BETWEEN:
and
____________________________________________________________________
Appeals heard on June 29 and 30, 2006, at Victoria, British Columbia,
and by videoconference on July 14, 2006, at Ottawa, Ontario,
with the appeals of Alice E. Large (2003-838(IT)G)
By: The Honourable Justice C.H. McArthur
Appearances:
|
Wendy M. Yoshida |
____________________________________________________________________
JUDGMENT
The appeals from reassessments of tax made under the Income Tax Act for the 1997 and 1998 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 14th day of September 2006.
Docket: 2003-838(IT)G
BETWEEN:
ALICE E. LARGE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeals heard on June 29 and 30, 2006, at Victoria, British Columbia,
and by videoconference on July 14, 2006, at Ottawa, Ontario,
with the appeals of Earl W. Large (2003-837(IT)G)
By: The Honourable Justice C.H. McArthur
Appearances:
|
Counsel for the Appellant: |
D. Laurence Armstrong |
|
Counsel for the Respondent: |
Tom Torrie and Wendy M. Yoshida |
____________________________________________________________________
JUDGMENT
The appeals from reassessments of tax made under the Income Tax Act for the 1997 and 1998 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 14th day of September 2006.
"C.H. McArthur"
McArthur J.
2003-838(IT)G
BETWEEN:
EARL W. LARGE and ALICE E. LARGE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] Both Appellants have appealed from reassessments of tax made by the Minister of National Revenue for the 1997 and 1998 taxation years, but for different reasons. Earl W. Large ("Earl") requested an entitlement to a personal credit for married status in each year on the basis that the income of his spouse, Alice E. Large ("Alice") did not exceed $5,918. Alice's appeals are with respect to whether interest income earned is exempt from tax on the basis that it is situated on a reserve pursuant to section 87 of the Indian Act. Earl's appeals are dependent on the outcome of Alice's appeals.
[2] Alice is an "Indian"[1] within the meaning of subsection 2(1) of the Indian Act, and she is a member of the Songhees Indian Band whose Reserve is located outside Victoria, British Columbia. She married Earl, a non-Indian, in 1988, with each of them bringing in three children from prior marriages. Earl is a successful chartered accountant and handled much of Alice's financial affairs.[2]
[3] In July 1992, Alicepurchased an on-reserve cigarette sale business at the Duncan Reserve which operated until 1997, earning approximately $2 million during those years.[3] In addition, in 1993 and 1994, Alice purchased a 40.26% interest in Datatech Systems Ltd. ("Datatech"), a publicly traded company on the Toronto Stock Exchange.[4] Earl was director and chairman of Datatech. In October 1994, Alicesold her shares to Systems House Limited ("SHL"), resulting in a significant gain.[5]
[4] Alice's profit from the sale of the Datatech shares and cigarette business was used to purchase investments which were held at a National Trust branch on the Squamish Indian Reserve. The investments consisted of various guaranteed investment certificates and securities of publicly traded companies. At that time, there was no doubt that the investments would not be situated on the reserve as the facts mirrored those in the decision of the Federal Court of Appeal in Recalma v. The Queen.[6] Therefore, with the advice and assistance of her husband and others, she effected some tax planning to situate personal property on a reserve. The workings of this plan are set out below.
[5] An arrangement was made with Carnaby Investments Ltd. ("Carnaby"), a corporation formed in 1964[7] with its address, during the relevant years, on the Songhees Reserve. Alicewas a director of Carnaby since 1992, was president and corporate secretary in the years under appeal, but was never a shareholder. Her spouse Earl, along with his children from a previous marriage owned the entire shareholdings. As well, Earl was a director of Carnaby during the taxation years in issue.
[6] On September 1, 1995, Alicesold investments with a fair market value of $1,287,088 to Carnaby in exchange for a $3,000,000 Promissory Note.[8] These shares and certificates were held at a National Trust branch on the Squamish Indian Reserve. Alice testified that the original Promissory Note was always located on the reserve, which is consistent with the tax plan. The interest earned by Alice from the Promissory Note is the subject of these appeals.
[7] A trust agreement was established that allowed Aliceto act as trustee of the investments held by Carnaby. It remained the beneficial owner and was entitled to any profits or would bear any losses. Alicenever lost de facto control of the investments. She testified that she would contact an individual at National Trust to perform trades regarding the investments.
