Date: 20011220

Docket: 98-2182-IT-G

BETWEEN:

722540 ONTARIO INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent,

Docket: 98-2422-IT-G

AND BETWEEN:

NOVOPHARM LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Bowie J.

[1]            Novopharm Limited (Novopharm) appeals from assessments under the Income Tax Act (the Act) for its taxation years 1987 and 1988. By these assessments the Minister of National Revenue (the Minister) disallowed deductions totalling $10,727,914 in 1987 and $9,579,540 in 1988 which were claimed by Novopharm in computing its income.

[2]            722540 Ontario Inc. (540) appeals from a determination of its non-capital loss for the taxation year 1988 made under subsection 152(1.1) of the Act. The Minister, in determining the non-capital loss to be nil, disallowed the deduction of 540's share of the reported losses of Millbank Limited Partnership (Millbank) amounting to $270,921. There is an issue as to whether this appeal is properly before this Court. The Minister says that it is not because no Notice of Objection was filed under section 165 of the Act. 540 has also appealed from its assessments for 1990 and 1991, claiming to be entitled to carry a non-capital loss forward from 1988 and apply it to those years.

[3]            The expenses disallowed by the Minister are interest on certain loans, and in the case of Novopharm's 1987 year, a financing fee of $500,000 and a consulting fee of $200,000, both paid in connection with one of those loans.

facts

[4]            The events giving rise to the appeals were a carefully orchestrated series of transactions designed to permit Novopharm to take advantage of the accumulated losses of $11,634,134 and the unused Canadian exploration and development expenses (CEDE) totalling $10,724,370 of a company called Royal Scot Resources Ltd. (Royal Scot), which was effectively defunct. For convenience, I shall refer to the losses and the CEDE collectively simply as the losses. The appeals were presented on the basis that the issue before me is whether the Appellants are entitled to the deductions in respect of interest and the other costs of borrowing that they have claimed. If they are, then the amounts claimed are the correct amounts; if they are not, then the assessments as issued must stand. Nor is it disputed that the transactions which I shall describe took place. The Crown does not allege sham, nor does it invoke the incomplete transactions doctrine.

[5]            Novopharm is a very profitable company whose principal business is the manufacture and distribution of generic pharmaceutical products. It also has investments in real estate, and in a variety of other businesses. Mr. Leslie Dan began the company in 1965, and he and his family still control it. Mr. Dan is president and chief executive officer. In 1986, the pre-tax profit was almost $14 million. In 1987 and 1988, it was $9.2 million and $10.3 million, respectively, even after the deduction of the amounts that are in dispute in these appeals. Clearly, Novopharm was an obvious candidate to utilize a sophisticated arrangement for the avoidance of income taxes. In 1987, such an arrangement was brought to Mr. Dan by Mr. Adrien Boulanger, an accountant with the firm Laventhal & Howarth (L & H), and Mr. Leslie Dollinger, a lawyer with the firm Fogler, Rubinoff.

[6]            In giving his evidence, Mr. Dan tried hard to convey the impression that to him the proposal that Mr. Boulanger and Mr. Dollinger put before him was just another business deal, and that he viewed it as an investment which he embarked on for sound business reasons, because it was likely to produce a satisfactory return for his company. On that basis, and on being assured of the legality of the scheme, he agreed that Novopharm would participate. He professed not to understand the details of the scheme, or that its benefit to Novopharm arose entirely from enabling it to utilize the losses of another company, totally unrelated to it, against which to offset some of its profits, and thereby pay less income tax than it otherwise would. In this he is disingenuous. Mr. Dan is a very shrewd, experienced and successful businessman. He makes his own evaluations of investment opportunities on the basis of his own analysis. His evidence suffered from a number of inconsistencies, and his memory failed him conveniently more than once. I have no doubt that he understood perfectly well that what Mr. Boulanger and Mr. Bollinger proferred was a scheme which had no purpose whatsoever other than to contrive a situation in which Novopharm could artificially reduce its income subject to tax by putting itself in a position to utilize the accumulated losses totalling some $20 million of another company, at a cost to Novopharm of about $3.5 million.

[7]            From the evidence of Mr. Boulanger and Mr. Dan, I find that the transactions which I shall describe[1] were undertaken on the understanding that all the transactions would take place in the way that they in fact did; as Mr. Dan said in his evidence, it was a package deal. I also find that Mr. Dan, on behalf of Novopharm, authorized these transactions to be undertaken because, and only because, he believed that they would result in a reduction of income taxes payable by Novopharm in the order of some $20 million for an outlay of approximately $3.5 million. No other purpose was served, or was intended to be served, by these transactions.

[8]            The Appellants led evidence to show that during 1988 and 1989, and thereafter until 1997, Millbank was an investment vehicle which produced dividend and interest income for the Appellants through its holdings of marketable securities. This income, however, did not result from the transactions with which these appeals are concerned, but from other, totally unrelated, injections of capital.

[9]            Once implementation of the transactions I am about to describe had been approved by Mr. Dan, Mr. Boulanger, through a business associate of his, Mr. Steven Kerr, took steps to locate a suitable company having accumulated losses of about $20 million. Mr. Kerr did this with the help of Mr. Kenneth Taves, a Vancouver lawyer in the firm Farris, Vaughan, Wills & Murphy. Royal Scot was a company with losses totalling some $22.3 million, and no ongoing business of any substance. Its chairman, Mr. Donald McLeod, and the Royal Bank, which as its major shareholder exercised de facto control, were only too willing to accept $2 million for its losses.

[10]          Once Royal Scot had been recruited, the following series of transactions took place, orchestrated by Mr. Boulanger and Mr. Dollinger. Appendix "A" is a series of charts, prepared by counsel for the Respondent, which illustrates these transactions.

[11]          On June 12, 1987, 722537 Ontario Inc. (537), 722538 Ontario Inc. (538), 722539 Ontario Inc. (539) and 540 were incorporated under the Business Corporations Act of Ontario. 537, 538 and 539 were incorporated as subsidiaries of Royal Scot, while 540 was incorporated as a subsidiary of 539. The same day, 537 and 538 entered into an agreement to create a limited partnership, Millbank. 537 was the general partner, with a .01% interest, and 538 was the limited partner, with a 99.99% interest. 538 made a capital contribution of $20,000.

[12]          On June 23, 1987, Millbank borrowed $193,913,043 from First Marathon Capital Corporation ("FMCC") at 11.50% per annum for a period of one year, maturing on June 23, 1988 ("loan #1"). In addition to the interest on loan #1, Millbank also obligated itself to pay a $500,000 loan arrangement fee to FMCC. It was a condition of loan #1 that Millbank lend the proceeds of loan #1 to First Marathon Inc. ("FMI"), FMCC's parent company, on the same day at 11.55% per annum for an identical period of time, in return for FMI's promissory note (the "FMI note"), and that the FMI note be pledged by Millbank to FMCC as security for loan #1. No loan arrangement fee was payable by FMI to Millbank. The terms of the FMI note entitled Millbank to demand prepayment of all the interest payable on it for the one-year term, and also that any such prepayment was to be applied in reduction of loan #1. To implement these transactions, FMCC issued a cheque to Millbank in the amount of $193,913,043 as the proceeds of loan #1, in return for Millbank's promissory note in the same amount, on the terms I have described. Millbank immediately endorsed this cheque in favour of FMI in return for the FMI note in that amount, on the terms described. Millbank immediately demanded prepayment of the interest on the FMI note, and received a cheque from FMI in the amount of $19,991,035, the discounted value of the future interest accruing on the FMI note from June 23, 1987 to June 23, 1988. Millbank immediately endorsed that cheque to FMCC to reduce the balance of loan #1 from $193,913,043 to $173,922,008, as it was required to do by the terms of the FMI note.

[13]          On June 24, 1987, Royal Scot acquired 538's 99.99% limited partnership interest in Millbank for $20,000, which it paid for by way of a demand promissory note in that amount.

[14]          On June 25, 1987, Millbank declared its first fiscal year end, reporting a net income for tax purposes of $19,381,440, consisting of the prepaid interest of $19,993,775, less the loan arrangement fee payable by Millbank to FMCC in the amount of $500,000, and two days' accrued interest of $109,539 on loan #1, and net of the loss for accounting purposes of $2,796. Of Millbank's net income for tax purposes of $19,381,440, 99.99%, or $19,379,502, was allocated to Royal Scot, and .01%, or $1,938, to 537. The amount which was allocated to Royal Scot was offset by the losses, and so attracted no income tax liability.

[15]          On June 30, 1987, the following transactions took place.

(i)             539 acquired 537's .01% general partnership interest in Millbank for $1.00.

(ii)            540 acquired Royal Scot's 99.99% limited partnership interest in Millbank, for which it gave Royal Scot two non-interest bearing promissory notes in the amounts of $20,000 and $2,000,000.

