing was a member of a valid partnership within the meaning of s. 2 of the Partnerships Act, was the partnership rendered invalid by s. 174(2) (i) of the Bank Act , by s. 34 of the Partnerships Act, or by the common law doctrines of illegality or ultra vires?
3. If the partnership was invalid, was Leasing liable for recapture under s. 13 of the Income Tax Act as the person that disposed of its depreciable assets to the Central subsidiary?
VI. Analysis
1. Was Leasing a member of a valid partnership with the subsidiaries of Central in December 1986 within the meaning of s. 2 of the Partnerships Act?
20 In order to answer this question, it is necessary to consider the various legal requirements for the proper characterization of the transactions entered into by Leasing. The sham doctrine will not be applied unless there is an element of deceit in the way a transaction was either constructed or conducted. This requirement was outlined by Estey J. as follows in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, at pp. 545-46:
A sham transaction: This expression 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 facade of reality quite different from the disguised reality.
Both the trial judge and the Court of Appeal correctly held that the transactions entered into by the parties did not amount to a sham and the sham issue was not argued in this Court. However, the Court of Appeal, after holding that the transaction did not amount to a sham, stated that the present case is an example of a transaction “[w]here legal reality is found to be lacking” (p. 726). The Court of Appeal found that the trial judge erred in law by relying exclusively on documents and forms and did not give proper consideration to the reality of the situation.
21 After it has been found that the sham doctrine does not apply, it is necessary to examine the documents outlining the transaction to determine whether the parties have satisfied the requirements of creating the legal entity that it sought to create. The proper approach is that outlined in Orion Finance Ltd. v. Crown Financial Management Ltd., [1996] 2 B.C.L.C. 78 (C.A.), at p. 84:
The first task is to determine whether the documents are a sham intended to mask the true agreement between the parties. If so, the court must disregard the deceptive language by which the parties have attempted to conceal the true nature of the transaction into which they have entered and must attempt by extrinsic evidence to discover what the real transaction was. There is no suggestion in the present case that any of the documents was a sham. Nor is it suggested that the parties departed from what they had agreed in the documents, so that they should be treated as having by their conduct replaced it by some other agreement.
Once the documents are accepted as genuinely representing the transaction into which the parties have entered, its proper legal categorisation is a matter of construction of the documents. This does not mean that the terms which the parties have adopted are necessarily determinative. The substance of the parties’ agreement must be found in the language they have used; but the categorisation of a document is determined by the legal effect which it is intended to have, and if when properly construed the effect of the document as a whole is inconsistent with the terminology which the parties have used, then their ill-chosen language must yield to the substance.
22 Section 2 of the Partnerships Act defines partnership as “the relation that subsists between persons carrying on a business in common with a view to profit”. This wording, which is common to the majority of partnership statutes in the common law world, discloses three essential ingredients: (1) a business, (2) carried on in common, (3) with a view to profit. I will examine each of the ingredients in turn.
23 The existence of a partnership is dependent on the facts and circumstances of each particular case. It is also determined by what the parties actually intended. As stated in Lindley & Banks on Partnership (17th ed. 1995), at p. 73: “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”.
24 The Partnerships Act does not set out the criteria for determining when a partnership exists. But since most of the case law dealing with partnerships results from disputes where one of the parties claims that a partnership does not exist, a number of criteria that indicate the existence of a partnership have been judicially recognized. The indicia of a partnership include the contribution by the parties of money, property, effort, knowledge, skill or other assets to a common undertaking, a joint property interest in the subject-matter of the adventure, the sharing of profits and losses, a mutual right of control or management of the enterprise, the filing of income tax returns as a partnership and joint bank accounts. (See A. R. Manzer, A Practical Guide to Canadian Partnership Law (1994 (loose-leaf)), at pp. 2-4 et seq. and the cases cited therein.)
25 In cases such as this, where the parties have entered into a formal written