Tax Court of Canada Judgments

Date: 19990624

Docket: 98-827-IT-G

BETWEEN:

JABS CONSTRUCTION LTD.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for judgment

Bowman, J.T.C.C.

[1] These appeals are from assessments for the appellant's taxation years which ended May 31, 1993, 1994 and 1995. The central issue is whether a transfer to a charitable foundation, Felsen Foundation, ("Felsen") on October 31, 1992 by the appellant of 13 properties was legally effective.

[2] The appellant's position is that:

(a) it transferred by way of gift 13 properties to Felsen in its 1993 taxation year and designated its proceeds of disposition to be the adjusted cost base ("ACB") of the properties;

(b) the subsequent sale of the properties to Callahan Construction Company Ltd. ("Callahan") by Felsen resulted in the realization by Felsen of a capital gain that was not taxable in Felsen's hands because it was a charitable foundation;

(c) Felsen loaned a portion of the proceeds of disposition of the properties to the appellant and the interest that the appellant paid on the loan is deductible in computing its income.

[3] The respondent's position is that the transfer of the 13 properties to Felsen was legally ineffective, that accordingly Callahan had beneficial ownership before the purported transfer to Felsen, that the proceeds of disposition of the properties belonged to the appellant and therefore the capital gain was realized by the appellant. On this basis Felsen had nothing to loan to the appellant and the appellant is precluded from deducting the interest paid to Felsen because it was seeking to deduct interest on its own money.

[4] In the alternative, the respondent alleges that if the transfer to Felsen was legally effective it was an avoidance transaction within the meaning of section 245, thereby permitting the Minister of National Revenue to reallocate the capital gain from Felsen to the appellant.

[5] The facts as established in the evidence are as follows. The appellant is a successful owner of commercial real estate. It is controlled by Mr. Eric Jabs. Mr. Jabs and his wife, Toni Alwine F. Jabs, are committed Christians. They have devoted substantial amounts of their time and considerable wealth to charitable causes and have made substantial contributions to charities carrying on activities in Canada and throughout the world.

[6] In 1991, they incorporated Felsen and it was registered as a private charitable foundation. The purpose of creating Felsen was to allow the accumulation of capital in the foundation as an endowment so that amounts could be distributed for charitable purposes without eroding the capital. Mr. Jabs' target was $1,000,000 per year and this would have required a capital fund of $10,000,000. Mr. and Mrs. Jabs and their two adult children are the directors of Felsen.

[7] In 1967, the appellant went into business with Callahan. Their relationship was described as a joint venture. The association was successful and over the years the joint venture prospered and acquired a large portfolio of real estate, including apartment buildings, development sites and commercial buildings.

[8] Differences developed between the appellant and Callahan in 1988 and an acrimonious dispute ensued, leading to a decision to terminate the joint venture and divide the properties. The parties could not agree on a method of doing so and litigation in the Supreme Court of British Columbia followed. That litigation was settled in 1992 pursuant to a settlement agreement, a copy of which the respondent appended to the reply to the notice of appeal.

[9] By the time of the settlement agreement made "as of" April 30, 1992, the litigation had reached a certain stage, including orders for the filing of sealed bids, an action for partition and an order relating to the shares of Argus Industries Ltd.

[10] The settlement agreement was evidently intended to bring the litigation to an end and to supersede any orders made in the course of that litigation.

[11] The settlement agreement was complex ("unnecessarily complex" according to Mr. Jabs as the result of the acrimony between the parties). It provided for a process for the division of the properties. The properties were to be divided into four packages and Mr. Jabs and Mr. Callahan were to assess the fair market value of the properties. A bidding process was established under which each of the parties could bid on the properties. If the bid was not accepted the other party would purchase the property at that price. Simply put, the settlement agreement was a somewhat unwieldy shotgun arrangement.

[12] Nonetheless, the bidding proceeded between May and October 1992 and at its conclusion it was determined that the 50% interest of the appellant in the 13 properties in issue here would be sold by the appellant to Callahan. It was further determined that they had an aggregate fair market value of $17,745,000, and an ACB of $8,335,751 and were encumbered by mortgages totalling $4,833,709.