(iii)           Novopharm acquired all of the issued shares of 539 from Royal Scot for $10.00.

(iv)           Novopharm acquired from 539 all of its shares in 540 for $10.00.

(v)            Novopharm purchased from Royal Scot 540's promissory note in the amount of $2,000,000 by substituting its own promissory note of $2,000,000 for 540's note. Novopharm's note was also payable without interest but, unlike the 540 note which it replaced, was payable only if certain changes to the Act which would have prevented Novopharm from deducting the interest payable by it on loan #2 did not come into effect.

(vi)           Novopharm subscribed for treasury shares of 540 for $20,000, and 540 then used the proceeds to pay its promissory note to Royal Scot in the same amount. Royal Scot endorsed the cheque from 540 to pay off its $20,000 promissory note owing to 538.

(vii)          Novopharm purchased additional treasury shares of 540 for $500,000, and 540 used the proceeds to make an additional capital contribution to Millbank, which in turn used it to pay off the loan arrangement fee in that amount to FMCC which it had incurred with respect to loan #1.

(viii)         Novopharm borrowed $173,922,008 from FMCC at 11.5%, maturing on June 23, 1988 ("loan #2"). It was a condition of this loan that Novopharm use the proceeds to purchase additional treasury shares of 540, which it did. 540 then used the proceeds of the share purchase to make a contribution of capital to Millbank.

(ix)            In addition to the interest that was payable on loan #2, Novopharm paid FMCC a loan arrangement fee of $500,000 for loan #2.

(x)             Novopharm also issued a promissory note to Westmorland Financial Service Inc. in the amount of $200,000. This promissory note was subject to the same condition relating to a possible amendment to the Act as Novopharm's $2,000,000 promissory note issued to Royal Scot.

(xi)            the FMI note was pledged to FMCC by Millbank as security for loan #2.

[16]          On August 10, 1987, Novopharm paid Messrs. Fogler, Rubinoff, $75,549.84 for their services in connection with these transactions. On August 13, 1987, Novopharm paid Laventhol & Horwath a fee of $200,000.

[17]          The amendment to the Income Tax Act about which the parties were concerned did not occur, and so in January 1988, Novopharm paid $2,000,000 to Royal Scot and $200,000 to Westmorland Financial Services to discharge its obligations to them.

[18]          As at June 23, 1988, the following amounts were owed on loan #1 and loan #2, and on the FMI note:

(i)             FMI owed Millbank $193,913,043 as principal on the FMI note.

(ii)            Millbank owed FMCC interest of $383,581 on loan #1.

(iii)           Novopharm owed FMCC $193,539,458 on loan #2, made up of $173,922,008 principal and $19,617,450 interest.

[19]          On June 23, 1988, both loan #2 and the FMI note matured, as a result of which the following events took place:

(i)             Millbank received the face amount of the FMI promissory note in the amount of $193,913,043.

(ii)            $193,529,462 of that $193,913,043 was returned by Millbank to 540 by way of reduction of 540's capital in Millbank. The difference between these two amounts, $383,581, was recorded by Millbank as a reduction of accrued interest on loan #1 for the period of June 23, 1987 to June 30, 1987. The payment to 540 took the form of a cheque issued by FMI to 540 for $193,529,462.

(iii)           540 applied this $193,529,462 to cancel most of Novopharm's shares in 540. 540 endorsed the FMI cheque in favour of Novopharm for this purpose.

(iv)           Novopharm then endorsed this FMI cheque in favour of FMCC to repay the principal amount of loan #2, which was $173,922,008, and $19,607,454 on account of the accrued, but as yet unpaid, interest thereon, which was $19,617,450. The remaining interest, $9,996, was paid by Novopharm to FMCC by its own cheque.

[20]          On the cancellation of its shares in 540, Novopharm realized a deemed dividend in the amount of $19,170,433 pursuant to subsection 84(3) of the Act, which it included in computing its income for income tax purposes for the 1988 taxation year, and also deducted pursuant to subsection 112(1) of the Act.

[21]          Notwithstanding the .05 percent difference between the loan rates on loan #1 and loan #2 (11.5%) and the rate payable on the FMI note (11.55%), the interest paid on loan #1 ($383,581) and on loan #2 ($19,617,450) (a total of $20,001,031) exceeded the interest paid on the FMI note ($19,991,035), producing a shortfall of $9,996, the amount which Novopharm paid to FMCC.[2]

[22]          Novopharm deducted for income tax purposes $10,027,914 and $9,579,540 (a total of $19,607,454) of the interest of $19,617,450 paid or accrued in respect of loan #2 in computing its income for its 1987 and 1988 taxation years, respectively.[3] Millbank deducted the interest of $383,581 paid on loan #1 in its 1987 and 1988 fiscal periods. Novopharm also deducted in computing its income for the 1987 taxation year the loan arrangement fee of $500,000 paid in respect of loan #2, and the $200,000 fee paid to Laventhol & Horwath.

[23]          In reassessing Novopharm for the years 1987 and 1988, the Minister disallowed all of these deductions, on the basis that neither the interest nor the fees were paid in respect of "borrowed money used for the purpose of earning income from a business or property ...", as subparagraphs 20(1)(c)(i) and 20(1)(e)(ii) require. The Minister also based the assessment, in the alternative, on section 245 as it existed prior to its re-enactment in 1988. In making a determination of the non-capital loss of 540 for the 1988 year, the Minister disallowed the deduction by it of its allocated share of the loss of Millbank which arose out of the interest and loan arrangement fee on loan #1, for the same reasons.

legislation

[24]          The following provisions of the Act are relevant to these appeals:

18(1)        In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a)            an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

20(1)        Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

...

(c)            an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i)             borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

(ii)            ...

or a reasonable amount in respect thereof, whichever is the lesser;

...

(e)            such part of an amount that is not otherwise deductible in computing the income of the taxpayer and that is an expense incurred in the year or a preceding taxation year

...

(ii)            in the course of a borrowing of money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt)

(including a commission, fee or other amount paid or payable for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course of the issuance, sale or borrowing, ...) ...

84(3)        Where at any time after December 31, 1977 a corporation resident in Canada has redeemed, acquired or cancelled in any manner whatever (otherwise than by way of a transaction described in subsection (2)) any of the shares of any class of its capital stock,

(a)            the corporation shall be deemed to have paid at that time a dividend on a separate class of shares comprising the shares so redeemed, acquired or cancelled equal to the amount, if any, by which the amount paid by the corporation on the redemption, acquisition or cancellation, as the case may be, of those shares exceeds the paid-up capital in respect of those shares immediately before that time; and

(b)            a dividend shall be deemed to have been received at that time by each person who held any of the shares of that separate class at that time equal to that portion of the amount of the excess determined under paragraph (a) that the number of those shares held by him immediately before that time is of the total number of shares of that separate class that the corporation has redeemed, acquired or cancelled, at that time.

111(5)      Where, at any time, control of a corporation has been acquired by a person or group of persons, no amount in respect of its non-capital loss or farm loss for a taxation year ending before that time is deductible by the corporation for a taxation year ending after that time and no amount in respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible by the corporation for a taxation year ending before that time except that

(a)            such portion of the corporation's non-capital loss or farm loss, as the case may be, for a taxation year ending before that time as may reasonably be regarded as its loss from carrying on a business and, where a business was carried on by the corporation in that year, such portion of the non-capital loss as may reasonably be regarded as being in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable income for the year is deductible by the corporation for a particular taxation year ending after that time

(i)             only if that business was carried on by the corporation for profit or with a reasonable expectation of profit throughout the particular year, and

(ii)            only to the extent of the total of the corporation's income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services; and

(b)            such portion of the corporation's non-capital loss or farm loss, as the case may be, for a taxation year ending after that time as may reasonably be regarded as its loss from carrying on a business and, where a business was carried on by the corporation in that year, such portion of the non-capital loss as may reasonably be regarded as being in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable income for the year is deductible by the corporation for a particular year ending before that time

(i)             only if throughout the taxation year and in the particular year that business was carried on by the corporation for profit or with a reasonable expectation of profit, and

(ii)            only to the extent of the corporation's income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services.

112(1)      Where a corporation in a taxation year has received a taxable dividend from

(a)            a taxable Canadian corporation, or

(b)            a corporation resident in Canada (other than a non-resident-owned investment corporation or a corporation exempt from tax under this Part) and controlled by it,

an amount equal to the dividend may be deducted from the income of the receiving corporation for the year for the purpose of computing its taxable income.

152(1.1)                   Where the Minister ascertains the amount of a taxpayer's non-capital loss, net capital loss, restricted farm loss, farm loss or limited partnership loss for a taxation year and the taxpayer has not reported that amount as such a loss in the taxpayer's return of income for that year, the Minister shall, at the request of the taxpayer, determine, with all due dispatch, the amount of the loss and shall send a notice of determination to the person by whom the return was filed.

