The Chairman (orally):—This is an appeal by W Vézina & fils Ltée against the reassessment of the Minister of National Revenue for the taxation year 1965 in which a sum paid into a pension plan, pursuant to section 76, for past services, was disallowed. I may say at the outset that there might be some pauses of unseemly length during the course of this judgment, but because of the 28 or 29 exhibits, all of which were in French, it has given me a little extra work to assemble my thoughts and to assure myself that I have taken the correct meaning from the exhibits placed before me.
I think first that I should say that this is what has commonly become known as a section 76 case and has come about as a result of the Supreme Court of Canada decision in MNR v Inland Industries Limited, the exact citation for which I do not have at the moment but which can be included in the judgment later.* [1]
A brief history of what led up to this situation I think is in order in this case because we all have tended to simply refer to section 76 cases without giving any thought to the background that led up to the possibility of businesses entering into the type of pension plan that was contemplated by that section.
I think that it is well known that amounts expended by an employee or a taxpayer with a view to providing an income for future years of reduced employment, or of retirement, are not expended with a view to earning the present income but are expended more with a view to averaging income over the years of the taxpayer’s life. This type of payment would not ordinarily be deductible in common law as being a proper deduction in computing the taxpayer’s net income or, to use the language of the courts, is not part of the cost of earning the income for the year. The fact that a superannuation or pension fund may be set up at the insistence of the employer to make contributions by employees compulsory does not alter this situation, and such payments will be equally disallowable as being personal expenditures of the taxpayer employee. However, Parliament, in its wisdom and through the vehicle of the Income Tax Act, conferred on employees a limited right to deduct contributions to pension plans. Correspondingly, the Act taxes payments out of such pension plans. Moreover, the Act encourages the formation of funds by employers by permitting them to deduct amounts paid into a registered pension fund or plan in computing their incomes for each taxation year. It further enables employers, in order to establish the fund or plan, to make provision for past services of employees, and this permits the deduction of what might otherwise have been regarded as a capital outlay.
I think that there is no doubt whatsoever that the provisions that were brought into the /ncome Tax Act by virtue of section 76 were the result of a desire to help small businesses, primarily family businesses, which would not otherwise have had an opportunity to accumulate funds for their owners’ later and less productive years, and thus provide small businessmen with an income sufficient to sustain their needs above the bare minimum level. Sucn provisions, of course, for executives in large international corporations, have always been taken into account in arriving at contractual arrangements between unions and companies, and although the Act, which must be universally applied to all taxpayers, also grants these benefits to other than small or family groups, nevertheless, in my mind, section 76 was originally conceived for their benefit. Therefore, a few years ago there was a great rush by companies, both large and small, to set up pension plans.
Section 76 of the Act provided a specific set of circumstances that had to be completed in order that the plan would be registered, and until the plan was registered and accepted by the Department of National Revenue, ie, the Minister, a company could not take advantage of these benefits, and so literally hundreds, perhaps thousands, of these plans were approved and a certificate issued by the Department of National Revenue indicating, as in the case before me today, that the plan was accepted and all compliances with the Act had been fufilled. Nothing more transpired, really, until the famous Inland Industries case cited above. The Inland Industries case did no more than confirm what has been accepted for years as the law in income tax cases, that is, that the Minister’s subordinates cannot bind him by their actions. The judgment of Mr Justice Pigeon succinctly put it that, regardless of what certificates were issued, if they were not in accordance with the provisions of the Act, in law they were worthless, and each pension scheme must therefore be scrutinized to see whether or not it fulfils the intention of the Act.
I am readily willing to admit to a high degree of plagiarism from the judgment of Mr Justice Walsh in Produits LDG Products Inc v MNR, [1973] CTC 273 ; 73 DTC 5222, the most recent case on this topic, which was received by this Board on May 22, 1973 and in which judgment was delivered on May 4, 1973, the case having been heard in this city (Montreal) in February of this year. Mr Justice Walsh has had a longer opportunity to scan the cases, most of which are the cases cited to me yesterday, and I therefore have taken the liberty of referring to a great many passages in his judgment.
On page 283 [5229], he quotes from page 32 [6017] of the judgment in Inland Industries (supra), which was the judgment of the Supreme Court of Canada by Mr Justice Pigeon:
. . . The existence of such an obligation is a statutory condition of the right to the deduction and in its absence, there is no right to deduct a special payment. It cannot be said that because the intention of making, at some future time, payments in the amount now claimed was disclosed to the department in the application for registration of the plan, an obligation to make the payments was created. On the contrary, the terms of the plan were perfectly clear to the effect that no obligation towards Mr Parker would arise in respect of those sums unless and until the company chose to, and actually did, make the contemplated payments into the fund.
He is simply saying there, or I am paraphrasing what he is saying, that all of these cases depend on their facts, subject to the general principle of law laid down by the highest court in the land that there must be a legal obligation on the employer to the fund and the fund to the employee.