[13] Given Mr. and Mrs. Jabs' decision to fund Felsen with a capital endowment of $10,000,000, the solution was obvious: transfer the 13 properties to Felsen at a designated consideration under subsection 110.1(3) equal to their ACB and let Felsen sell them to Callahan and realize, tax free, the capital gain. This, together with the amounts already given to Felsen by Mr. and Mrs. Jabs, would bring Felsen's capital up to the targeted figure of about $10,000,000. The alternative would have been for the appellant to sell the properties to Callahan, realize the capital gain of approximately $9,000,000, pay tax of about $3,100,000 and be left with cash of about $5,900,000 which it could keep or donate to charity, including Felsen, and obtain a deduction within the limits permitted by the Income Tax Act. The mortgages to the bank of $4,833,709 would have to be retired and the appellant would also be liable for tax on the recapture of capital cost allowance of about $3,000,000. These consequences were inevitable, irrespective of which alternative was chosen. However what emerges is that from the appellant's point of view the second alternative, whereby the appellant would sell the property rather than Felsen was financially advantageous to the appellant, whereas the first was far more beneficial to Felsen.

[14] In the result, the appellant on October 31, 1992 executed a deed of gift of each of the 13 properties in favour of Felsen and designated under subsection 110.1(3) the proceeds of disposition to be the ACB of each property[1].

[15] Paragraph 1 of the deed of gift reads as follows:

1. Subject to paragraph 2 hereof, the Company hereby assigns and transfers by way of gift to the Foundation all of its right, title and interest in and to the Land for the Foundation's sole use and benefit absolutely and effective the day and date first above written, subject to the Foundation subsequently issuing a Receipt containing prescribed information as well as the Designated Amount and subject to the Minister of National Revenue accepting the Receipt as evidence of a charitable gift as described in paragraph 110.1(1)(a) of the Act made on the date set out in the Receipt and accepting the Designated Amount as being the Company's deemed proceeds of disposition of the Land pursuant to Subsection 110.1(3).

[16] On the same day, the appellant executed a Declaration of Nominee Status whereby it declared and acknowledged that it held the legal and registered title to the property as bare trustee and nominee for the benefit of Felsen.

[17] As noted above, this transfer gave rise to recapture of capital cost allowance in the appellant's hands.

[18] The following is a list of the steps contemplated and in fact followed on October 29, 30 and 31, 1992 in accordance with the advice of Mr. Nicholas P. Smith of Douglas, Symes & Brissenden, solicitors (this summary is taken from paragraph 15 of the appellant's written submissions):

15. In order to carry out its objective, Jabs Construction did the following in conjunction with the Felsen Foundation:

(a) The Felsen Foundation would borrow $3 million from the Bank of Montreal secured by the personal guarantee of Mr. Jabs;

(b) The Felsen Foundation would then loan the $3 million plus an additional sum [$293,000] to Jabs Construction. This loan would be secured by equitable mortgages^[[2]^] over each of the 13 properties. The mortgages carried an interest rate of 10% per annum;

(c) Jabs Construction would then gift its 50% interest in each of the 13 properties to the Felsen Foundation by signing and delivering 13 Deeds of Gift transferring the ownership of each of the 13 properties to the Felsen Foundation. The Felsen Foundation [an obvious error: it should read Jabs Construction] would sign a Declaration of Nominee Status in which Jabs Construction would agree to hold the 50% interest in the 13 properties in trust, as a bare trustee for the Felsen Foundation;

(d) The value designated for the 13 properties for income tax purposes would be the adjusted cost base of those properties or $8,335,751.00;

(e) The Felsen Foundation would then have two interests in each of the 13 properties: the 50% interest and the equitable mortgage. By operation of the doctrine of merger, the two interests would merge in the hands of the Felsen Foundation. The mortgages given by Jabs Construction would then be discharged and the debt would be extinguished;^[[3]^]

(f) In order to complete the obligations under the Settlement Agreement, Jabs Construction would then sell, as bare trustee for Felsen Foundation, the 13 properties to Callahan Construction for the amount agreed upon through the bidding process, being $17,745,000.00 less the Bank mortgages on the 13 properties of $4,833,709.00;

All of the above steps took place on October 29, 30 and 31, 1992.