152(1.2)                   Paragraphs 56(1)(l) and 60(o), this Division and Division J, as they relate to an assessment or a reassessment and to assessing or reassessing tax, apply, with such modifications as the circumstances require, to a determination or redetermination of an amount under this Division or an amount deemed under section 122.61 or 126.1 to be an overpayment on account of a taxpayer's liability under this Part, except that subsections (1) and (2) do not apply to determinations made under subsections (1.1) and (1.11) and, for greater certainty, an original determination of a taxpayer's non-capital loss, net capital loss, restricted farm loss, farm loss or limited partnership loss for a taxation year may be made by the Minister only at the request of the taxpayer.

152(1.3)                   For greater certainty, where the Minister makes a determination of the amount of a taxpayer's non-capital loss, net capital loss, restricted farm loss, farm loss or limited partnership loss for a taxation year or makes a determination under subsection (1.11) with respect to a taxpayer, the determination is (subject to the taxpayer's rights of objection and appeal in respect of the determination and to any redetermination by the Minister) binding on both the Minister and the taxpayer for the purpose of calculating the income, taxable income or taxable income earned in Canada of, tax or other amount payable by, or amount refundable to, the taxpayer, as the case may be, for any taxation year.

152(9)      The Minister may advance an alternative argument in support of an assessment at any time after the normal reassessment period unless, on an appeal under this Act

(a)            there is relevant evidence that the taxpayer is no longer able to adduce without the leave of the court; and

(b)            it is not appropriate in the circumstances for the court to order that the evidence be adduced.

166.1(1)                   Where no notice of objection to an assessment has been served under section 165, nor any request under subsection 245(6) made, within the time limited by those provisions for doing so, the taxpayer may apply to the Minister to extend the time for serving the notice of objection or making the request.

166.2(1)                   A taxpayer who has made an application under subsection 166.1 may apply to the Tax Court of Canada to have the application granted after either

(a)            the Minister has refused the application, or

(b)            90 days have elapsed after service of the application under subsection 166.1(1) and the Minister has not notified the taxpayer of the Minister's decision,

but no application under this section may be made after the expiration of 90 days after the day on which notification of the decision was mailed to the taxpayer.

245(1)      In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

preliminary issue

[25]          Before dealing with the merits of these appeals, I must consider whether the appeal of 540 for the 1988 taxation year is properly before me. That requires an account of the facts that pertain to this issue. On May 18, 1993, 540 was reassessed for the 1988, 1990 and 1991 taxation years. The reassessment for 1988 disallowed the non-capital loss which 540 had claimed for that year, being its allocated share of the non-capital loss of Millbank. The 1990 and 1991 years were reassessed in consequence to disallow the carry-forward of that loss. On August 16, 1993, 540 filed with the Minister Notices of Objection for each of these three years. The Notice of Objection for 1988 recognized that the reassessment for that year was a nil assessment, and requested that the Minister determine the taxpayer's non-capital loss for that year pursuant to subsection 152(1.1) of the Act. The Minister responded to this with a Notice of Determination of a Loss for the 1988 taxation year of 540, which is dated May 25, 1998, which determined the loss to be nil. On June 9, 1998, the Minister sent to 540 Notice of Confirmation of the reassessments for the 1990 and 1991 years.[4] On August 24, 1998, 540 filed a Notice of Appeal in this Court in respect of the three years 1988, 1990 and 1991. In paragraphs 2 to 6 of the Reply to Notice of Appeal, which is dated October 23, 1998, the Respondent took the position that the Appellant had no right of appeal for any of the years, for the following reason. The reassessment for 1988 was a nil assessment, from which no appeal lies. The Notice of Redetermination of Loss would be subject to appeal, if only a Notice of Objection had been filed in respect of it, but none was. The appeals for 1990 and 1991 cannot succeed, as they depend on the success of the 1988 appeal. Upon receipt of this pleading, counsel for the Appellant 540 wrote to the Minister on November 17, 1998 to request an extension of time, pursuant to subsection 166.1(1) of the Act, to file a Notice of Objection in response to the Notice of Determination of a Loss for 1988. At the top of this letter appear the words "WITHOUT PREJUDICE". The Minister's letter in reply to this, dated December 9, 1998, is not long, and as it is central to this issue, I shall reproduce it in full:

Mr. Peter K. Guselle

Fogler, Rubinoff,

P.O. Box 95, Royal Trust Tower

T-D Centre, Toronto

M5K 1G8

December 9, 1998

Dear Sir

Re:           722540 Ontario Inc., - 1988 Taxation Year

The receipt of your Without Prejudice letter dated November 17, 1998 is acknowledged.

We are prepared to give favourable consideration to the request for an extension of the time to file a Notice of Objection, but we first raise these matters for your attention.

The letter, which is also intended to constitute the objection, fails to state the reasons for the objection, other than to say that "the Minister has wrongly disallowed the interest". As the taxpayer is subject to subsection 165(1.11) of the Act, there should be a clear statement of the facts and reasons and the amount of the relief sought. Furthermore, we believe that it is inappropriate for an objection to be issued "Without Prejudice". Finally, we must ask that the objection be signed by an authorized officer of the taxpayer.

Upon satisfying these matters, we will give prompt attention to the request.

Yours truly,

"W.G. Wilson"

Appeals Officer

To this, counsel replied on December 22, 1998,

"I acknowledge receipt of your letter of December 9, 1998, and will respond early in the new year. I trust this is satisfactory".

There was no further correspondence on the subject.

[26]          Counsel for 540 advances two arguments to support the validity of its appeals. Relying on what was said by Bowman J., as he then was, inAallcann Wood Suppliers Inc. v. The Queen,[5] he says that a valid appeal for the 1988 year is unnecessary, because the amount of the loss for that year may be ascertained within the appeals for 1989 and 1990, which are validly before the Court. It is the following part of Bowman J.'s Reasons for Judgment on which counsel relies:[6]

One preliminary procedural or possibly jurisdictional point should be disposed of at the outset. Originally the appellant asked that this court make a determination of its loss for 1988 as the size of that loss affected its taxable income for 1985, 1986 and 1987. The respondent took the position that in the appeals for 1985, 1986 and 1987 the appellant could not challenge the Minister's computation of the loss for 1988 because the appellant had not requested a determination of loss for 1988.

The appellant acceded to this position and requested a loss determination for 1988 under subsection 152(1.1) of the Income Tax Act. A determination was made by the Minister, an objection was filed, the determination was confirmed and an appeal was brought to this court from the loss determination for 1988.

The Minister's position in the original reply to the notice of appeal that the Minister's ascertainment of a loss for a particular taxation year is immutable unless a loss determination is made under subsection 152(1.1) is, however, wrong. It is true that this court cannot make a formal loss determination under subsection 152(1.1). That is the Minister's function. If such a loss determination is made it is valid and binding unless challenged by way of objection or appeal and, if it is sustained on appeal, it stands. The purpose of subsection 152(1.1) is to permit a taxpayer to have its loss for a year determined definitively and, if necessary, to have the Minister's determination reviewed by the court. One of the reasons for the enactment of subsection 152(1.1) was that no appeal lies from a nil assessment. In the absence of a binding loss determination under subsection 152(1.1), it is open to a taxpayer to challenge the Minister's calculation of a loss for a particular year in an appeal for another year where the amount of the taxpayer's taxable income is affected by the size of the loss that is available for carry-forward under section 111. In challenging the assessment for a year in which tax is payable on the basis that the Minister has incorrectly ascertained the amount of a loss for a prior or subsequent year that is available for deduction under section 111 in the computation of the taxpayer's taxable income for the year under appeal, the taxpayer is requesting the court to do precisely what the appeal procedures of the Income Tax Act contemplate: to determine the correctness of an assessment of tax by reviewing the correctness of one or more of the constituent elements thereof, in this case the size of a loss available from another year. This does not involve the court's making a determination of loss under subsection 152(1.1) or entertaining an appeal from a nil assessment. It involves merely the determination of the correctness of the assessment for the year before it.

It was, therefore, unnecessary for the appellant to seek a determination of loss under subsection 152(1.1). The matter of the 1988 loss is now before the court on two bases — both as an appeal from the 1988 loss determination and as a component of the taxable income for 1985, 1986, and 1987 and, to the extent that any amount of loss remains available for carry-forward, for 1989. While it was unnecessary for the purposes of these appeals that I deal at length with the point, the Crown's position is so out of line with both the law and with prevailing practice and could potentially have such far-reaching effects on any number of appeals before this court that I considered it desirable that the idea be nipped in the bud.

Counsel also takes the position, in the alternative, that the letter of November 17, 1998 by which he requested an extension of time pursuant to subsection 166.1(1) "... is a sufficient form of Notice of Objection ...", because it made reference to the earlier Notice of Objection filed on August 16, 1993.

