Urie, J (concurred in by Le Dain, J and Mackay, DJ):—This is an appeal from a judgment of the Trial Division dismissing the appeal of the appellant from the respondent’s assessment for income tax for its 1965 taxation year. The respondent in that assessment had, for purposes of calculation of capital cost allowance, reduced the capital cost for the acquisition of certain patent rights by the appellant in 1964, as shown on its 1965 income tax return, in the sum of $500,000 to the sum of $244,861, the actual cost of the patent rights to the vendor, on the ground that the transaction between the vendor and the appellant as purchaser, was not at arm’s length. The learned trial judge held that the parties to the transaction were not, within the relevant statutory provisions, dealing at arm’s length and that, in essence, is the sole issue in this appeal.
The history and surrounding circumstances of the transaction in question are somewhat complex and, for a proper understanding of the problem, it will be necessary to refer to them in some detail.
The appellant was incorporated in Ontario in 1933. Prior to June 17, 1964 or thereabouts, Eclipse Consultants Limited (hereinafter called “Eclipse”) was the beneficial owner of all of the outstanding shares of the appellant. Charles N Robson was at all material times the beneficial owner of all of the issued shares of Eclipse.
By trust deed dated June 17, 1964 the Robson Family Trust (hereinafter called the “trust”) was created, the settlor being the mother of Charles N Robson. The trust, some time before October 31, 1964, became the owner of 21,000 of the issued shares of the appellant, which it purchased from Eclipse. Eclipse retained 7,000 shares of the appellant, the remaining 3 issued shares being qualifying shares held by its directors, Charles N Robson, Herbert Schell and Francis Lorenzen (hereinafter called “Lorenzen”). The beneficiaries of the trusts were Ursula Robson, wife of Charles N Robson, and their children.
In 1955 Appel Process Limited (hereinafter called ‘‘Appel Process”) had been incorporated for the purpose of manufacturing and distributing machines or processes used in the production of tubing for various commercial purposes. The world patent rights, of which the US patent rights became the subject matter of the transaction in issue here, were transferred to that company by their inventor, Dr Gerhard Appel. By October of 1964 its shares were owned to the extent of 50% by Appel Consultants Limited, a corporation apparently owned by Dr Appel and his family, and to the extent of the remaining 50% by Eclipse.
Charles N Robson and/or one or more of his companies had, from time to time, advanced approximately $850,000 to Appel Process which borrowing by October 31, 1964 had been reduced to $350,000. In addition, Appel Process had suffered considerable losses, the aggregate sum of which at the relevant time was some $600,000.
In 1963 the appellant had acquired two businesses, ultimately leading to the incorporation of at least two companies, Robson-Lang Leathers Limited and Murray-Selby Shoe Co Limited. The latter successfully operated in the shoe manufacturing business until 1966 or 1967.
Lorenzen was the financial adviser to the group of companies owned or controlled by the appellant as well as to Appel Process and, in particular, to Dr Appel. Because of the lack of success of Appel Process, Dr Appel by 1963 or 1964 had financial difficulties and was unhappy with the lack of progress of Appel Process. At the same time, Robson and his group of companies were not prepared to add to their already large investment in Appel Process, there being little prospect of recovery of moneys already advanced or for recouping losses. Lorenzen was, it appears, at all material times a director of both Appel Process and of the appellant. He conceived the idea of a complicated transaction with a view to satisfying a number of objectives. Firstly, he was desirous of providing Dr Appel with the money he required to escape from Appel Process and to go on to develop and advance other of his inventions. Secondly, to do so, he would arrange for the purchase of the shares of Appel Process which were not already owned by Eclipse as a first step in making it a profitable enterprise. Thirdly, the corporate affairs of Appel Process would be re-arranged to make use of the accumulated tax losses therein by acquiring the business of a profitmaking enterprise in order to bring forward the accumulated losses and apply them against the profits generated by the new business. The company he chose was Murray-Selby Shoe Co Limited so that his plan was to arrange for the sale to Appel Process of the business of that profitable firm. Fourthly, he would dispose of the patent rights owned by Appel Process to provide money to pay off its obligations to the Robson group of companies, so that thereafter it would be basically a manufacturer of shoes.