(g) Jabs Construction would receive the purchase funds from Callahan Construction as bare trustee for the Felsen Foundation (which it did on January 15, 1993) and, pursuant to the terms of the Declaration of Nominee Status, would be required to hold these funds for the account of Felsen Foundation;

(h) On November 15, 1992 Jabs Construction loaned to the Felsen Foundation an amount of $3 million, enabling the Felsen Foundation to repay its loan with the Bank of Montreal. Out of the proceeds of disposition received by the Felsen Foundation from the sale of Jabs Construction's interest in the 13 properties to Callahan Construction, the Felsen Foundation repaid the $3 million loan to Jabs Construction. This repayment, in turn, provided Jabs Construction with the necessary funds to pay its tax liability for recapture.

[19] These steps are substantially in accordance with the letter of October 30, 1992 from Mr. Nicholas P. Smith to the appellant's accountants, Doane Raymond Pannell. That letter reads, in part, as follows (Exhibit R-81):

The transactions should occur in the following order and on the following dates:

1. The Foundation must borrow $3 million from the bank and $350,000 from Eric Jabs personally by October 29, 1992. We confirm your advice that Bank of Montreal (the "Bank") has already advanced the $3 million to the Foundation and Eric advanced the $350,000 to the Foundation on October 29, 1992.

2. The Foundation must then advance the $3,350,000 to Construction on October 29, 1992 and Construction must date the Promissory Notes October 29, 1992. On the same date, the mortgages securing the debt owing by Construction to the Foundation should be dated. We confirm your advice that the Foundation advanced the $3,350,000 to Construction on October 29, 1992.

3. The Construction director's resolution authorizing the gift of the Properties to the Foundation should be dated the following day, October 30, 1992.

4. The Deeds of Gift whereunder Construction will gift the Properties to the Foundation and the Declarations of Nominee Status should be dated the next day, October 31, 1992. At that point in time, the mortgages in favour of the Foundation will merge with the Foundation's interest in the Properties so that the debt of $3,350,000 owing by Construction to the Foundation will disappear. The Foundation will still owe the Bank $3 million and Eric $350,000. Construction will be left with $3,350,000 cash and no offsetting obligation. In fact, Construction may consider lending the Foundation the $3 million to repay the Bank, so that the Foundation would owe Construction $3 million and interest accruing to the Bank would cease.

5. The Foundation should sign the Irrevocable Direction on, say, November 5, 1992 instructing Construction to complete the transfer of the properties to Callahan Construction on November 10, 1992 (if that is indeed the closing date).

6. On November 10, 1992, the Foundation will sell the Properties to Callahan Construction and part of the proceeds will be used to retire the first mortgages over the Properties. The Foundation will end up with cash in the amount of the purchase price paid by Callahan Construction less the amounts required to pay out the first mortgages.

7. Prior to November 10, 1992, the Foundation may wish to retire the Bank debt to avoid having to pay ongoing interest. This may be accomplished by having Construction lend funds to the Foundation prior to November 10 out of the moneys previously lent to Construction by the Foundation. Alternatively, Eric might consider reducing his shareholder loan balance with Construction and lending this money to the Foundation so that it could in part repay the Bank. We understand Eric's shareholder loan balance is not large enough to sufficiently fund the Foundation so as to retire the entire $3 million debt with the Bank. We also understand that any properties which might be purchased from Callahan Construction will be purchased by Construction, so Construction may require liquidity and may not be in a position to pay out Eric's shareholder loan or lend the Foundation the money.