[27]          Counsel for the Respondent, quite correctly, says that the passage from Aallcann Wood Suppliers on which the Appellant relies is obiter, because in that case, the Appellant, faced with the Crown's argument that the loss for 1988, could not be determined within the appeals for the years to which it was to be carried back, rectified the problem by obtaining a Determination of Loss from the Minister, objecting to it, and launching a fresh, and valid, appeal from it.

[28]          Although obiter, this statement by Bowman J. has been followed in this Court,[7] and by the Federal Court Trial Division,[8] and I have no doubt that the principle there stated is correct. If the sequence of events in this case were the same, I would have no hesitation in finding that the Appellant 540 could attack the Minister's original nil assessment of the 1988 loss indirectly on the appeals of the carry-forward years 1990 and 1991. There is, however, a vital difference in the events. In both cases, the Appellant requested and obtained a loss determination under subsection 152(1.1), and as a result its rights with respect to the quantum of that loss are thereafter governed by subsections 152(1.2) and (1.3). The first of these provides the taxpayer with a right to object to, and then to appeal from, a loss determination just as though it were an assessment of tax. Subsection 152(1.3) provides that:

... the determination is (subject to the taxpayer's rights of objection and appeal in respect of the determination and to any redetermination by the Minister) binding on both the Minister and the taxpayer for the purpose of calculating the income, taxable income or taxable income earned in Canada of, tax or other amount payable by, or amount refundable to, the taxpayer, as the case may be, for any taxation year.

The concluding words of this subsection put it beyond any doubt that the taxpayer who obtains a loss determination cannot thereafter launch a collateral attack on the Minister's determination; it must be done by objection to and appeal from that determination, or not at all. In Aallcann Wood Suppliers, the Appellant, having obtained the Determination of Loss, took the necessary steps to appeal from it. In the present case, the Appellant has not done that, and any collateral attack is foreclosed by the words of subsection 152(1.3). It follows from this that I do not entirely agree with Judge Bowman's statement to the effect that the matter of the 1988 loss could proceed before him on both bases; once there has been a loss determination requested and made, it is only by filing a Notice of Objection to it, followed by a Notice of Appeal from it, that that determination of the loss can be brought before the Court.

[29]          I see no merit in the Appellant's alternative position on this point. The letter of December 9, 1998 is perhaps unfortunately worded, in that it neither grants nor refuses the extension of time that the taxpayer requested. Instead, it takes issue with the content of the November 17 letter, which purported to be a Notice of Objection as well as a request for an extension of time. The last paragraph of that letter begins:

We therefore request that you grant the taxpayer's application for an extension of time and accept this letter as the taxpayer's Notice of Objection to the Notice of Determination/Redetermination of Loss in respect of its 1988 taxation year, ...

[30]          Counsel for the Appellant argued that I should read into the letter in reply of December 9th that the Minister granted the requested extension of time, and accepted the letter as a Notice of Objection validly filed. Although the writer indicated that he was favourably disposed to the application, that letter cannot be read as doing either of those things. The time for filing the Notice of Objection had expired in August 1998, and it was never extended; nor was the requested extension refused. No doubt the taxpayer was entitled to a disposition of the application, but it never got one. It could have applied to this Court at any time after February 15, 1999 to grant the extension of time under section 166.2, but it did not. The matter simply died with counsel's letter of December 22, 1998, to which I have already referred. In any event, an extension of time to file a Notice of Objection granted by either the Minister or the Court, even if that application were accepted as being the Notice of Objection as well, could not validate an appeal already begun. It could only enable the taxpayer to then begin a new and valid appeal, which of course it has not done.

[31]          As the appeal from the Determination of Loss for 1988 is not properly before the Court, and as the only relief sought by 540 in its appeals for 1990 and 1991 must depend on a successful attack on that determination, all three appeals must fail.

the positions of the parties on the substantive issue

[32]          Between them, counsel for the parties produced more than one hundred pages of written argument,[9] and occupied one full day in oral argument. They have cited some 50 cases, and several journal articles. I shall summarize their positions as briefly as I can. I should start with those few, but important, matters as to which counsel for the parties are in agreement. First, this is not a case of either sham or incomplete transactions. The various steps were fully and effectively carried out. They were intended to, and they did, create binding legal relationships among the various actors, just as they purport to do. Second, the step transaction doctrine is not in play. The Appellants' counsel says that it is no part of our law; the Respondent's counsel says that this is a straw man, as he does not invoke it.

the Appellants

[33]          The fundamental position of the Appellants is that Novopharm entered into its loan transaction to borrow money in order to purchase shares of 540 as an investment from which it would earn income. Income, in the context of subparagraph 20(1)(c)(i), means gross income, not profit, and so it is irrelevant that the cost of borrowing, made up of the interest and the fees paid to L & H and to FMCC, would inevitably exceed the income which Novopharm would receive from 540 by way of the deemed dividend. So long as there is some gross income to be produced through the use of the borrowed funds, the purpose test has been met.

[34]          The Appellant argues that it is not open to me to examine the commercial and economic reality underlying the loan transaction to test its purpose. To the extent that the obiter dictum of Dickson J. in the Bronfman Trust[10] case may be said to sanction this, it has since been overruled by the Supreme Court's later decisions in Antosko,[11], Friesen,[12] Continental Bank[13] and Shell Canada.[14] In a variation of the same argument, the Appellant submitted that only the direct and not an indirect use of the borrowed funds must govern the availability of the deduction. The direct use in this case is said to be the purchase of the shares of 540, and it is impermissible to look beyond that. To do so would, in the Appellant's view of it, be to import to Canada the step transaction doctrine. The Appellant goes further, however, submitting that in the present case "the transactions in issue are not preordained"[15]. Finally, on this point, counsel for the Appellant argued that the Court is not permitted to seek "the ultimate or true purpose" of the borrowing, as Bowman J. did in Mark Resources[16] and McArthur J. did in Canwest Broadcasting,[17] because this approach has now been disapproved, by the Supreme Court of Canada in Shell Canada, and more recently, in Singleton andLudco. In any event, Mark Resources and Canwest Broadcasting are, in the Appellant's view, distinguishable on their facts.

[35]          With respect to the fees paid to FMCC and L & H ($500,000 and $200,000, respectively), the Appellant argued that the former is deductible under subparagraph 20(1)(e)(ii), and that the latter is deductible under paragraph 18(1)(a), both on the same basis that the interest is deductible under subparagraph 20(1)(c)(i). In other words, the claims to deduct these amounts stand or fall with the claim to deduct the interest.

[36]          Counsel for the Appellant submitted that section 245 of the Act has no application to this case. He did not accept that the tripartite test established by the Federal Court of Appeal in the Fording Coal case[18] is necessarily the correct one, but neither did he suggest any alternative test. Instead, he argued that in the present case none of the three elements of the Fording Coal test to establish undue or artificial reduction of the Appellants' incomes is present, for the following reasons. If the Appellants successfully establish their entitlement to the deductions under section 20, then those deductions cannot be inconsistent with the object and spirit of the Act. In the absence of any pleaded assumption by the Minister that the borrowings were not in accordance with normal business practice, the Respondent has the onus of proving that fact, and she has not done so. Finally, the Appellant's counsel argued that the third element of the Fording Coal test, absence of a bona fide business purpose, is inconsistent with the decisions of the Supreme Court of Canada in Stubart Investments,[19] Continental Bank,[20] Hickman Motors[21] and Neuman[22]. He went on then to argue that, in any event, the purchase by Novopharm of shares of 540 was a transaction which had a business purpose, namely earning dividend income.

the Respondent

[37]          The Respondent accepts that the Duke of Westminster[23] principle remains the law in Canada, but says that the interpretation of subsection 20(1) should be approached in a way that accords with the scheme of the Act, and in particular, Subdivision b of Division B of Part I, in which it appears. That subdivision is concerned with the computation of income or loss from a business or property, and is intended to permit only the deduction from revenues of those expenses that have been laid out for the purpose of gaining an economic profit. It is not there to advance schemes of tax avoidance. The purpose served by permitting the deduction of interest and other borrowing costs is to encourage the accumulation of capital. The reference to income in subsection 20(1), therefore, must refer to net income and not gross income, as the Appellant contends. On the facts of this case it was not just improbable, but impossible, for either loan #1 or loan #2 to produce income. All the transactions which took place were preordained, and without the tax savings, the result would inevitably be substantial losses.

[38]          The Respondent also argued that in looking for the purpose for which borrowed money is used, the Court should not simply look in isolation at the first transaction following the borrowing transaction. In a case such as this, where there are a large number of transactions, all of which are, as Mr. Dan put in his evidence, "a package deal", in which the money moves from one participant to another, the Court has to look for the true or real purpose of the borrowing, not simply the first thing that was done with the borrowed funds. This, counsel argues, is not to apply the step transaction doctrine, because it does not involve ignoring for tax purposes any of the transactions.