As a result, on or about October 15, 1964 Lorenzen set the wheels in motion to achieve the desired results. The first step was the purchase by him on October 28, 1964 of the 500 common shares of Appel Process owned by Appel Consultants Limited for the sum of $120,000. He testified that he held 475 of those shares in trust for Garsam Investments Limited, a shell company acquired some time after the sale, whose shareholders were to be and, in fact, came from among the executives of various companies in the Robson group as part of a profit-sharing plan for their benefit. None of those executives participated in the negotiations for purchase of the shares.
On November 1, 1964, with a view to making it a profitable company, Appel Process completed the purchase of the business of Murray-Selby Shoe Co Limited for a consideration comprised generally of the assumption by the purchaser of its liabilities (less liability for tax) and the sum of $200,000. The offer of purchase had been made on or about October 28, 1964.
On October 31, 1964 Appel Process sold its US patent rights to the appellant for the sum of $500,000.
On October 31, 1964 Appel Process leased to Eclipse all of its patent rights, other than the US patent rights which had already been sold to the appellant. The lease was for a term of 10 years in consideration for royalty payments of $20,000 per annum.
The only additional circumstances required for an understanding of the transaction relates first to the Robson Family Trust. As already indicated, Mr Robson’s mother was the settlor and Mr Robson was one of three trustees. Article VII of the trust document reads, to the extent necessary for purposes of this judgment, as follows:
If at any time during the terms of this trust Charles Robson desires the retirement of any one or more of the Trustees for any reason whatsoever, and a substitute therefor of some other person or persons as Trustee, then the said retiring Trustee or Trustees shall forthwith transfer the trust estate to the remaining Trustees, if any, and to the Trustee or Trustees designated by Charles Robson in substitution therefor.
Second, the agreement between Appel Process and the appellant dated October 31, 1964 concerning the sale of the patent rights was signed by Charles N Robson and Francis Lorenzen as secretary on behalf of Appel Process and by Ursula Robson as president and Francis Lorenzen as secretary on behalf of the appellant.
Third, the purchase of the shares of Appel Process by Lorenzen was financed by a loan of $60,000 for the down-payment from Eclipse and the payment for the balance of $60,000 by a loan which was personally guaranteed by Charles N Robson.
Fourth, the executives of the companies in the Robson group who became the shareholders of Garsam Limited paid only $100 each for their respective interests, the organizational expenses having been financed by Robson-Lang Leathers Ltd. Moreover, none were involved in the negotiation for the sale and lease of patent rights by Appel Process to the appellant and to Eclipse.
Fifth, the minutes of the meeting of directors of Appel Process held at 4:30 on the afternoon of October 28, 1964 chaired by Charles N Robson, and at which Lorenzen acted as secretary, approved of the sale by Appel Consultants Limited of its 500 shares of Appel Process to Lorenzen. At 5:15 on the same day another meeting was held with Robson and Lorenzen again acting as chairman and secretary respectively at which the sale of the US patent rights to the appellant and the lease of the other patent rights to Eclipse were approved. The minutes also record that “The Chairman (Robson) reported that he had offered to purchase all the business assets and assume all the liabilities of the Murray-Selby Shoe Co Ltd” as at November 1. It seems clear from those minutes that Robson was still deeply involved in the affairs of Appel Process immediately following the acquisition of 500 of its shares by Lorenzen and, in particular, in carrying out Lorenzen’s plan in respect of the sale and lease of its patent rights to companies in which he had substantial interests.