The Foundation may, on the other hand, be prepared to pay interest on the Bank debt accruing until November 10 and then retire this debt with the proceeds received from Callahan Construction (after the first mortgages have been paid out). However, if the closing is delayed until after November 10, the Foundation will continue to incur interest charges on the Bank debt.

[20] When the sale to Callahan was completed Felsen loaned the proceeds to the appellant at a rate of interest higher than it could have obtained by depositing the money in the bank. The evidence discloses — indeed it is not disputed — that the funds were used in the appellant's business. The appellant paid or accrued interest to Felsen in the following amounts in the taxation year 1993, 1994 and 1995:

1993 $48,155

1994 $663,893

1995 $771,599

[21] One of the issues in these appeals is the deductibility of these amounts.

[22] The result of the gift to Felsen was that it was able to disburse much larger amounts of its funds for the purposes of carrying on the wide range of charitable activities throughout the world.

[23] The Minister assessed in the manner set out at the beginning of these reasons, on the basis that the transfer to Felsen was ineffective, the capital gain on the sale to Callahan belonged to the appellant, the interest paid to Felsen was not deductible and in any event section 245 applied. The Minister sees the whole series of transactions as an elaborate and sinister form of tax avoidance. For the reasons that follow, I see it as no such thing. It is in my view a sensible and carefully conceived plan carried out within the specific provisions of the Act designed to achieve the overall charitable objectives of Mr. and Mrs. Jabs.

Was the transfer to Felsen legally effective?

[24] It is not suggested that any of the discrete steps were shams. They created genuine legal relationships. The deeds of gift and the declarations of nominee status were effective to convey the beneficial interest in the properties to Felsen.

[25] The Minister contends that the settlement agreement, as well as the subsequent negotiations which identified the 13 properties that would be sold to Callahan, resulted in Callahan obtaining the beneficial ownership of the 13 properties so that the appellant had nothing to give to Felsen on October 31, 1992. I do not accept this proposition. The appellant retained beneficial ownership in the property until it gave it to Felsen. It would have retained beneficial ownership up to the date of sale to Callahan had it not disposed of it to Felsen. A vendor under an agreement of sale retains full ownership of the property until the conveyance of legal title, subject only to the obligation to ensure that on closing the purchaser obtain title. Had the vendor put itself in a position of being unable to do so, the vendor would be liable in damages. Whether a purchaser has an equitable interest in the property amounting to beneficial ownership depends upon the contract being specifically enforceable. The law, as set out in Semelhago v. Paramadevan, (1996) 136 D.L.R. (4th) 1 (S.C.C.) at pages 10 and 11, is that specific performance will not lie if an alternative remedy [e.g. damages] is available. Certainly there was nothing unique about a group of commercial properties such as were involved here: Arbutus Garden Homes Ltd. v. Arbutus Gardens Apartments Corp., (1996) 20 B.C.L.R. (3d) 292.

[26] In that case, Parrett J. said at pages 326 and 327:

The final submission directed solely at the claim for specific performance is that damages are in this case an adequate remedy and that, as a result, specific performance should not be ordered.

The equitable remedy of specific performance is one which in historical terms was based on a concept which recognized land as having a unique value. In recent times the law has moved to a more modern recognition of the fact that where the land in question is being purchased solely for investment purposes, the "unique quality" envisioned by the law is absent and damages are an adequate remedy. McNabb v. Smith (1981), 30 B.C.L.R. 37 at 41, affirmed (1982), 44 B.C.L.R. 295 (C.A.); Zalaudek v. De Boer (1981), 33 B.C.L.R. 57 at 65 (S.C.); and Chaulk v. Fairview Construction Ltd. (1977), 3 R.P.R. 116 at 122 (Nfld. C.A.).

Specific performance is a discretionary remedy and the modern trend appears to be based on the exercise of that discretion to achieve justice and equity in the circumstances of the particular case viewed from a more modern and flexible view of the "unique" nature of land.

In the present case the position advanced by the plaintiff is traditional in the sense that they submit that the Arbutus Gardens property is unique and "one of the most desirable and well located complexes in the City of Vancouver."