[39]          The Respondent argues, in the alternative, that the deduction of the interest and other borrowing costs would unduly or artificially reduce the incomes of the Appellants, and so is prohibited by section 245 of the Act as it stood at the relevant time. Counsel urged me to apply the test established by the Federal Court of Appeal in Fording Coal, and to find that all three elements of that test are met in the present case. The transactions here under consideration, he said, are contrary to the object and spirit of the Act, and particularly section 20, which was enacted to enable businesses to build up their capital, not to assist them in carrying out tax avoidance schemes. The transactions here are not normal business transactions; Novopharm borrowed hundreds of millions of dollars to invest them indirectly in a partnership which could not possibly profit from that investment. From the start it was clear that Novopharm would suffer a multi-million dollar commercial loss. Finally, the transactions lacked any bona fide business purpose; their only purpose was to provide Novopharm with access to the losses of Royal Scot for tax avoidance purposes.

subparagraph 20(1)(c)(i)

[40]          The Supreme Court of Canada has identified the four elements of subparagraph 20(1)(c)(i) that a taxpayer must be able to satisfy for interest to be a permissible deduction in the computation of income under the Act:[24]

Section 20(1)(c)(i) allows taxpayers to deduct from their income interest payments on borrowed money that is used for the purpose of earning income from a business or property. It is an exception to s. 9 and s. 18(1)(b), which would otherwise prohibit the deduction of amounts expended on account of capital, i.e., interest on borrowed funds used to produce income: Canada Safeway Ltd. v. Minister of National Revenue [57 DTC 1239], [1957] S.C.R. 717, at pp. 722-23, per Kerwin, C.J., and at p. 727, per Rand, J.; Bronfman Trust v. The Queen [87 DTC 5059], [1987] 1 S.C.R. 32, at p. 45, per Dickson, C.J. The provision has four elements: (1) the amount must be paid in the year or be payable in the year in which it is sought to be deducted; (2) the amount must be paid pursuant to a legal obligation to pay interest on borrowed money; (3) the borrowed money must be used for the purpose of earning non-exempt income from a business or property; and (4) the amount must be reasonable, as assessed by reference to the first three requirements.

It is only the third of these that is at issue here.

[41]          In the same case the Court reminds us that "courts must be sensitive to the economic realities of a particular transaction", while avoiding both a recharacterization of transactions on the basis of economic realities, and any policy-based deviation from the clear provisions of the statute.[25]

[42]          The question here, as in numerous previous cases, is simply whether the money that Novopharm borrowed (loan #2) was "used for the purpose of earning income from a business or property ...". The Appellant's position, simply put, is that the purchase of the common shares of 540 is such a use; common shares can be expected to yield dividends, and dividends are income. If the Appellant is correct in this then, subject to the application of section 245, it must succeed.

[43]          In Shell, the borrowing was in New Zealand currency (NZ$). Shell's requirement for use in its business was for $100 million in U.S. currency (US$). It converted the borrowed NZ$ to US$, at the same time entering into certain futures transactions through which it secured a tax advantage in terms of the deductibility of interest payments. The Supreme Court held that although the first use of the funds borrowed was to purchase US$, it was nevertheless the borrowed funds that were applied in the Appellant's business. Deductibility of the interest payments was unaffected by either the conversion to US$ or the fact that Shell had necessarily paid a much higher rate of interest to borrow in NZ$ than it would have had to pay had it borrowed US$.

[44]          More recently, in Ludco, the Supreme Court held that to satisfy the purpose requirement in subparagraph 20(1)(c)(i) requires only that one of the purposes of the borrowing must be to earn non-exempt income from a business or property, even though that purpose be a subsidiary one. The interest paid on money borrowed to purchase shares is deductible, provided only that the investment, viewed objectively, manifests a reasonable expectation of earning gross income for the borrower. This principle was unaffected by the fact that the earning of income, as opposed to achieving capital gains, was only an ancillary purpose of the use to which the money was put.

[45]          The Supreme Court of Canada decided The Queen v. Singleton on the same day as Ludco. The taxpayer was a member of a partnership, with a balance in his capital account of greater than $300,000. Having decided to buy a house, he borrowed $400,000 from the bank, $300,000 of which was deposited in the partnership bank account, to the credit of his capital account. On the same day, he withdrew $300,000 from the partnership general account, debiting his capital account, which he then used as part payment for the house. The majority of the Court held that the interest on the loan was deductible under subparagraph 20(1)(c)(i). The purpose of the loan was to refinance the Appellant's partnership interest. In giving the majority reasons, Major J. said this:[26]

In my respectful opinion, it is an error to treat this as one simultaneous transaction. In order to give effect to the legal relationships, the transactions must be viewed independently. When viewed that way, on either version of the facts (i.e., regardless of the sequence), what the respondent did in this case was use the borrowed funds for the purpose of refinancing his partnership capital account with debt. This is the legal transaction to which the Court must give effect. In this regard, I adopt the following reasons of Rothstein, J.A. (para. 54):

In the case at bar, the direct use of the borrowed funds was to refinance the appellant's capital account at the firm. Treating the borrowed funds as used for financing the purchase of the home ignores what the appellant actually did, i.e., used the borrowed funds to replace the funds required for his capital account at the firm. As stated by Dickson, C.J. in Bronfman Trust, the Court cannot ignore the direct use to which the appellant put the borrowed money.

The fact that the money was borrowed in order to allow the respondent to use his own money to purchase the house is of no moment. The Shell decision decided that why the money was borrowed is irrelevant. The fact that money was transferred from the firm to the respondent for the purchase of a residential property has no impact on the application of s. 20(1)(c)(i) to the interest incurred on borrowed money which was used directly for the purpose of refinancing the capital, and as such used for the purpose of earning income from the law firm.

It is therefore now well settled that it is the actual use to which the borrowed money is put, not some subsequent use or some perceived economic reality, that must govern the question of deductibility.

[46]          Counsel for the Respondent acknowledged in his written submission filed following the Ludco and Singleton judgments that these decisions made much of the argument he had advanced at the conclusion of the hearing untenable. Indeed, following these two decisions his argument on this branch of the case became simply that the investment in the shares of 540 was never intended to produce income, and had no prospect of doing so. All that it was intended to produce, and all that it did produce, was a return of capital, which was deemed to be a dividend by the operation of subsection 84(3) of the Act.

[47]          Counsel for the Appellant, in a written Answer to the Respondent's Supplementary Submissions, takes the position that this is a new argument, not previously pleaded or advanced at the hearing of the appeal, and that it is therefore not open to the Respondent to raise it now. I do not agree. Counsel for the Respondent does not by this argument seek to raise any new factual issue. The argument is simply as to the correct characterization of the legal effect of facts that have never been in dispute, and counsel for the Appellant has been afforded, and has availed himself of, an opportunity to respond to the argument. If there were any doubt about the Crown's right to raise the argument now, it would be resolved by subsection 152(9). Counsel for the Appellant has not suggested that there is any additional evidence bearing on this new argument that he should be permitted to adduce.

[48]          Counsel for the Respondent traces the source of the deemed dividend of $19,170,433, which Novopharm received and reported as income, back to the prepayment of interest on loan #1 by FMI to Millbank on June 23, 1987. At that time 538 was the limited partner in Millbank, with an interest of 99.99%. The following day 538 sold its interest in Millbank to Royal Scot for $20,000. One week later Royal Scot, having been allocated 99.99% of the partnership's net income for tax purposes ($19,379,502), sold that same interest to 540 for $2,020,000. Although there had been a year-end allocation for purposes of the Act, there had been no distribution of the assets of Millbank. 538's share of the capital of Millbank therefore passed through to 540, and was the source of the deemed dividend, which counsel argues was in reality simply a return of part of the capital of 540 to its sole shareholder, Novopharm.

[49]          Nevertheless, having regard to what was said by Iacobucci J. at paragraphs 57 to 65 of his Reasons for Judgment in Ludco as to the meaning of the word "income", I do not find this argument to be persuasive. In particular, it cannot be reconciled with the statement at paragraph 61 of Ludco that "...it is clear that 'income' in s. 20(1)(c)(i) refers to income generally, that is an amount that would come into income for taxation purposes, not just net income".     (emphasis added)

[50]          In my view, no examination of economic realities is required in order to conclude that in the present case the Appellant Novopharm did not invest the borrowed money (loan #2) for the purpose of earning income. This is not a case in which there are primary and subsidiary purposes, or real and less real purposes, for the borrowing. Nor is it a case in which there are direct and indirect uses to which the borrowed funds were put. These definitions of the noun "purpose" are found in the Canadian Oxford Dictionary:

1.              a              something to be attained; a thing intended.

b              the reason for which something is done or made, or for which it exists.