The respondent based his assessment on the authority of subsection 20(4) of the Income Tax Act, RSC 1952, c 148 and amendments thereto. That section reads as follows:
20. (4) Depreciation.—Where depreciable property did, at any time after the commencement of 1949, belong to a person (hereinafter referred to as the original owner) and has, by one or more transactions between persons not dealing at arm’s length, become vested in a taxpayer, the following rules are, notwithstanding section 17, applicable for the purposes of this section and regulations made under paragraph (a) of subsection (1) of section 11 :
(a) the capital cost of the property to the taxpayer shall be deemed to be the amount that was the capital cost of the property to the original owner;
(b) where the capital cost of the property to the original owner exceeds the actual capital cost of the property to the taxpayer, the excess shall be deemed to have been allowed to the taxpayer in respect of the property under regulations made under paragraph (a) of subsection (1) of section 11 in computing income for taxation years before the acquisition thereof by the taxpayer.
As observed by the learned trial judge, the expression “arm’s length’’ is not precisely defined in the Income Tax Act, but subsection 139(5) does have some bearing on the problem. It reads as follows:
139. (5) Arm's length.—For the purposes of this Act,
(a) related persons shall be deemed not to deal with each other at arm’s length; and
(b) it is a question of fact whether persons not related to each other
were at a particular time dealing with each other at arm’s length.
It will thus be seen that the trial judge correctly observed that “the question here to be determined is, therefore, essentially one of fact, with whatever assistance can be gleaned from the case law or other jurisprudence”. In deciding this question of fact he made the following findings as to how Lorenzen’s plan was carried out [p 876]:
Mr Lorenzen dealt with Dr Appel. He says there was bargaining between the Appel interests and himself, representing all other interests. He did not necessarily go back to Mr Robson with the round-by-round details of these negotiations. He conducted the auction, he says, pretty well on his own. I accept that evidence. I cannot overlook the fact, however, that any money or financing required to carry out this purchase, or any of the other facets of the overall plan, had to come from the Robson group, either directly or by loans obtained or guaranteed in some manner, by the cornerstone of this whole corporate monolith, Robson Leather. Charles Robson and the Robson Family Trust were therefore involved and vitally interested. No matter what price seemed reasonable to Dr Appel or Mr Lorenzen for the Appel family’s interest, the concurrence, in a practical and business sense, of the Robson group was vital. In any event, the 500 shares of Appel (not held by Eclipse) were purchased for an agreed price of $120,000. The terms are set out in Exhibit 2.2, dated October 28, 1964. The shares were purchased in the name of Mr Lorenzen. The evidence is quite clear, setting aside any legal niceties, that 475 shares were ultimately to go to a company in which the senior executives and employees previously referred to would have an interest. Because of the time factor, as October 31 had been selected as the effective date for the implementation of the overall plan, a dormant “paper” company had been obtained from a firm of solicitors. The evidence is clear the practical and commercial reality of the operation of this part of the plan through Garsam did not occur until some time after the October 31 date.
Mr Lorenzen held the remaining 25% [sic] of the shares for himself and his family company. The only reasonable inference to be drawn from the evidence is that that facet of the scheme obviously had to have the express approval of Robson Leather and Mr Robson.
On October 31, the agreement in question (the sale of the American patent rights) was executed. The appellant says that at the “particular time” (paragraph 139(5)(b)) of this transaction, Appel and Robson Leather were dealing with each other at arm’s length. The onus, in this case, is on the appellant to prove this.
The question of the meaning of the expression “at arm’s length” was considered by the Supreme Court of Canada in MNR v Sheldons Engineering Ltd, [1955] CTC 174; 55 DTC 1110. The Court was dealing in that case with the meaning to be attributed to the term arising out of its use in the same section of the Act as here. At page 180 [1113], Locke, J, speaking for the Court, said:
Where corporations are controlled directly or indirectly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm’s length. Apart altogether from the provisions of that section, it could not, in my opinion, be fairly contended that, where depreciable assets were sold by a taxpayer to an entity wholly controlled by him or by a corporation controlled by the taxpayer to another corporation controlled by him, the taxpayer as the controlling shareholder dictating the terms of the bargain, the parties were dealing with each other at arm’s length and that Section 20(2) was inapplicable.
In MNR v T R Merritt Estate, [1969] CTC 207; 69 DTC 5159, Cat- tanach, J in an Exchequer Court judgment usefully enlarged Locke, J’s proposition when he stated at page 217 [5165]:
In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm’s length. In other words where the evidence reveals that the same person was “dictating” the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.