While this may be true the submission ignores the reality of the situation and the position of the plaintiff in the present litigation. The plaintiff intended to pre-sell units in the property by the time it was required to close. Their intention, clearly found in Mr. Skalbania's affidavit material, was to have it completely sold by the time they were to take title. This property was never unique to them except in the context of an investment opportunity. Not only are damages capable of calculation in this case they have already purported to present that calculation.

This is precisely the type of case which lies at the root of the more recent trend in these types of cases. In this case it is clear, in all of the circumstances that damages are an entirely adequate remedy.

[27] It is incorrect to suggest that, as the result of the complex procedures under the settlement agreement, resulting in 13 properties being identified as those that would be sold to Callahan, this without more made Callahan the beneficial or equitable owner of those properties or constituted a legal impediment to their being given to Felsen.

[28] The respondent relies upon The Queen v. Paxton, 97 DTC 5012 (F.C.A.), where it was held that a pre-existing sale of shares to a purchaser prevented a "sale" to the taxpayer's children. That is not the situation here. All we have is a settlement agreement in which the parties agreed to negotiate a manner of dividing up a number of properties comprising a large group held jointly, followed by an identification of which properties would be sold to whom. It is in my view quite erroneous to suggest that on October 31, 1992 Callahan had acquired any beneficial interest in the appellant's one-half interest in the properties that Callahan ultimately acquired from Felsen. Until the properties that were to be sold to Callahan were identified, it could not be determined which ones should be given to Felsen.

[29] By October 31, 1992, the parties had not even reached the point of having an agreement of purchase and sale. They had substantially reached the end of a complicated and acrimonious negotiation under the settlement agreement and had identified the properties to be sold. However, as Mr. Jabs observed, the situation was fluid and until the end Mr. Callahan kept coming up with changes.

[30] The respondent advanced other arguments in support of the contention that there was no legally effective gift. Counsel argues, in paragraph 31 of his written submissions, that the appellant wanted to "transfer only the capital gain from the 13 properties to Felsen Foundation and expected to recover the appellant's costs of these properties".

[31] The use of the expression "to transfer only the capital gain ... to Felsen" is, I think, susceptible of misinterpretation. The term "capital gain" is a tax concept. It is not something that can be transferred. What is transferred is property the disposition of which gives rise to a capital gain. The respondent reads more into the use of a shorthand expression that is descriptive of the intended economic result than is warranted. Where the Act permits the transfer of property at its ACB to another entity and the property is then sold at a gain, in a sense one might say that the capital gain is "transferred" to the transferee, but this is not descriptive of the legal reality.

[32] Counsel then contends that of the net proceeds of $12,911,291 ($17,745,00 – the mortgages of $4,833,709) $3,472,042.08 was received as an amount owing to the appellant by Felsen. This figure appears in an accounting record of the appellant, headed "Jabs Construction Ltd., A/R-Other" [A/R means, I assume, accounts receivable]. The figure is arrived at as follows, according to Exhibit R-67:

Elected amount $8,335,750.68

Less mortgages $4,833,708.60

Donations $30,000.00

$3,472,042.08

[33] The date of the document (Exhibit R-67) is 21-09-93 and it purports to describe the situation as of 31-05-93. I am not prepared to treat these accounting entries as reflecting the true legal relationship between the appellant and Felsen. Accounting entries are supposed to reflect reality, not create it (Ed Sinclair Construction & Supplies Ltd. et al. v. M.N.R., 92 DTC 1163; Gresham Life Society v. Bishop, (1902) 4 T.C. 464 at 476).