As a result, many cases again have been heard to determine further the implications of the Inland Industries decision, and the judgment of Mr Justice Walsh in the LDG Products case (to which I have referred and will refer), the Cam Gard Supply Ltd v MNR decision of Mr Justice Cattanach ([1973] CTC 111; 73 DTC 5133), and the decision in Mittler Bros of Quebec Ltd v MNR, [1973] CTC 182; 73 DTC 5158 (a decision of the Associate Chief Justice of the Federal Court of Canada) merely confirm, and in my view correctly so, that one cannot make a blanket statement affecting pension plan cases but must deal with each on its merits, I say this as a perhaps rather lengthy introduction to the judgment in this case, but I do so out of abundant caution lest we perhaps tend to lose sight of the purpose of the legislation, and the purpose of the legislation was unquestionably to give an advantage to those people who could qualify strictly within the confines of the Act.
The facts of this case are rather simple. There were four, or perhaps five, Vézina brothers who operated a plumbing business in the City of Montreal. Aimé Vézina was called as the representative of the company, and gave evidence that he had worked for his father in the business since he was 14 or 15 years of age, that the business had started out as an unincorporated company operated by his father, and that in, I think it was 1951, the company was incorporated. Apparently the father is now deceased—at least he appears no longer in the picture—but there is some evidence of the mother, although having no official status under corporate law, being still present at board meetings. The business is primarily that of the brothers. They have not worked for exorbitant salaries over the years but have put whatever meagre earnings there were back into the company. In 1960 the witness Vézina suffered a heart attack, which gave him the initiative to consider the prospects for the future—presumably those of himself and his family and the business. The brothers discussed the possibility at that time of insurance—term partnership insurance—or what I think is more properly understood as insurance that is implemented in a buy-sell agreement. When one member of a closely knit corporation dies, the funds from the insurance policy are used to buy the shares of the estate of the deceased. However, the profits of the company were not sufficiently great to make any serious strides towards that security possible until the year 1965.
In the year 1965, the company had made a substantial profit. It had jumped from profits of some two, three or four thousand dollars until, I think by the month of October, almost a hundred thousand dollars was apparent by way of profit. Again the thought of security came to Mr Vézina and he discussed it with his advisers—with, I believe, a member of the Metropolitan Life Insurance Company and of the Royal Trust Company, and eventually, in any event, it was pointed out that the company could now take advantage of the Income Tax Act and set up a pension plan which could include, and which eventually did include, an insurance factor in its terms. Several meetings were held of the informal nature that one would expect from such a small family company, but the evidence is uncontradicted that by December 17, 1965, or give or take a day from that date, the decision had been made to take the step, and by December 29 the funds had been paid into the pension plan, which I will identify as such throughout as distinguished from the company, in the amount of $93,100. Immediately, the company sold to the pension plan, or the pension plan purchased from the company, non-cumulative 5% preference shares to the extent of $91,000.
It is the contention of the Minister that this was a sham, that there were no funds available in the bank of the appellant company to honour the cheque to the pension plan, and this is true. There weren’t sufficient funds in the bank to so honour it. Respondent’s Exhibit 2 is a photocopy of the two cheques, the first one to the pension fund dated December 29, 1965 and the return cheque for the preferred shares dated December 30, 1965, both negotiated at the bank, according to the stamp on the face of them, on December 30, 1965. So I think that I must deal first with this aspect of the case, because, if it is a sham at this point, there is no need for me to consider the possibility, or existence, of a legal obligation as referred to in the Inland Industries case.
The thrust of the Department lying behind the term “sham”, whether or not they used it, is the provision of subsection 137(1) of the Income Tax Act which, notwithstanding all other sections, prohibits a taxpayer from artificially reducing his income. In other words, the sole purpose, in the eyes of the Minister, in this branch of his argument, is that the appellant was motivated solely by the potential benefits that it would reap by virtue of the reduction of its tax payments by a considerable sum of money, probably half of the $91,000, in the year 1965. This is something that must be considered, and has been considered, and that has been referred to again in the judgment of Mr Justice Walsh in the LDG Products Inc case, where he quotes from pages 267-8 [5174] of his judgment in Concorde Automobiles Ltée v MNR, [1971] CTC 246; 71 DTC 5161, as follows:
. I. . 1 therefore believe it is necessary in any given case to attempt to determine from the facts of that case whether the company was merely incidentally gaining a tax advantage as a result of setting up a bona fide pension plan, or whether it would not have considered setting up this pension plan but for the tax advantage to be gained as a result thereof, and in the latter event, Section 137(1) would be applied.