Again at pages 217-18 [5166] Cattanach, J having examined the evidence found facts which resembled closely those found in this case by the learned trial judge. He held:
In my view, it is immaterial that the whole arrangement was the “brain child” of the professional advisers. It would have been of no effect if the deceased had not accepted their advice, made the scheme his own, and given instructions that it be carried out. It is also immaterial whether he ever completely absorbed the details of the plan. He stipulated the result that he required from the scheme and, in effect, he instructed the carrying out of a scheme so devised as to accomplish that result. The situation is therefore that the corporation was created pursuant to those instructions as the instrumentality to carry out the scheme. . . . The only time when any decision was taken was when the instructions for the scheme as a whole were given, and the decision to give such instructions was a unilateral decision by the deceased. From that time on, everything that was done was done to implement those instructions and there was no part of the arrangement that involved bargaining between parties with independent interests.
Both Sheldons case and the Merritt case were referred to by the learned trial judge, as was the judgment of Thurlow, J in Swiss Bank Corporation and others v MNR, [1971] CTC 427; 71 DTC 5235, an excerpt from which judgment further indicates the kind of reasoning involved in determining the question of fact as to whether parties to a transaction are dealing at arm’s length. At page 437 [5241] Thurlow, J said:
To this I would add that where several parties—whether natural persons or corporations or a combination of the two—act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the “mind” that directs may be that of the combination as a whole acting in concert or that of any of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to be made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest from the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqualify the transaction as one between parties dealing at arm’s length. The Sheldon’s Engineering case (supra), as I see it, is an instance of this.
The Swiss Bank decision was affirmed by the Supreme Court ([1972] CTC 614; 72 DTC 6470).
In his argument, counsel for the appellant argued vigorously that the interests represented by Lorenzen on behalf of 50% of the shares of Appel Process were different from those of the other 50% owned by Eclipse and thus the transaction must be held to be at arm’s length. In his Memorandum of Fact and Law he put the matter in this way:
Lorenzen, both as the owner of 25 shares of Appel Process Limited and as trustee for 475 shares had an interest in getting as much for the American patent rights as possible. Robson Leathers’ interest was paying as little as possible. As the Minister does not challenge the adequacy of the price, it must be an arm’s length transaction, unless there is evidence that Lorenzen was subject to the control and direction of the Purchaser at the time of the sale. There is no such evidence.* [1]
With respect, this is not a fair view of the evidence as a whole as the following excerpt from the cross-examination of Lorenzen discloses, commencing at page 94 of the transcript:
Q. Is it fair to say you would not have purchased those shares unless on instructions of Eclipse Consultants Limited or Charles Robson? A. I don’t think that is a correct assumption.
Q. You would have in any event? A. My proposal was that I would purchase them in trust for my own company and for a company to be formed and owned by the officers of Robson Lang Leathers Limited and Murray Selby, so I certainly wasn’t taking any dictation from Mr Robson.
Q. These were employees of the Robson group of companies that were Known as Garsam? A. Yes.
Q. The idea was that this Appel Process Limited would be a profit-sharing plan for Garsam? A. Yes.
Q. Would you form a profit-sharing program using Appel Process Limited for employees of the Robson group if the employer had not instructed you to do so? A. There were no instructions given to me. I was independent.
Q. Did you not, on October 15th, have this idea of all these groups—you went to Charles Robson, presented the idea to him—why would you present the idea to Charles Robson? A. Because I had to get approval from Robson Leather for the purchase of the patents, the approval of Eclipse Consultants for the purchase or the leasing of the patents and I had to get approval from the Robson group for the sale of the Murray Selby assets to Appel Process, and I had to get the financing which would enable me to buy in trust for the officers of these companies and myself, the 50 per cent shares of Appel Process.
Q. You were able to get that approval by going to Charles Robson? A. Yes, but not instructions. That is the only quarrel I have with your question.
Q. The only point being, if you had not got the approval which included the financing, you would have not bought the shares? A. I might have tried to find the money elsewhere. I don’t know.