[34] The respondent argues that only $9,230,534 was shown as owing by the appellant to Felsen. This figure is found in Exhibit R-70, a document called "Comments on Draft Financial Statements (Draft Copy) January 31, 1993". This document relates not to the appellant but to Felsen and is dated 28-06-93. It shows the gross proceeds from the sale of $17,345,000 (excluding the sale of the Cargo property for $400,000 which took place later) less the mortgages of $4,833,709, for a net $12,511,291. To this is added a donation of $20,000, interest on $3,293,000 and $9,192,636, other income of $200,130 and repayment of cash advances $285,000 and $3,573,000 for a total of $16,637,576. From this is deducted $7,407,042 a figure made up of amounts owing to the appellant, including the $3,000,000 that the appellant loaned Felsen on November 15, 1992. (It could not have been the $3,000,000 that Felsen loaned to the appellant. That had disappeared on the merger.) It also included the $3,472,042 discussed above, being the elected amount less the mortgages and a donation.

[35] It is here that the unreliability of the accounting records comes into sharp focus. The designated amount for the purpose of subsection 110.1(3) of the Act has absolutely nothing to do with the commercial reality of the matter. The appellant gave Felsen property with a fair market value of $17,745,000 less the encumbrances of $4,833,709, for a net value of $12,911,291. That is the commercial value of the gift. The Act permits a corporate donor to designate a lesser figure, between the ACB and the fair market value. Somehow the accountants have mixed up the financial accounting with the deemed proceeds and the deemed fair market value under the Act and this has skewed the accounts. It is no wonder that the accounting entries are incomprehensible, that the accountants have had to admit to errors (Exhibit R-64, paragraph 15) and that the respondent has drawn some interesting but unsupported inferences from the accounts. Moreover, there was according to the respondent some confusion whether the loan of $3,000,000 to the appellant was repaid or extinguished. I do not find the accounting evidence, including the documentary evidence adduced by the respondent, reliable. I am basing my conclusions of fact on the other documents filed and the evidence of Mr. Jabs and Mr. Blake Bromley.

[36] I find that Felsen borrowed $3,000,000 from the bank and loaned it plus an additional $293,000 to the appellant, secured by mortgages and that the appellant gave the 13 properties to Felsen by way of gift, subject to the bank mortgages and to the equitable mortgages and those equitable mortgages disappeared on merger. The appellant loaned $3,000,000 to Felsen on November 15, 1992 with which it retired the bank loan. When the properties were sold by the appellant as nominee and trustee for Felsen, Felsen became the beneficial owner of the proceeds which were used in part to retire the mortgages of $4,833,709, and in part to repay the appellant its loan of $3,000,000. The balance, or a substantial part of it, was loaned to the appellant at the greater of 7% or the prescribed rate set by Revenue Canada.

[37] These are the objective facts that the evidence has established and it is unfortunate that the waters have been muddied by the accounting entries.

[38] The respondent makes two further submissions. First, it is contended that there was no gift but rather a transfer for consideration. The evidence simply does not support this position. The deeds of gift refer to no consideration and I am unable to accept that the extinguishment of the debt of $3,293,000 on the transfer of the properties to Felsen, by reason of the doctrine of merger, constituted consideration within the generally accepted meaning of that term[4]. The extinguishment of the debt was not the price exacted for the gift. It was simply the legal result of the transfer to Felsen of property that was subject to the equitable mortgages.

[39] The second contention is that the gift was subject to a condition that was unfulfilled, by reason of the words in the deed of gift:

...subject to the Foundation subsequently issuing a Receipt containing prescribed information as well as the Designated Amount and subject to the Minister of National Revenue accepting the Receipt as evidence of a charitable gift as described in paragraph 110.1(1)(a) of the Actmade on the date set out in the Receipt and accepting the Designated Amount as being the Company's deemed proceeds of disposition of the Land pursuant to Subsection 110.1(3).

[40] I find on the evidence that such receipts were issued. It is true, however, that the Minister has not accepted anything about the transaction — including the making of the gift, the receipts and the designated amounts under subsection 110.1(3). Without dealing at length with the somewhat elusive meaning of the words "subject to" — it has different effects depending on the context — the short answer is that if I allow this appeal the Minister has no alternative but to accept the validity of the charitable gift and the designation under subsection 110.1(3).

[41] Therefore there was a valid gift to Felsen of the appellant's ownership of the 13 properties.