[8] Lianne Bourdages, a former trust administrator with National Trust, testified on behalf of the Respondent to the effect that Alicecould only make trades through an external broker. This witness did not work at the particular branch that Alice dealt with and her testimony was substantially consistent with that of Alice. I believe Alicecontacted a National Trust representative to make the trades, who in turn, contacted an external broker to execute each actual trade. Nothing appears to turn on this.
[9] The Respondent noted that Alicehad no formal training in investments; however, it is clear that she got help from her husband, Earl. The Respondent's cross-examination of Alicewith respect to the investment decisions had little to do with the situs of the interest income. This may be of relevance in determining the reasonableness of salary deductions, but that is not the subject of these appeals.
[10] Carnaby reported investment income from the investments in the amounts of $118,628 and $115,447 during its fiscal years ending August 31, 1997 and 1998, respectively. After deductions, it had little or no taxable income.[9] In the 1997 and 1998 taxation years, Alice received income from Carnaby in the amounts of $157,477 and $157,586, respectively, which was comprised of salary, rent and interest on the Promissory Note as follows:
|
|
1997 |
1998 |
|
Salary |
$72,000 |
$72,000 |
|
Rent |
$16,500 |
$24,000 |
|
Interest |
$68,977 |
$61,586 |
|
Total |
$157,477 |
$157,586 |
In argument, counsel for the Respondent referred to 1998 and 1999 as the years under appeal. In fact, the taxation years before me are 1997 and 1998, and the above figures are set out in paragraph 10 of the Reply to the Notice of Appeal.
[11] The Minister of National Revenue allowed the above salary and rental payments as being tax-exempt income, but by Notice of Reassessment dated January 4, 2001, reassessed Alice to include in her income the interest income from the Promissory Note for the taxation years 1997 and 1998.
[12] Alice claimed that her residence was located at 57 Lekwammen Drive on the Songhees Reserve. This is a pre-fabricated two-bedroom home with two garages, one of which was converted into an office. She testified that her husband Earl lived at 4060 Granville Avenue, Victoria, which is located off the reserve. In addition, Alice stated that she lived on and off the reserve, sometimes staying with her husband in the off-reserve residence during the weekends.
Issues
[13] The primary issue is whether Alice's interest income from the Promissory Note was personal property "situated on a reserve" and therefore exempt from taxation pursuant to paragraph 87(1)(b) of the Indian Act and, as a result of that, exempt under paragraph 81(1)(a) of the Income Tax Act.
[14] Also, a preliminary issue was whether the Respondent could introduce documents at trial which were not known to the Appellants because they were not listed in the Respondent's List of Documents, nor dealt with during examinations for discovery.
[15] There were four separate documents that the Respondent wished to introduce at trial, none of which were previously disclosed to the Appellants as required by Rule 81 of the Tax Court Rules (General Procedure). Counsel for the Respondent had obtained the following documents[10] well in advance of trial:
(i) Certified copy of the transfer of the house at 57 Lekwammen Drive from a third party to Alice dated the 18th of April 1990;
(ii) Certified copy of the transfer of the off-reserve property from Alice to Earl;
(iii) Annual Reports of Carnaby filed pursuant to the British Columbia Company's Act that were signed by Alice certifying that her residence was off-reserve; and
(iv) Pages of Sherry Davis' notes regarding audit meetings with Alice for the 2001, 2002, and 2003 taxation years.
[16] Counsel for the Appellants strongly objected to the admission of the documents without notice, claiming as follows:
... I haven't had a chance to consider it - I'm just objecting to it being introduced in this fashion when it's not listed and I'm trying to avoid saying trial by ambush, but...you know here we are, they've had the document since the 9th of June, they've had her evidence since the examination for discovery. I don't think it should be introduced. (Transcript, p. 107)
[17] Counsel for the Respondent replied by simply stating that the issues were important, that the evidence would impugn Alice's credibility, that Rule 89(2) of the General Procedure Rules did not require the documents be listed in advance, and that there was nothing wrong with producing documents for the first time in cross-examination at trial.
[18] For expediency, the documents were allowed in at trial with their relevance, if any, to be determined at a later time. In addition, counsel made submissions with respect to Rule 89(2).
[19] As stated, the Respondent submitted that the documents would impugn the credibility of Alice as a witness. At the outset, one must question the relevance of the documents used by the Respondent. Aliceadmitted in cross-examination that she went back and forth from the on-reserve to off-reserve residence. Nothing in the documents presented contradicts this.