Q. Do you really believe you might have? A. There was no need for me to look. I found it there. That was part of my recommendation.
Q. Do you mean to say you might have taken—HIS LORDSHIP: Suppose Mr Robson had said “To hell with all of these schemes’’, would you have still gone ahead? THE WITNESS: No, it would have been impossible, my lord.
MR. THOMAS: I think that answers the question. THE WITNESS: We had to have the consent of both parties.
It is abundantly clear from the above excerpt that no part of the scheme could have been proceeded with without the prior approval of Charles N Robson and that approval was in fact given. To attempt to distinguish the situation from that prevailing in the Merritt case because Lorenzen said he received no “instructions” from Robson but only had to obtain his “approval” to the scheme is to my mind a futile exercise in semantics. There were, therefore, viewing the transaction as a whole, no “separate interests” as between Charles N Robson and Lorenzen. Nothing could have been proceeded with until Robson gave his approval to the whole scheme.
This view is reinforced by the evidence that all the financing required for the purchase of Appel Process shares was provided by Robson or his group of companies either by the actual loan of money or the guarantee of other loans; by the fact that Lorenzen was indemnified against any personal loss on the transaction of purchase from Appel Consultants (Evidence, p 111); and by the fact that other than the $100 advanced by each of the shareholders of Garsam Limited personally, all organization expenses of that company were absorbed by Robson-Lang Leathers Limited (Evidence, p 113).
Now, was there any separation of interests as between Robson and Dr Appel? Eclipse, all the shares of which were beneficially owned by Charles Robson, owned 50% of the issued shares of Appel Process, the other 50% being owned by Appel Consultants Limited. While the exact shareholdings in the latter company is not completely clear from the evidence, it does disclose Dr Appel was a shareholder and, apparently, a director and that Lorenzen was the accountant, financial adviser, director and secretary of both Appel Process and Appel Consultants Limited prior to October 31, 1964. It also discloses that Appel Process was indebted to the Robson group of companies to the extent of approximately $350,000, that Dr Appel and his family were without income, that Robson had refused to advance any further moneys to Appel Process and that Lorenzen had advised Appel and Appel Consultants Limited that if they were willing to sell their shares in Appel Process he might be able to find a buyer. In all these circumstances, and particularly due to the large debt owing to Robson with little or no prospect of Appel Process ever being in a position to repay it, it does not require a very fertile imagination to see that Robson, to use a colloquialism, was in the driver’s seat when his representative, Lorenzen, who was also Appel’s representative was given the approval to bargain for the purchase of the Appel Process shares.
Therefore, while Robson did not have voting control, the financial plight of Dr Appel and his company was such that Robson, who from a practical point of view could be perhaps the only possible purchaser, was in a position to exert the kind of pressure that enabled him to have his will prevail in the business of Appel Process. When the tranaction of purchase was completed on October 28, 1964, the interests of Lorenzen being, as already found, inseparable from that of Robson, Robson effectively controlled by one means or another the decision-making of both the vendor and purchaser, with the result that the sale of the patent rights to Robson Leather for $500,000 on October 31, 1964 was not a transaction between parties dealing at arm’s length.
To put the position in the language of the relevant jurisprudence as cited earlier, the directing mind at the material time, which I take it to be October 31, 1964 when the US patent rights were sold, was Charles N Robson. He was in the position of having de facto control of both sides of the transaction, which thus was one not made at arm’s length.
Was this conclusion affected by the fact that Robson Leather was not at October 31, 1964 de jure controlled by Eclipse Consultants Limited, Robson’s wholly-owned company which held at that date only a 25% interest in Robson Leather, the other 75% being held by the Robson Family Trust?