GAAR

[42] As has been stated before[5], the general anti-avoidance rule (GAAR) contained in section 245 is a measure of last resort, to be applied if all else fails. It may only be applied if a tax avoidance scheme otherwise works. It need not be applied if the scheme is otherwise defective.

[43] Section 245 reads:

(1) In this section,

"tax benefit" — "tax benefit" means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in a refund of tax or other amount under this Act;

"tax consequences" — "tax consequences" to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;

"transaction" — "transaction" includes an arrangement or event.

(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.

(3) An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

(4) For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

(5) Without restricting the generality of subsection (2),

(a) any deduction in computing income, taxable income, taxable income earned in Canada or tax payable or any part thereof may be allowed or disallowed in whole or in part,

(b) any such deduction, any income, loss or other amount or part thereof may be allocated to any person,

(c) the nature of any payment or other amount may be recharacterized, and

(d) the tax effects that would otherwise result from the application of other provisions of this Act may be ignored,

in determining the tax consequences to a person as is reasonable in the circumstances in order to deny a tax benefit that would, but for this section, result, directly or indirectly, from an avoidance transaction.

(6) Where with respect to a transaction

(a) a notice of assessment, reassessment or additional assessment involving the application of subsection (2) with respect to the transaction has been sent to a person, or

(b) a notice of determination pursuant to subsection 152(1.11) has been sent to a person with respect to the transaction,

any person (other than a person referred to in paragraph (a) or (b)) shall be entitled, within 180 days after the day of mailing of the notice, to request in writing that the Minister make an assessment, reassessment or additional assessment applying subsection (2) or make a determination applying subsection 152(1.11) with respect to that transaction.

(7) Notwithstanding any other provision of this Act, the tax consequences to any person, following the application of this section, shall only be determined through a notice of assessment, reassessment, additional assessment or determination pursuant to subsection 152(1.11) involving the application of this section.

(8) On receipt of a request by a person under subsection (6), the Minister shall, with all due dispatch, consider the request and, notwithstanding subsection 152(4), assess, reassess or make an additional assessment or determination pursuant to subsection 152(1.11) with respect to that person, except that an assessment, reassessment, additional assessment or determination may be made under this subsection only to the extent that it may reasonably be regarded as relating to the transaction referred to in subsection (6).

[44] The reasoning that lay behind the application of section 245 to the appellant's transactions is found in a memorandum dated June 5, 1995 to the Head Office, Tax Avoidance and Legislative Recommendation Division from the Southern Interior B.C. TSO, Tax Avoidance Section.

[45] The concluding paragraphs read as follows:

Issues:

The real property was transferred in such a way that the resulting capital gains were reflected in the income and tax return of a non-taxable entity rather than in the corporation's income and return. The cash from these capital gains, though, was available to the corporation anyway under loan terms that are very imprecise and generous.

Further, the taxable corporation now incurs significant interest expense on the funds to offset its current and future taxable income.

General Anti-Avoidance Consideration

It is evident that this arrangement is a version of a loanback scheme mentioned in Claire Nelson's bulletin dated November 22, 1994 in which she recommended that any such schemes be referred to Avoidance Services for consideration of the General Anti-avoidance Rules.

Tax Benefit and the Avoidance Transaction

The tax benefit derived by this arrangement is the tax savings to Jabs Construction Ltd by not having to report the taxable capital gains on the disposition of its interest in the real property to Callahan Construction Company Ltd. The capital gain would be the same as the loan from Jabs Construction to the Felsen Foundation ($10,004,470). This would translate to tax of approximately $2,885,000.

The "avoidance transaction" would be the series of transactions whereby Jabs Construction transferred the real property to the Felsen Foundation below the properties' fair market value after having agreed with Callahan Construction to transfer the property to that corporation; Jabs then caused the Foundation to sell the property to Callahan Construction and then further caused the Foundation to loan the funds back to Jabs Construction.