[51]          The controlling mind of Novopharm at all times was that of Leslie Dan. He made the decisions, on the basis of his own appreciation of the merit of proposals brought to him, including the proposal of Mr. Boulanger and Mr. Dollinger to enter into these transactions. The search for "purpose" in this case therefore begins and ends with that which Mr. Dan sought to attain for Novopharm. My appreciation of the evidence, particularly that of Mr. Boulanger and Mr. Dan, is that Mr. Dan authorized these transactions with no purpose in mind other than to secure for Novopharm the use of the accumulated losses of Royal Scot, to be applied against the profits of Novopharm, in order to reduce the amount of tax that Novopharm would have to pay. There was no subsidiary purpose. I have already noted the statement of McLachlin J. in Shell Canada that courts must be sensitive to the economic realities of transactions.[27] I note, too, that Iacobucci J., in Ludco, while rejecting the bona fide and dominant purpose tests for the application of subparagraph 20(1)(c)(i), said:[28]

Presumably, a court would take such an approach in response to concerns over tax avoidance.

[52]          The transactions in question here, as I have found, have no purpose other than the avoidance by Novopharm of liability for income tax. Contrary to Mr. Guselle's submission, they were certainly pre-ordained, with that object alone in mind. Estey J. said in Stubart v. the Queen:[29]

Today there is only one principal or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

Commenting on this statement of the law, Iacobucci J. said in Antosko v. The Queen:[30]

It is this principle that must prevail unless the transaction is a sham or is so blatantly synthetic as to be effectively artificial.                                   (emphasis added)

Sham is not an issue in this case, but in my view the second half of this sentence describes accurately the tax avoidance arrangement that Mr. Boulanger and Mr. Dollinger devised for Mr. Dan. It is not, in my opinion, necessary to do more than apply the ordinary grammatical meaning of the words of subparagraph 20(1)(c)(i) to find that this borrowing does not meet its requirements. If I am wrong in that, I would certainly construe the words "used for the purpose of earning income from a business or property" as not being intended to include the use of borrowed funds to implement schemes which have no purpose other than tax avoidance.

[53]          Two schemes similar to this one have previously been considered by this Court. In Mark Resources,[31]the taxpayer entered into a complex series of transactions which had as their object to make available to the taxpayer, a Canadian resident corporation, the accumulated losses of a subsidiary corporation resident in the United States. As in this case, the goal was accomplished by arranging the borrowings, and the related transactions, in such a way as to make the profitable taxpayer liable to pay interest, which it then sought to deduct from income under subparagraph 20(1)(c)(i), while the income yield was channeled into the U.S. corporation, where the losses could be applied against it. The funds then flowed to the Canadian taxpayer in the form of a tax-free intercorporate dividend. Bowman J., as he then was, found that what he called "the true purpose" of the use to which the borrowed funds were put to be the importation of the losses of the U.S. subsidiary, so that they might be deducted in the computation of the Canadian taxpayer's income. In the course of his Reasons for Judgment he said:[32]

Both the appellant's and the respondent's characterizations of the purpose for which the funds were used have a certain superficial correctness, but I think they are both based on a logical fallacy in that they attribute to one event in the series a purpose based upon the immediately subsequent event. The true purpose is a broader one that subsumes all of the subordinate and incidental links in the chain. The overriding ultimate economic purpose for which the borrowed funds were used was to permit the U.S. losses of PDI to be, in effect, imported into Canada and deducted in computing PDL's income.                            (emphasis added)

and further on:[33]

What, then, is the "direct" use to which the borrowed funds were put here? The direct and immediate use was the injection of capital into a subsidiary with the necessary and intended consequence that the subsidiary should earn interest income from term deposits from which it could pay dividends. The earning of dividend income cannot, however, in my opinion, be said to be the real purpose of the use of the borrowed funds. Theoretically one might, in a connected series of events leading to a predetermined conclusion, postulate as the purpose of each event in the sequence the achievement of the result that immediately follows but in determining the "purpose" of the use of borrowed funds within the meaning of paragraph 20(1)(c) the court is faced with practical considerations with which the pure theorist is not concerned. That purpose — and it is a practical and real one, and in no way remote, fanciful or indirect — is the importation of the losses from the U.S. This case is not the converse of Bronfman. The vague purpose of protecting assets that produced virtually no income was patently subservient to the direct and uneconomic purpose of distributing capital to a beneficiary of the trust. Here the immediate step of investing in a subsidiary that in accordance with the scheme must necessarily pay dividends was not the real purpose of the use of the funds. The earning of interest income by PDI and the payment by it of dividends to PDL were integral but subservient and incidental steps to the real objective that lay behind the implementation of the plan. The amount of dividends, albeit deductible in computing taxable income, and based upon the interest from the term deposits, was less than the interest paid to the Royal Bank. It is true that the overall economic result, if all of the elements of the plan work, is a net gain to the appellant, but this type of gain is not from the production of income but from a reduction of taxes otherwise payable in Canada. I am cognizant of the fact that the dividends, although deductible in computing taxable income, are nonetheless income. It is, however, this feature of our Canadian tax system whereby such dividends are deductible in computing taxable income that gives to the plan its apparent economic viability.

Although he refers there to the "true purpose", the "economic purpose" and "the overall economic result", clearly Bowman J. found there, as I do here, that there was only one purpose to which the borrowed funds were put.

[54]          In Canwest,[34] McArthur J. reached the same conclusion for essentially the same reasons. In that case some 32 transactions were entered into for no purpose other than to put the Appellant in a position to claim the right to deduct some $5,000,000 under subparagraph 20(1)(c)(i), while recovering almost all of it in the form of a tax-free intercorporate dividend. As in Mark Resources, there was no apparent purpose in view, except the generation of income in the loss company and losses in the profitable one.

[55]          Counsel for the Appellant sought to distinguish both of these cases on their facts. He also argued that these decisions had been effectively overruled by the decisions in Shell, Ludco and Singleton. It is true that the series of transactions carried out in each of Mark Resources, Canwest and this case are not identical. What they have in common, however, and what distinguishes them all from Shell, Ludco and Singleton, is that in each of these cases an elaborate series of transactions was carried out for no other reason than to create an interest deduction in the profitable corporation, while ensuring that the corresponding yield from the borrowed funds became income of the loss company, which then passed into the hands of the profitable company as an intercorporate dividend, free of taxation. In contrast, Shell Canada had a need to borrow money for the operation of its business. In Ludco, the taxpayer borrowed the funds to invest them, and thereby make money, in the form of both income and capital gains. Singleton's purpose, like Shell's, was to use the money in his business. In each of these cases, the taxpayer had an income-producing goal; they all arranged their affairs in the way that accomplished that goal most effectively for them, as the Supreme Court of Canada has said repeatedly that taxpayers in this country are entitled to do. The Appellant submits that there is no business purpose test in our law; as a general proposition that is correct. However, in order to have a deduction under subparagraph 20(1)(c)(i) there must be a "purpose of earning income from a business or property", even though it may be only a subservient purpose within the whole of the taxpayer's objective, and even though the income to be earned may be miniscule alongside the interest cost. This is so, not because it is part of the general law, but because those words are found in the paragraph written by Parliament. And those words are not satisfied by an intention, standing alone, to render the losses of one company applicable to reduce the taxes of another. I find that Novopharm is not entitled to the deduction which it claimed under subparagraph 20(1)(c)(i). For the same reasons, it is not entitled to deduct either the loan arrangement fee that it paid or the fee to L & H.

[56]          Mr. Guselle also sought to distinguish Mark Resources and Canwest on the basis that in both those cases the corporate vehicle used as the source of the intercorporate dividend paid to the Appellant was dissolved once the scheme had been executed, while 539 and 540 continued in existence, and operated the Millbank partnership, buying and selling marketable securities and producing profits for Novopharm until their sale in 1995. However, neither the few investments that Millbank made in marketable securities in 1988 and 1989, nor its continued existence after 1989, has any bearing on the transactions with which these appeals are concerned. These were financed by funds other than the proceeds of loan #2, all of which Millbank used to retire loan #1. The issue before me relates only to the purpose for which the proceeds of loan #2 were used. This is unaffected by other activities of Millbank, whether contemporaneous or subsequent.

undue or artificial reduction of income

[57]          Prior to its re-enactment in 1988, subsection 245(1) provided:

245(1)      In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In Mark Resources, Bowman J. considered whether this provision applied to the facts before him, and he concluded that it did not. He did not, however, have the benefit of the decisions of the Federal Court of Appeal in Fording Coal,[35] and The Queen v. Central Supply Company (1972) Limited et al.[36] In those decisions, the Court of Appeal has set out the following three factors that are to be considered in the application of subsection 245(1). Would the deduction, if permitted, be contrary to the object and spirit of the Act? Are the transactions giving rise to the deductions made in accordance with normal business practice? Were the transactions entered into for bona fide business purposes? The Supreme Court of Canada had occasion to consider this formulation of the test in Shell Canada, but chose neither to disapprove nor to endorse it.[37]

would the deductions be contrary to the object and spirit of the Act?