The appellant’s submission in this regard is that even assuming that Mr Robson was the directing mind in a series of transactions made through Lorenzen, “the mind that directed the bargaining. on behalf of Robson Leather was not that of Mr Robson, or a mind acting on his dictates” (see reasons for judgment, page 877). Since there was no majority voting clause in the trust agreement there had to be a unanimous vote of the trustees in the exercise of their powers including decisions which they had to make in voting the trust shares in the business of the appellant. It was argued that it could not be assumed that the trustees would not carry out their duties as trustees in accordance with the legal obligations imposed on trustees to formulate their own judgments in matters affecting the trusts, but rather would follow Robson’s instructions merely because he had the power to cause the retirement of either or both of the other two trustees if they did not do so.
The learned trial judge refused to accept this submission for the reasons set out hereafter [p 877]:
In my opinion, however, in deciding the larger issue before me, I must look at the practical and business reality of the operation of the trust. By demanding retirement of trustees, or even the threat of such a demand, or the knowledge in the co-trustees that the ultimate power was always in Mr Robson, I have no doubt that Mr Robson, for practical and legal purposes, controlled the trust and, therefore, controlled Robson Leather. I add the caveat here, that share control alone (or absence of it) is not necessarily conclusive; it is a factor to be considered in determining questions of “arm’s length”.
With this conclusion I agree and I think that it is supported by the fact that it is well settled that, in the execution of their powers, whether absolute or discretionary, executors must be unanimous in their decision unless the trust document by its terms permits the exercise of their powers to be by something less than unanimous vote (see Re Haasz, [1959] OWN 395 at 397). It would be naive, I suggest, to suppose that, having approved Lorenzen’s whole plan, dependent as it was, at least in part, on the appellant acquiring the US patent rights, Robson, in his capacity as one of the trustees of the Family Trust, which had voting control of the appellant, would oppose any part of the plan which he had already approved in his personal capacity, and which plan included that acquisition. In the unlikely event that in his capacity as trustee he did oppose the acquisition or if one of the other trustees did so, the result would be that the trustees would not be in a position to vote their shares in the appellant on the question of the acquisition at all. Since Eclipse was controlled by Robson, its vote would obviously be cast for approval of the transaction. Thus, while Robson did not have de jure control of the appellant, he did have de facto control.
In so far as the position of Garsam Limited is concerned, it could only influence the result if actual voting control of Appel Process is of vital importance. As observed by the trial judge, voting control can only affect the result to the extent that it is one of the circumstances surrounding the transaction to be weighed in the determination of whether the purchase was, or was not, at arm’s length. In my view, it does not affect the result in this case because of all of the other circumstances to which I have already referred which indicated that its interposition was of little importance in that determination in this case.
It is relevant to observe that Garsam’s shareholders did not participate in any way in the negotiation for the purchase of the 475 shares of Appel Process, nor were they involved in any way in the decisionmaking with respect to the sale by Appel Process of its US patent rights to the appellant, other than formally approving it at a shareholders’ meeting. They were at the time of that sale, it is clear from the evidence, mere pawns of Lorenzen and Robson in the whole scheme. Their sole and understandable interest was in ultimately benefiting from the profitability of Appel Process and the fact that they could obtain this benefit at little cost or risk to themselves.
Until Garsam Limited acquired the shares, the company had no assets nor any prospects of generating profits to the ultimate benefit of its shareholders. Since the acquisition of the shares was wholly dependent upon Lorenzen, who was the alter ego of Robson, its intervention in the transaction could not and did not change its character. It was simply part of the overall plan approved by Robson which, because of its character, deprived the sale of patents of its arm’s length character. The relationship between Garsam, Robson and Lorenzen after the acquisition of the patents might conceivably be at arm’s length for any subsequent transactions but that is, in my view, irrelevant in the determination of whether or not the patents were purchased in an arm’s length deal.
On the whole of the evidence, therefore, the practical answer to the question as to whether or not the directing mind in the impugned transaction was the same person for both the vendor and purchaser is that it was. That person was Charles Robson by virtue of his de facto control of the trust, the various corporations to which I! have referred and of Lorenzen. For this reason I agree with the learned trial judge that the transaction of sale of the US patent rights owned by Appel Process to the appellant was not at arm’s length and the assessment of the respondent was properly made.
Accordingly, I would dismiss the appeal with costs.
Italics mine.