Misuse and Abuse of the Act

The Act clearly intends to tax the capital gains on the disposition of a taxpayer's interest in capital properties in the year the disposition occurs (sections 38 and 39 and, of course, subsection 3(b)). The Act also clearly allows deductions from income of a corporation's donations to a registered charity in the year (or five prior years) that the donation is made (reference subparagraph 110.1(1)(a)(i)). The courts have determined that a gift to such charities must be "transferred voluntarily and not as a result of a contractual obligation to transfer it and that no advantage of a material character was received by the transferor by way of return" (reference The Queen v. Burns (88 DTC 6101)).

In this particular situation, the taxpayer generated capital gains on the disposition of the real properties per terms of an agreement between it and a third party. It legally structured the dispositions in such a fashion to avoid these resulting gains. In the real and practical sense, the funds were paid to it, however, these were now called loan proceeds rather than proceeds of disposition. The controlling shareholder of Jabs Construction always controlled the Felsen Foundation. Eric Jabs could determine when and how these loan funds would be repaid. Further, the arrangement created a situation where the corporation would be able to deduct interest expenses on the funds "borrowed" from the Foundation and evidently used in its business; at the same time, the recipient of the interest was tax exempt.

Reasonable Tax Consequences

It is estimated that the scheme saved, or at least deferred approximately $2,885,000 in federal taxes.

Timing Consideration

All transactions occurred well after 1988; the provisions of section 245 could be applied.

[46] Essential to the operation of the section is that there be an avoidance transaction, i.e. a transaction resulting in a "tax benefit", as defined. It is true, the appellant did not, as a result of the gift to Felsen, have to pay tax on the capital gain that it would have realized had it sold the properties itself to Callahan. If this were the tax benefit upon which the respondent relies, every gift at a designated amount less than fair market value to a charity under subsection 110.1(3) would be an avoidance transaction. Such gifts are however precisely what subsection 110.1(3) contemplates. I fail to see how the use of a specific provision of the Act that allows the tax consequences of a charitable gift to be mitigated can by any stretch of the imagination be a misuse of the provisions of the Act or an abuse within the meaning of subsection 245(4). It is simply a use of a provision of the Act — not a misuse or abuse — for the very purpose for which it was designed.

[47] Does the loaning of the proceeds back to the appellant by Felsen at a favourable interest rate turn what is patently not an avoidance transaction into one? Once again the loaning of money by a private foundation to persons with which the foundation does not deal at arm's length is specifically contemplated by section 189 of the Act which in essence penalizes a non-arm's length borrower from a private foundation to the extent that the interest paid on the debt falls below the prescribed rate. I accept Mr. Jabs' testimony that he believed that loaning the money to the appellant was a prudent investment for Felsen and resulted in a better rate that could have been achieved elsewhere and was less subject to the vagaries of the stock market.

[48] I can discern nothing else in the entire series of transactions that could possibly justify their being avoidance transactions, either separately or collectively. This transaction is the last one that would have occurred to me as subject to attack under section 245. Section 245 is an extreme sanction. It should not be used routinely every time the Minister gets upset just because a taxpayer structures a transaction in a tax effective way, or does not structure it in a manner that maximizes the tax.

[49] The appeals from assessments for the appellant's taxation years 1993, 1994 and 1995 are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons and specifically on the basis that:

(a) the transfer of the 13 properties to Felsen is a valid and effective charitable gift and the appellant's proceeds of disposition are the amounts designated by it;

(b) the sale of the 13 properties to Callahan constituted a sale by Felsen of its beneficial interest in those properties giving rise to a capital gain in the hands of Felsen and not in the hands of the appellant;

(c) the interest paid or accrued by the appellant in the amounts of $48,155, $663,893 and $711,599 in its taxation years 1993, 1994 and 1995 on the loans made to it by Felsen respectively is deductible by the appellant in computing its income pursuant to paragraph 20(1)(c) of the Act;

(d) the series of transactions in issue in these appeals do not constitute avoidance transactions within the meaning of section 245 of the Act.

[50] The appellant is entitled to its costs.

Signed at Ottawa, Canada, this 24th day of June 1999.

"D.G.H. Bowman"

J.T.C.C.

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