[20] First, the transfer document showing that Alicetransferred the off-reserve house to her husband Earl in 1996 is of no relevance; it is entirely consistent with her testimony regarding tax planning. Second, the Annual Reports of Carnaby signed by Aliceas director do not impugn her credibility. She stated throughout the hearing that Earl "did the financial matters", and it is understandable that she did not remember the small print on a document that she signed 15 years before trial. Third, the transfer price of the off-reserve property from Aliceto Earl is not relevant and again, did not impugn Alice's credibility. Finally, the testimony of the auditor Sherry Davis was not only completely irrelevant, but also potentially misleading. The evidence she gave related to the taxation years 2001, 2002, and 2003 with respect to the reasonableness of salary payments from Carnaby to Alice. This has nothing to do with the interest payments at issue in these appeals.
[21] In summary, the concern of counsel for Alicethat the documents have little relevance is warranted and, consequently, none of this evidence has in any way affected the outcome of this case. However, given the fact that counsel had the opportunity to make submissions, I feel obliged to address the law surrounding Rule 89. The relevant parts of the Rules are set out below:
81(1) A party shall, within thirty days following the closing of the pleadings, file and serve on every other party a list of the documents of which the party has knowledge at that time that might be used in evidence,
(a) to establish or to assist in establishing any allegation of fact in any pleading filed by that party, or
(b) to rebut or to assist in rebutting any allegation of fact in any pleading filed by any other party.
87 Where, after the list of documents has been served under either section 81 or section 82, it comes to the attention of the party serving it that the list has for any reason become inaccurate or incomplete, that party shall serve forthwith a supplementary list specifying the inaccuracy or describing the document.
89(1) Unless the Court otherwise directs, except with the consent in writing of the other party or where discovery of documents has been waived by the other party, no document shall be used in evidence by a party unless
(b) it has been produced by one of the parties, or some person being examined on behalf of one of the parties, at the examination for discovery, or
(c) ...
89(2) Subsection 89(1) does not apply to a document that is used solely as a foundation for or as part of a question in cross-examination or re-examination.
[22] Rule 89(1) provides that no document may be used in evidence unless it has previously been referred to in the pleadings, a List of Documents, disclosed at the examination for discovery, or produced by a witness who is not in control of the party. Rule 89(2) states that Rule 89(1) does not apply if the document is used solely as a foundation for or as part of a question in cross-examination, or re-examination. As stated above, counsel for the Respondent tendered into evidence various documents that had not been previously disclosed to the Appellants in any manner. No reasons were given except that the documents were important, as they may impugn the credibility of the Appellants, and that Rule 89(2) specifically allowed this procedure.
[23] A recent case on point is that of Scavuzzo v. The Queen.[11] In that case, Chief Justice Bowman allowed the Respondent to introduce two volumes of documents on cross-examination that had not previously been disclosed. Chief Justice Bowman stated:
4. I did so on the basis that under subsection 89(2) of the Tax Court of Canada Rules (General Procedure), the prohibition against the case of documents not included in a party's list of documents did not apply where a document is used solely as a basis for a question in cross-examination.
However, he then went on to say:
5. Notwithstanding the rule, to confront counsel with a large mass of documents at trial that were not disclosed in the respondent's list of documents took counsel for the appellant by surprise and put him at a significant and, in my view, possibly unfair disadvantage.
[24] Justice Lamarre Proulx likewise allowed the Crown to introduce a previously undisclosed document pursuant to Rule 89(2) in Morency v. The Queen.[12] After Justice Lamarre Proulx allowed the Crown to file the exhibit, she expressed reservation with Rule 89(2):
16. ... I indicated that she was correct but regretted the nature of this provision which, in my opinion, is a departure from the usual rules of total disclosure of relevant documents to both parties before the hearing in the interests of the proper administration of justice. However, it should be noted that the document filed merely confirms the accountant's evidence in chief.
[25] It is not surprising that there is limited case law with respect to Rule 89 as the major reform occurred in 1991. In the above cases, Bowman J. and Lamarre Proulx J. seemed to express an uneasiness regarding the Crown's surprise tactics. The disclosure process has many positive attributes, including the facilitation of settlement and the narrowing of issues prior to trial. The changes made to the General Procedure Rules in 1991 were supposed to prevent trial by ambush. The whole scheme of the disclosure process would be subverted if one party was simply able to introduce a document in cross-examination.