[58]          The transactions under consideration were entered into for only one purpose, as I have found. They amounted to a purchase by Novopharm of the accumulated losses of Royal Scot for 10 ¢ on the dollar. The Federal Court of Appeal has recently held, in OSFC Holdings Ltd v. The Queen,[38] that such transactions, if effective in reducing taxes, would be an abuse of the provisions of the Act. Rothstein J.A. discussed the policy of the Act in relation to the transfer of losses from one taxpayer to another at some length. After considering the academic commentary, and the provisions of subsection 111(5), which permits the transfer of losses between corporations in certain very limited circumstances, he concluded at paragraph 98 of his Reasons:

I have no difficulty concluding that the general policy of the Income Tax Act is against the trading of non-capital losses by corporations, subject to specific limited circumstances.

Those limited circumstances to which he referred involve a change of control of a business and its continued operation thereafter, and, of course, have no application to the present case. It would also be contrary to the spirit of subparagraph 20(1)(c)(i) of the Act to permit the deduction of interest in this case. As the Supreme Court has long held,[39] the purpose of this provision is to encourage the accumulation of capital which would then produce taxable income. Its application to implement a transfer of losses between unrelated corporations in furtherance of a tax avoidance arrangement is certainly inconsistent with this purpose. The Appellant's argument that a deduction from income which is permitted by the specific provisions of the Act cannot be contrary to its object and spirit has no merit. It was considered and rejected by Strayer J.A. in Fording Coal[40], and more recently by Rothstein J.A. in OSFC.[41] The answer to the first question is "yes".

are the transactions in accordance with normal business practice?

[59]          Counsel for the Appellant argued that the purchase of common stock is a normal business transaction, and that absent any pleaded assumption to the contrary by the Minister, the Respondent could only succeed as to this issue by leading evidence to establish non-conformity with normal business practice. No such evidence was led. There may well be cases in which evidence will be required to resolve the question whether a transaction, or a group of transactions, is in accordance with normal business practice, but this is not one of them. The facts of this case demonstrate quite clearly that the transactions are not ones that would be entered into in the normal course of business. In Canwest, McArthur J. described a similar, but different, tax avoidance arrangement as "... fiscal manipulation not commercial reality...". Those words describe precisely the scheme which Mr. Dollinger and Mr. Boulanger sold to Mr. Dan in the present case. Leaving aside for the moment its tax avoidance result, these pre-ordained transactions ("a package deal") could only result in the loss by Novopharm of some $3.5 million.

bona fide business purpose?

[60]          I did not understand counsel for the Appellants to contend that any business purpose other than the avoidance of taxation motivated the Appellants in the present case. To do so would certainly require some considerable explanation, and none was made.

conclusion

[61]          The appeals of Novopharm fail, on the basis that it cannot satisfy the requirements of subparagraph 20(1)(c)(i), as to the interest, the requirements of subparagraph 20(1)(e)(ii), as to the loan arrangement fee, or the requirements of paragraph 18(1)(a) as to the fee paid to L & H. They also fail on the basis of section 245 as it stood at the relevant time.

[62]          The appeals of 540 fail for the reasons given at paragraph 31 above. If 540 had a valid appeal before me for 1988, it would nevertheless fail for the same reasons that the appeals of Novopharm fail, and the appeals for 1990 and 1991, being consequential, would fail as well.

[63]          All of the appeals are dismissed. The Respondent is entitled to one set of costs.

Signed at Ottawa, Canada, this 20th day of December, 2001.

"E.A. Bowie"

J.T.C.C.

APPENDIX "A"

CHART 1

JUNE 12, 1987

Incorporation of numbered companies

                                                              

        100%                    100%                   100%

                                                                                                                          

100%

                                                                                                                       

·          722537 Ontario Inc. ("722537"), 722538 Ontario Inc. ("722538") and 722539 Ontario Inc. ("722539") incorporated as subsidiaries of Royal Scot Resources Ltd. ("Royal Scot").

·          722540 Ontario Inc. incorporated as a subsidiary of 722539.

CHART 2

JUNE 12, 1987

Formation of Millbank Limited Partnership

                                                                       

                           

                            100%                                                                 100%

                                   

GENERAL PARTNER                             LIMITED PARTNER

(.01%) interest                                                                 (99.99%)          

                           

·          722537 and 722538 enter into an agreement to create a limited partnership under the name of "Millbank Limited Partnership" ("Millbank").

·          722537 is Millbank's general partner, with a .01 % partnership interest in it.

·          722538 is Millbank's limited partner with a 99.99% partnership interest in it.

·          722537 contributed no money to Millbank, and 722538 $20,000.

·         

CHART 3

JUNE 23, 1987

Loan #1

                                                                  

Cheque for $193,913,043                                     FMI Note for $193,913,043

                         

                                                                   

Cheque for $193,913,043                                     FMI Note for $193,913,043 endorsed to FMI                                             

                        

·          First Marathon Capital Corporation ("FMCC") issues a cheque for $193,913,043 to Millbank as proceeds of Loan #1, at 11.5% p.a. A loan arrangement fee of $500,000 is payable to FMCC.

·          As a condition of Loan #1 Millbank endorses FMCC'S cheque for $193,913,043 to First Marathon Inc. ("FMI") by way of loan.

·        In return, FMI gives Millbank a promissory note for $193,913,043 (the "FMI Note"), at 11.55% p.a., but no loan arrangement fee is payable.

·          Millbank pledges the FMI Note to FMCC as security for Loan #1.

·         

CHART 4

JUNE 23, 1987

Prepayment of interest on FMI Note

                                                                           

Millbank endorses FMI cheque for

$19,991,035

                                                                           

Cheque for $19,991,035

·        Millbank receives cheque for $19,991,035 from FMI by way of prepayment of interest demanded by Millbank on the FMI Note.

·        Millbank endorses FMI's cheque for $19,991,035 to FMCC in reduction of the principal amount of Loan #1 from $193,913,043 to $173,922,008 as a condition of Loan #1.

·       

CHART 5

JUNE 24, 1987

                                    Royal Scot Resources Ltd. becomes

                                    new limited partner in Millbank

                                                                                      

                                                                             

                                                                                                          (1) Limited

                                                    partnership

                                                                                                                   interest in

                                                   Millbank

                                      

                100%                                                                              100%

                                                                                                  

                                   

General Partner                                                                          Limited Partner

(.01%)                                                                                        (99.99%)

		MILLBANK

(1)         Royal Scot acquires 722538's limited partnership interest in Millbank.

(2)         Royal Scot gives 722538 a promissory note for $20,000.

CHART 6

JUNE 25, 1987

Millbank's first fiscal year-end

                                     

$1,938 (.01% of net income)                                                        $19,379,502 (99.99% of net

                                                                         income)

                                                                                    $19,381,440 (100% of net income)

·          The first fiscal year-end of June 25, 1987 of Millbank is declared.

·          Millbank's net income for tax purposes of $19,381,440 was calculated, as follows:

                        Prepaid interest                                                  $19,991,035

                        Less: 2 days' interest

                                    on Loan #1                   $109,595

           

                        Loan arrangement fee on

                        Loan #1                                      500,000                 609,595

                                                                                                            $19,381,440

                                                                                                                                  

·          $1,938 of Millbank's net income for tax purposes was allocated to 722537 and $19,379,502 to Royal Scot.

Royal Scot offset its $19,379,502 share of Millbank's net income allocation by its noncapital losses and Canadian Exploration Expenses.CHART 7

JUNE 30, 1987

722537 and Royal Scot cease to be partners in Millbank

                     

(1) general                 (2) $1.00 (3) limited             (4) promissory

partnership                                               partnership            notes for

interest                                                                 interest               $20,000 and

                                                                                                                            $2,000,000

                                          

General Partner                                                                          Limited Partner

(0.01%)                                                                                    (99.99%)

                         

(1)         722537 sells its 0.01% general partnership interest in Millbank to 722539 for $1.00.

(2)         722537 receives $1.00.

(3)         Royal Scot sells its limited partnership interest in Millbank to 722540.

(4)         Royal Scot receives promissory notes for $20,000 and $2,000,000.

CHART 8

JUNE 30, 1987

Novopharm's acquisition of 722539 and 722540

                                   

                                   

                                   

                                           

                            100%                                                                  100%

·          Novopharm acquires from Royal Scot the shares of 722539 and acquired from 722539 the shares of 722540 for $10.00 each.

CHART 9

JUNE 30, 1987

Novopharm's purchase of $2,000,000 promissory note

                                                                  

(2) Novopharm's promissory                                             (1) 722540's promissory

note for $2,000,000                                                note for $2,000,000

                                      

(3) $2,000,000 debt owing            (3)                               (4) Conversion of 722540's

   by 722540 to Novopharm                                                   debt owing by 722540 to

                                                                                                    Novopharm into share

                                                                                                    equity on July 18, 1988

(1)         Novopharm purchases Royal Scot's $2,000,000 promissory note issued by 722540.