[26] Rule 81 is a rule of disclosure; it is not a rule of admissibility. On the other hand, Rule 89(2) deals with admissibility. It appears to provide a limited use of documents not disclosed under the disclosure rules. Any other interpretation would render Rule 89(2) meaningless. Unfortunately, the Tax Court Rules simply do not grant me a specific discretion as to whether to allow in a document in cross-examination that was not previously disclosed. Having said that, counsel should exercise good judgment and discretion when invoking Rule 89(2) to introduce a document not previously disclosed. Litigants should not introduce documents simply to ambush the other side in an attempt to determine some inconsistency in the evidence. The danger in such measures is that the ambushed counsel will not have adequate time to properly rebut such documents. Although, in this trial, counsel was fortunate to have the time and resources to properly do so.
[27] Given the time and expense of taking a tax appeal to trial at the general procedure level, and the comments of Chief Justice Bowman and Justice Lamarre Proulx, perhaps the Rules Committee of this Court should reconsider the wisdom of Rule 89(2). Having said that, for the time being, Rule 89(2) does provide an exemption to the general disclosure rule.
[28] The main issue in these appeals is whether the interest income earned by Alice is exempt by virtue of the Indian Act. Section 87 of that Act reads as follows:
87(1) Notwithstanding any other Act of Parliament or any Act of the legislature of a province, but subject to section 83, the following property is exempt from taxation, namely,
(a) ...
(b) the personal property of an Indian or a band situated on a reserve.
87(2) No Indian or band is subject to taxation in respect of the ownership, occupation, possession or use of any property mentioned in paragraph (1)(a) or (b) or is otherwise subject to taxation in respect of any such property.
Also, section 81 of the Income Tax Act reads as follows:
81(1) There shall not be included in computing the income of a taxpayer for a taxation year,
(a) an amount that is declared to be exempt from income tax by any other enactment of Parliament, other than an amount received or receivable by an individual that is exempt by virtue of a provision contained in a tax convention or agreement with another country that has the force of law in Canada;
For Alice's purposes, section 87 states that property is exempt from taxation if that personal property of an Indian is situated on a reserve. Simply put, Alice submits that she is a status Indian and since the Promissory Note, as her personal property, is located on a reserve, that should be the end of these appeals.
Analysis
[29] Indians are citizens, and in affairs not governed by treaties or the Indian Act, are subject to all social responsibilities, including payment of taxes: Nowegijick v. R.;[13] quoted with approval in Mitchell v. Peguis Indian Band.[14] By the same token, Indians, like all other Canadians, are permitted to engage in tax planning; there is nothing inherently wrong with deliberately arranging one's affairs to minimize tax. In Recalma, Linden J.A., speaking for the Court, stated as follows:
5. There is, of course, nothing wrong with Canadians arranging their affairs in order to minimize their tax burden. This is no less so for Natives than it is for other entrepreneurs who arrange mergers and offshore vehicles to reduce their tax burdens. Some efforts made to save taxes are successful and others are not. We must decide whether this one succeeded or whether it has failed. In our view, it has not succeeded.
[30] This is consistent with the decision of the Supreme Court of Canada in Neuman v. M.N.R.:[15]
39. Finally, it is important to remember that this Court held unanimously in Stubart, supra, at p. 575, that a transaction should not be disregarded for tax purposes because it has no independent or bona fide business purpose (Estey J. wrote for himself and Beetz and McIntyre JJ,; Wilson J. wrote concurring reasons for herself and Ritchie J.). Thus, taxpayers can arrange their affairs in a particular way for the sole purpose of deliberately availing themselves of tax reduction devices in the ITA. ...
[31] In absence of an allegation of sham or the applicability of the general anti-avoidance rule under section 245 of the Income Tax Act, the motivation to situate personal property on a reserve to avoid taxation is not a concern: see Shilling v. M.N.R. and Tsuruda v. R. [16]
[32] At paragraph 10(z) of the Reply to the Notice of Appeal, the Minister alleged that the transactions were "artificial". The Minister did not allege a sham and the general anti-avoidance rule was not applied. Thus, the Minister's argument that the transactions were artificial bears no weight on any of the factors below. The only issue is whether Alice's tax plan was successful.
[33] Counsel for the Appellants argues that the "choice" to situate the property on the reserve, by leaving the commercial mainstream, should be respected. In many cases, the taxpayer "attempts" to situate income on a reserve for tax-exempt status; the role of this Court is to determine whether the imposition of tax has been successfully avoided.
[34] In Mitchell, La Forest J., after a comprehensive historical examination to interpret the meaning of section 87 of the Indian Act, stated at pages 226 to 228:
In summary, the historical record makes it clear that ss. 87 and 89 of the Indian Act, the sections to which the deeming provision of s. 90 applies, constitute part of a legislative "package" which bears the impress of an obligation to native peoples which the Crown has recognized at least since the signing of the Royal Proclamation of 1763. From that time on, the Crown has always acknowledged that it is honour-bound to shield Indians from any efforts by non-natives to dispossess Indians of the property which they hold qua Indians, i.e., their land base and the chattels on that land base.
It is also important to underscore the corollary to the conclusion I have just drawn. The fact that the modern-day legislation, like its historical counterparts, is so careful to underline that exemptions from taxation and distraint apply only in respect of personal property situated on reserves demonstrates that the purpose of the legislation is not to remedy the economically disadvantaged position of Indians by ensuring that Indians may acquire, hold, and deal with property in the commercial mainstream on different terms than their fellow citizens. An examination of the decisions bearing on these sections confirms that Indians who acquire and deal in property outside lands reserved for their use, deal with it on the same basis as all other Canadians.
...
But I would reiterate that in the absence of a discernible nexus between the property concerned and the occupancy of reserve lands by the owner of that property, the protections and privileges of ss. 87 and 89 have no application.
I draw attention to these decisions by way of emphasizing once again that one must guard against ascribing an overly broad purpose to ss. 87 and 89. These provisions are not intended to confer privileges on Indians in respect of any property they may acquire and possess, wherever situated. Rather, their purpose is simply to insulate the property interests of Indians in their reserve lands from the intrusions and interference of the larger society so as to ensure that Indians are not dispossessed of their entitlements. ...
[35] In Williams v. R.,[17] the Supreme Court of Canada quoted at length from the statements of La Forest J. in Mitchell. In formulating the method to be used by future Courts, the Supreme Court, in a unanimous decision, stated that:
19. ... Where it is necessary to decide amongst various methods of fixing the location of the relevant property, such a method must be selected having regard to that purpose.
The Court, after noting that the difficulty with determining the situs of intangible property under the Indian Act, created the following flexible test that has been applied by numerous Courts since:
37. ... The first step is to identify the various connecting factors which are potentially relevant. These factors should then be analyzed to determine what weight they should be given in identifying the location of the property, in light of three considerations: (1) the purpose of the exemption under the Indian Act; (2) the type of property in question; and (3) the nature of the taxation of that property. The question with regard to each connecting factor is therefore what weight should be given that factor in answering the question whether to tax that form of property in that manner would amount to the erosion of the entitlement of the Indian qua Indian on a reserve.
[36] To summarize, the connecting factors test is to be applied to the particular facts of a given case giving due consideration to the purpose of the exemption, the type of property and its taxation. Again, one must focus on the purpose of the Indian Act exemption:
35. Furthermore, it would be dangerous to balance connecting factors in an abstract manner, divorced from the purpose of the exemption under the Indian Act. A connecting factor is only relevant in so much as it identifies the location of the property in question for the purposes of the Indian Act. In particular categories of cases, therefore, one connecting factor may have much more weight than another. It would be easy in balancing connecting factors on a case-by-case basis to lose sight of this.
[37] As demonstrated below, Courts have refined the connecting factors to be used when considering investment income. At the outset, it should be noted that it is the interest earned on the Promissory Note that is the issue, not the Promissory Note itself. Therefore, the question is whether the interest income, not the Promissory Note, is situated on the reserve.
[38] The leading decision on the taxation of investment income earned by Indians is the decision of the Federal Court of Appeal in Recalma. In that appeal, the Indian taxpayers were community-oriented and lived fulltime on the Qualicum Indian Reserve. After years of operating a successful fishing business on-reserve, the taxpayers invested the accumulated wealth in Banker's Acceptances and mutual funds through a Bank of Montreal branch located on the Squamish Bank Reserve in West Vancouver. The Court dismissed the taxpayers' appeals finding that the investment income was in the general mainstream of the economy and, thus, not situated on the reserve.
[39] After explaining that different factors apply to different types of income, the Court found:
11. So too, where investment income is at issue, it must be viewed in relation to its connection to the Reserve, its benefit to the traditional Native way of life, the potential danger to the erosion of Native property and the extent to which it may be considered as being derived from economic mainstream activity. In our view, the Tax Court Judge correctly placed considerable weight on the way the investment income was generated, just as the Courts have done in cases involving employment, U.I. benefits and business income. Investment income, being passive income, is not generated by the individual work of the taxpayer. In a way, the work is done by the money which is invested across the land. ...