(2)         Novopharm gives Royal Scot its own promissory note for $2,000,000 as consideration. The payment of this promissory note is conditional, as provided by Exhibit R-1, (107), Schedule "A".

(3)         722540 owes Novopharm $2,000,000 as a result of (1) and (2), above.

(4)         Novopharm converts 722540's debt of $2,000,000 owing to it into share equity of 722540 on July 18, 1988.

CHART 10

JUNE 30, 1987

The payment of the $20,000 promissory note

                                                                                                 (3) Royal Scot endorses

                                                                                               Novopharm's cheque

(1) Cheque for     

$20,000 for

share subscription                                    100%           100%   

(2) 722540 endorses

Novopharm's cheque

for $20,000

(1)         Novopharm issues a cheque for $20,000 to 722540 for the purchase of treasury shares.

(2)         722540 endorses the $20,000 cheque to Royal Scot in payment of its promissory note of $20,000 owing to Royal Scot (see Chart 7).

(3)         Royal Scot endorses the $20,000 cheque to 722538 to pay off its promissory note of $20,000 (see Chart 5).

CHART 11

JUNE 30, 1987

Loan #2

(1) Cheque for $173,922,008                         (4) Endorsement of FMCC to pay

       off Loan #1. Millbank pledge

       FMI Note of $193,913,043 as

       security for Loan #2.

(2) Endorsement of FMCC   

cheque for $173,922,008

(3) Endorsement of FMCC    

cheque for $173,922,008   

(1)         FMCC issues a cheque for $173,922,008 to Novopharm as proceeds of Loan #2, at 11.5% p.a. A loan arrangement fee of $500,000 is paid by Novopharm to FMCC.

(2)         Novopharm endorses FMCC cheque for $173,922,008 to 722540 for share subscription.

(3)         722540 endorses FMCC cheque for $173,922,008 to Millbank as a capital contribution.

(4)         Millbank endorses FMCC cheque for $173,922,008 to FMCC to repay balance of Loan #1 of $173,922,008. Millbank pledges the FMI Note for $193,913,043 as security for Loan #2.

CHART 12

JUNE 30, 1987

Payment of loan arrangement fee on Loan #1

                                                                                                               (3) Cheque for $500,000 for

                                                                                                        payment of loan

                                                                                                                arrangement fee on Loan #1

                                                                                               

                                                                    

(1) Cheque for $500,000 for

treasury shares                 

(2) Cheque for $500,000 for

capital contribution              

(1)         Novopharm issues cheque for $500,000 to 722540 for treasury shares.

(2)         Millbank receives a cheque for $500,000 from 722540 for capital contribution.

(3)         FMCC receives a cheque for $500,000 from Millbank for payment of loan arrangement fee on Loan #1.

CHART 13

JUNE 23, 1988

Amount owing on Loan #1 and #2 and on the FMI Note

                                                                             

(1)         $193,913,043

             

     

(1)         FMI owes Millbank $193,913,043 as principal on the FMI Note.

(2)         Millbank owes FMCC $383,581 as interest on Loan #1.

(3)         Novopharm owes FMCC on Loan #2:

            •            principal                         $173,922,008

            •            interest              19,617,450

                                                            $193,539,458

                                                                                  

CHART 14

JUNE 23, 1988

Loan #2 and the FMI Note mature

(1) Cheque for                                             

$193,913,043

(2) Endorsement of cheque          (3) Endorsement of

$193,529,462                        cheque for $193,529,462

(1)         FMI issues a cheque for $193,529,462 to 722540, (the proceeds of the FMI note of $193,913,043 less $383,581 of interest owing by Millbank to FMCC).

(2)         722540 endorses the $193,529,462 FMI cheque to Novopharm.

(3)         Novopharm endorses the $193,529,462 FMI cheque to FMCC.

(4)         Novopharm issues a cheque of $9,996 to FMCC, the difference between the total amount of $193,539,458 owed to FMCC (Chart 13) and the $193,529,462 FMI net cheque endorsed to FMCC.

CHART 15

JUNE 23, 1988

Flow of funds

FMI owes Millbank on FMI Note                                                   $193,913,043

Less: Millbank owes interest to

            FMCC on Loan #1                                                                         (383,581)

FMI net cheque to Millbank,

endorsed to 722540, endorsed

to Novopharm, endorsed to FMCC

to pay principal and interest on Loan #2                                       193,529,462

Novopharm owes FMCC:

•            Principal on Loan #2                    $173,922,008

•            Interest on Loan #2                     19,617,450                   193,539,458

Shortfall owed by Novopharm

to FMCC                                                                                                                 (9,996)

Paid by Novopharm to FMCC                                                                               9,996

                                                                                                                           0

CHART 16

June 30, 1987 - March 4, 1988

Novopharm's Cash Outlays

                                                                        (2)

                            (3)     (4)     (8)                                               

722540

(6)

Laventhol & Horwath

(4)                 (5)

  

Millbank

Westmorland

(4)

  

FMCC

Fogler, Rubinoff

                                                                       

                                                                       

(1)         Novopharm pays 722539 for the shares of 722540

            on June 30, 1987                                                                                                $       10

(2)         Novopharm pays Royal Scot for shares of 722539

on June 30, 1987                                                                                                        10

Forward                                                                                                              $             20

Brought Forward                                                                                                     $          20

(3)         Novopharm subscribes for treasury shares of 722540                                 20,000

            on June 30, 1987                                                                                               

(4)         Novopharm funds the payment by Millbank of the

            loan arrangement fee on Loan #1 to FMCC on

            June 30, 1987                                                                                                     500,000

(5)         Novopharm pays the loan arrangement fee on Loan #2

            to FMCC on June 30, 1987                                                                                  500,000

(6)         Novopharm pays legal fees to Fogler, Rubinoff on

            August 10, 1987                                                                                                       75,550

(7)         Novopharm pays Royal Scot on January 26, 1988                 2,000,000

(8)         Novopharm pays consulting fees to Laventhol &

            Horwath on August 13, 1987                                                                         200,000

(9)         Novopharm pays finder's fee to Westmorland on

            March 4, 1988                                                                                                    200,000

(10)        Novopharm pays additional interest to FMCC on

            repayment of Loan #2 on June 23, 1988                                               9,996

            Total cash outlays                                                                                               $ 3,505,566

                                                                                                                                               

COURT FILE NO.:                                                                 98-2182(IT)G and 98-2422(IT)G

STYLE OF CAUSE:                                                               722540 Ontario Inc. and Novopharm Limited and Her Majesty the Queen

PLACE OF HEARING:                                                         Toronto, Ontario and Vancouver,

                                                                                                British Columbia

DATE OF HEARING:                                                           June 19, 20, 21 and 23, 2000,

July 7 and 19, 2000

REASONS FOR JUDGMENT BY:                                      The Honourable Judge E.A. Bowie

DATE OF JUDGMENT:                                                       December 20, 2001

APPEARANCES:

Counsel for the Appellant:                                  Peter K. Guselle & Kay W. Leung

Counsel for the Respondent:                              Luther P. Chambers, Q.C.

COUNSEL OF RECORD:

For the Appellant:                

Name:                                Peter K. Guselle

Firm:                                  Fogler, Rubinoff

For the Respondent:                                             Morris Rosenberg

                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa, Canada

98-2182(IT)G

BETWEEN:

722540 ONTARIO INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on common evidence with the appeals of Novopharm Limited (98-2422(IT)G) on June 19, 20, 21 and 23, 2000, at Toronto, Ontario, July 7, 2000, at Vancouver, British Columbia and July 19, 2000, at Toronto, Ontario, by

the Honourable Judge E.A. Bowie

Appearances

Counsel for the Appellant:          Peter K. Guselle and Kay W. Leung

Counsel for the Respondent:      Luther P. Chambers, Q.C.

JUDGMENT

          The appeals from assessments of tax made under the Income Tax Act for the 1988, 1990 and 1991 taxation years are dismissed.

The Respondent is entitled to one set of costs.

Signed at Ottawa, Canada, this 20th day of December, 2001.

"E.A. Bowie"

J.T.C.C.

98-2422(IT)G

BETWEEN:

NOVOPHARM LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on common evidence with the appeals of 722540 Ontario Inc.(98-2182(IT)G on June 19, 20, 21 and 23, 2000, at Toronto, Ontario, July 7, 2000, at Vancouver, British Columbia and July 19, 2000, at Toronto, Ontario, by

the Honourable Judge E.A. Bowie

Appearances

Counsel for the Appellant:          Peter K. Guselle and Kay W. Leung

Counsel for the Respondent:      Luther P. Chambers, Q.C.

JUDGMENT

          The appeals from assessments of tax made under the Income Tax Act for the 1987 and 1988 taxation years are dismissed.

The Respondent is entitled to one set of costs.

Signed at Ottawa, Canada, this 20th day of December, 2001.

"E.A. Bowie"

J.T.C.C.

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