The Court also found that the Tax Court Judge correctly placed great weight on the following factors: (i) residence of the issuer of the security; (ii) location of the issuer's income generating operations; and (iii) location of the security issuer's property. The Court stated that one must determine whether the income is "intimately connected to the Reserve" and whether it is "an integral part of Reserve life":
9. In evaluating the various factors the Court must decide where it "makes the most sense" to locate the personal property in issue in order to avoid the "erosion of property held by Indians qua Indians" so as to protect the traditional Native way of life. It is also important in assessing the different factors to consider whether the activity generating the income was "intimately connected to" the Reserve, that is, an "integral part" of Reserve life, or whether it was more appropriate to consider it a part of "commercial mainstream" activity. (see Clarke v. Minister of National Revenue (1997), 97 D.T.C. 5315 (Fed. C.A.)) We should indicate that the concept of "commercial mainstream" is not a test for determining whether property is situated on a reserve; it is merely an aid to be used in evaluating the various factors being considered. It is by no means determinative. ...
[40] The Court found that less weight ought to be given to the residence of the taxpayer; the source of the capital with which the security was bought; the place where the security was purchased and income received; the place where the security documents were held; and the place where the income was spent. Taking these factors into consideration, the Court noted:
11. ... While the dealer in these securities, the local branch of the Bank of Montreal, was on a Reserve, the issuers of the securities were not; the corporations which offered the Bankers' Acceptances and the managers of the Mutual Funds in question were not connected in any way to a Reserve. They were in the head offices of the corporations in cities far removed from any reserve. Similarly, the main income generating activity of the issuers was situated in towns and cities across Canada and around the world, not on Reserves. In addition, the assets of the issuers of the securities in question were predominantly off Reserves, which in case of default would be most significant.
[41] When dealing with investment income, the Court made the following warning of using different connecting factors:
14. To hold otherwise would open the door to wealthy Natives living on reserves across Canada to place their holdings into banks or other financial institutions situated on reserves and through these agencies invest in stocks, bonds and mortgages across Canada and the world without attracting any income tax on their profits. We cannot imagine that such a result was meant to be achieved by the drafters of section 87. The result may, of course, be otherwise in factual circumstances where funds invested directly or through banks on reserves are used exclusively or mainly for loans to Natives on reserves. When Natives, however worthy and committed to their traditions, choose to invest their funds in the general mainstream of the economy, they cannot shield themselves from tax merely by using a financial institution situated on a reserve to do so.
[42] In Lewin v. R.,[18] in a brief judgment following Recalma, the Federal Court of Appeal upheld the decision of the Tax Court that interest income from investments issued by a credit union located on-reserve was not exempt under section 87 of the Indian Act. In that case, while the taxpayer lived off-reserve, the credit union's head office and chief place of business were located on-reserve; it was run by Indians for Indians. However, the income earned by the credit union was derived by sending its surpluses into the ordinary capital market, including mortgage loans, personal loans, and other investments. At trial, Justice Tardif stated:
36. If it had been a financial institution created solely for the purposes, concerns and needs of the Indians living on the reserve and if the bulk of its income had primarily been reinvested on the reserve to strengthen, develop and improve the social, cultural and economic well-being of the Indians living there, the situation could have been different.
[43] The fact that the financial institution was not created solely for Indians living on the reserve and did not improve the well-being of the Indians living there appeared to be of much significance to Tardif J. This statement was not criticized by the Federal Court of Appeal.
[44] In Sero v. R. and its companion case, Frazer v. R.,[19] the Indian taxpayers earned interest on monies invested at a branch of the Royal Bank of Canada located on the Six Nations Reserve. In Sero, the taxpayer never resided or worked on a reserve; moreover, the original investment capital was earned off-reserve. In Frazer, the taxpayer was resident on the reserve and the investment money was earned on-reserve. In dismissing both appeals, the Federal Court of Appeal noted that only a minor amount of the Royal Bank income-earning activities was carried out on reserves and only an insignificant percentage of its assets were located on reserves. Also, its central control and management was not situated on a reserve. In other words, Royal Bank operated in the "commercial mainstream". The Court could not find any relevant factual distinction from Lewin and Recalma. The Court also noted that the fact that Mr. Frazer's investment was from an on-reserve source was a relatively weak factor.
[45] The above analysis illustrates that Alicemust demonstrate a factual distinction from the Federal Court of Appeal decisions that have dismissed previous taxpayers' appeals. The facts at hand are similar to those set out in Recalma. Counsel for Alice argues that the mere insertion of a corporation between Alice and an on-reserve bank branch is enough of a factual distinction to place the situation at hand outside the grasp of the Federal Court of Appeal decisions. I find no such material distinction is warranted from the cases of Recalma, Lewin, and Sero.
[46] As enunciated by the trial judge in Recalma, and accepted by the Federal Court of Appeal, the following factors will be given great weight in investment income cases: (i) residence of the issuer of the security; (ii) location of the issuer's income generating operations; and (iii) location of the security issuer's property. In particular, the Federal Court of Appeal noted in that case that consideration ought to be given to the "way the income was derived". In addition, as mentioned above, the Federal Court of Appeal stated that the following factors should be considered:
11. So too, where investment income is at issue, it must be viewed in relation to its connection to the Reserve, its benefit to the traditional Native way of life, the potential danger to the erosion of Native property and the extent to which it may be considered as being derived from economic mainstream activity. ...
The connecting factor referring to "the traditional Native way of life" has been criticized. I may be supportive of that criticism, but see no need to address this as it is not critical to the outcome of this case.
[47] Carnaby is the issuer of the Promissory Note. The issue is whether the income stream derived from the Promissory Note, not the security itself, is on-reserve. The investments Carnaby holds consist primarily of guaranteed investment securities and publicly traded securities. It is clear from the evidence that the income earned through the activities of the publicly traded companies, whose office, assets, and activities are wholly or substantially off-reserve, bear no relation or connection to the reserve. Carnaby's only link to the reserve is that it is resident on the reserve. Earl, a non-Indian, along with his children from a previous marriage, were the sole shareholders of Carnaby, which then paid the interest income to Alice. Carnaby's income was derived passively through investments in companies and activities wholly or substantially off the reserve; Carnaby clearly operates in the "commercial mainstream".
[48] Mere corporate residence on a reserve will be of limited significance in investment income cases. This is especially so when the corporate issuer is merely arranged as an intermediary to create a connection to a reserve. In other words, the mere insertion of a corporation on a reserve to place a distance between the Indian taxpayer and the ultimate issuer, that is the publicly traded corporations or otherwise, will not necessarily be enough to situate the passive income on a reserve. Adherence to such a rigid principle would create odd results. For example, an Indian investor with passive investments, with otherwise no connection to any reserve whatsoever, could simply place a corporation resident on a reserve to situate investment income onto that reserve. Such an example would clearly have concerned the Federal Court of Appeal in Recalma:
14. To hold otherwise would open the door to wealthy Natives living on reserves across Canada to place their holdings into banks or other financial institutions situated on reserves and through these agencies invest in stocks, bonds and mortgages across Canada and the world without attracting any income tax on their profits. We cannot imagine that such a result was meant to be achieved by the drafters of section 87. ... When Natives, however worthy and committed to their traditions, choose to invest their funds in the general mainstream of the economy, they cannot shield themselves from tax merely by using a financial institution situated on a reserve to do so.
[49] This is exactly what happened in this case. Alice's investments were funds in the general or commercial mainstream of the economy. She then attempted to shield the income earned by merely inserting a corporate entity, Carnaby, on the reserve. In Sero, the Federal Court of Appeal contemplated the use of a debt investment with the issuer being an on-reserve entity. The Court held that such an arrangement does not necessarily create a strong enough connection to place the income on-reserve:
20. It was argued in Lewin that the location of the credit union on the reserve, combined with the fact that the investments in issue were debts of the credit union itself rather than third party corporations, created a connection to the reserve that was enough to distinguish Lewin from Recalma. However, the Court found no reason to distinguish the two cases.
[50] Of course, the use of a corporation by an Indian will not necessarily preclude the protection of section 87 of the Indian Act. In this case, the other factual circumstances point toward the income being situated off-reserve or are, at best, inconclusive. These include:
(i) Alice resides both on and off reserve.
(ii) The source of the investment capital was derived from both on-reserve sources (cigarette business) and off-reserve (gains from sale of Datatech shares).
(iii) She handled her ordinary banking at the Bank of Montreal in Victoria, which was located off-reserve.
(iv) There was no evidence that Carnaby or Alice benefited the community. There also was no concrete evidence of where the interest income was used.
(v) The National Trust branch, at which the investments are held, is located at a different reserve (Squamish) from which the Appellant resides (Songhees).
[51] While my decision is independent of the following general observations, they may have had some importance had the conclusion been less certain. Alice was very guarded in her replies to questions, and she was not forthcoming and informative with regard to the operation of the investment portfolio. In addition counsel, in the examination-in-chief, asked many leading questions and her responses must be given less weight. She repeated over and over again the fact that Earl is an accountant and she relied on his expertise. The management of the million dollar plus assets was probably above her expertise. One wonders why Earl did not testify. Alice required his support in all other financial matters. Her evidence with respect to her domicile was, I believe, deliberately vague. Again, this was not an issue. Her evidence with respect to the ciragette business was vague. She appears to have been the owner of that business which was operated by a third party as an aside to Earl's grocery business. There was no evidence as to what the net income was. I believe her business was discontinued after a change in government regulations. And I believe the overall tax planning, that is the subject of these appeals, was orchestrated by Earl. It was aggressive. Notwithstanding that Alice was generously allowed the management and rental expenses by the Respondent, she pursued the interest appeals and Earl sought a personal exemption for married persons. Again, there is nothing wrong with organizing their affairs to gain tax advantages, but the present scheme does not fit into the spirit of the section 87 exemption. Earl played an important role in deciding which investments were purchased or sold. Earl's home address was 4060 Granville Avenue, Victoria and he had an office at 1095 McKenzie Avenue, Victoria. It is disappointing he did not testify. He was the driving force behind the entire arrangement which is the subject of these appeals.
[52] Having found that the 1997 and 1998 interest income is to be included in Alice's taxable income, her income for those years exceeds $5,918. Earl's appeals are therefore also dismissed pursuant to limitations in paragraph 118(1)(a) of the Income Tax Act.
[53] In conclusion, the appeals of both Appellants are dismissed, with one set of costs to the Respondent.
Signed at Ottawa, Canada, this 14th day of September 2006.
"C.H. McArthur"
McArthur J.
COURT FILE NOS.: 2003-837(IT)G and 2003-838(IT)G
STYLE OF CAUSE: EARL W. LARGE and ALICE E. LARGE and HER MAJESTY THE QUEEN
PLACE OF HEARING: Victoria, British Columbia and
Ottawa, Ontario
DATE OF HEARING: June 29, 30 and July 14, 2006
REASONS FOR JUDGMENT BY: The Honourable Justice C.H. McArthur
DATE OF JUDGMENT: September 14, 2006
APPEARANCES:
|
Counsel for the Appellants: |
D. Laurence Armstrong |
|
Counsel for the Respondent: |
Tom Torrie and Wendy M. Yoshida |
COUNSEL OF RECORD:
Firm: Armstrong Nikolich
For the Respondent: John H. Sims, Q.C.
Deputy Attorney General of Canada
Ottawa, Canada
[1] Exhibit A-1, Tab 1. It is recognized the preferred term is "First Nations People" or "Native" but the term Indian will be used throughout as it continues to exist in statutory enactments.
[2] Earl did not testify. He was the founder of Datatech which appears to have been highly successful with outlets across Canada.
[3] The exact amount is unknown as there was insufficient business records.
[4] Exhibit A-1, Tab 8 at page 7.
[5] Exhibit A-1, Tab 9.
[6] 98 DTC 6238; leave to appeal to S.C.C. refused [1998] S.C.C.A. No. 250.
[7] It was incorporated under a different name in 1964; in 1983, well before these appeals, the name was changed to Carnaby Investments Ltd.
[8] Exhibit A-1, Tab 13. The exaggerated amount was intended to provide for future sales of investments by Alice to Carnaby.
[9] Exhibit R-6, Tabs 14 and 15. Carnaby is not tax-exempt as it is not an "Indian" as defined in the Indian Act.
[10] Exhibits R-2, R-3, R-4 and R-7, respectively.
[11] 2004 TCC 806.
[12] 98 DTC 2228.
[13] [1983] 1 S.C.R. 29.
[14] [1990] 2 S.C.R. 85.
[15] 98 DTC 6297.
[16] 2001 FCA 178 and 2006 TCC 288.
[17] [1992] 1 S.C.R. 877.
[18] 2002 FCA 461; leave to appeal to S.C.C. refused [2003] C.S.C.R. No. 19.
[19] 2004 FCA 6, leave to appeal to S.C.C. refused [2004] S.C.C.A. No. 89.