That there was bound to be a tax advantage in any of these section 76 cases is obvious from my opening remarks, because the very funds that were to be paid for past services, as in this case, would, without the existence of section 76, not have been a deductible expense. So, in every pension plan, no matter how pure, there is an element of tax avoidance present. The very salient questions raised in the Concorde case are: was the decision based on a desire to protect the individuals in the future? or was it made solely for the purpose of avoiding tax? The second part of this argument of the Minister is that it could only have been for the purpose of avoiding tax that they made this transaction of exchanging cheques, which was a worthless transaction, in his assertion, because they did not have the funds to meet it. Reliance is placed on the decision in MNR v Cox Estate, [1971] CTC 227; 71 DTC 5150, a judgment of Mr Justice Judson. What Mr Justice Judson said in that case was that there were no funds, the cheques would not have been honoured had they been presented to the bank, and so the whole affair was one single transaction between the parties, and this is set out again in the decision of Mr Justice Walsh in the LDG Products case at page 281 [5228] where he says:
. . . Respondent pointed out that when the company issued its cheques for the pension plan payments it did not have sufficient money in the bank to cover them and relied on the Supreme Court case of MNR v Cox Estate, [1971] CTC 227; 71 DTC 5150, as authority that the exchanges of cheques tween the company and the pension fund did not really constitute a payment by either. ! would doubt whether it would be applicable to the present situation, however, as in rendering judgment Judson, J said at page 229 [5151]:
“The simultaneous exchange of cheques, where neither would be honoured due to insufficient funds were it not for the offsetting entry of the other cheque, can only be viewed as a single transaction.”
I view it as a single transaction in that case, and I agree with that comment.
I also agree with Mr Justice Walsh when he says “I would doubt whether it would be applicable to the present situation”, and I refer now to the evidence of Mr René Tremblay, who is the manager of the Banque Provinciale du Canada, 1909 Laurier East, and who, although he was not connected with the appellant company in 1965, did have access to the company records and, by a letter dated February 16, 1973, which was obviously prepared for this hearing (appellant’s Exhibit 19), he pointed out that, in May of 1966, credit to the appellant company was in the order of seventy thousand dollars. He feels, on the evidence of the accounts receivable, that in the year 1965, the appellant company would have encountered no difficulty whatsoever in obtaining a credit rating of $90,000. I think he said the general rule is that the bank looks at the accounts receivable, with the usual allowance for doubtful accounts, and will go as high as 40 or 50%. In the letter written in 1973, he said that the accounts receivable in 1971 were almost a million dollars, the capital surplus was over two hundred thousand dollars, and the credit rating of this company was half a million dollars. So, in comparing the appellant company with others, considering its management and its activities, he, as an experienced bank manager, would have the belief that in 1965 the company could easily have obtained a credit of $90,000 with his bank. This, of course, would have required the personal guarantees of each of the individual shareholders, but that does not make the appellant any different from any other corporation controlled by a small group of individuals, particularly a family group.
I should point out at this time that the only evidence called in this case was Called on behalf of the appellant and that the witnesses were all in some way connected with the appellant. Mr Genest, the actuary, could, I suppose, to some extent be said to have an interest, in that he was necessarily justfying his granting of an actuarial certificate in 1968 and 1971, and Mr Tremblay could hardly be declared independent in all senses of the word, because he was giving evidence on behalf of a company that has become a very good customer. Nevertheless, I have observed these witnesses in the box. They are both relatively young men, men whose veracity I have no hestitation whatsoever in accepting, who were subjected to very extensive and learned cross- examination by counsel on behalf of the Minister. I therefore accept their evidence and find as a fact that in 1965, had the appellant company applied to its bankers for a loan, it would have received one in the amount required.
We must not overlook the fact that, after the decision was made, Vézina was not sure that the company could deal In its own preference shares, and it was only after the event that this became known. It subsequently turned out that the Quebec Supplementary Pension Board, by amendments to its requirements, prohibited the holding of the preference shares of the company in the pension plan and allowed the appellant five years in which to dispose of—or perhaps redeem is the better word—its preference shares, which the company did in the year, or in or about the year, 1970. (I believe July 1970 was the date given in evidence.)
So, I am satisfied, on the evidence of Mr Vézina, that the sole interest in the company and in its controlling shareholders and officers and directors in December of 1965 was to create a pension fund that would provide for them the security that they needed and wanted in later life. True, there was a tax advantage, but I am satisfied that the tax advantage was incidentally gained by virtue of their action and was not the overriding consideration in the setting up of this plan. Secondly, I am satisfied that they used the vehicle of the preference shares to the extent permitted by law at that time, as any good business operator would do. I am not overlooking the fact that they had a bank credit of $25,000, as shown in Exhibit R-2, and that they used $20,000, approximately, of that credit. This is a revolving credit that all businesses establish, and it may vary from time to time as to the amount that is needed. It does not, in my view, on the evidence of Tremblay, represent the maximum that would have been available to them but, on the contrary, they could have achieved the credit necessary to make the past payments fixed by the actuarial certificate of Mr Genest’s predecessor.
I therefore find that this was not a sham and that subsection 137(1) of the Income Tax Act is not a bar to the pension plan if 'I can find that the said plan meets the other criterion set out in the Inland Industries case, namely, that a legal obligation exists in the plan. This, of course, is the most difficult part, because the interpretation of words and phrases must of necessity vary within the minds of the persons making the interpretations.
There are a few facts evidenced in the 26 exhibits of the appellant that indicate the lengths to which the company went to make this a true plan. They complied with the Quebec Board’s requirements of new actuarial certificates every three years; the Quebec Board, by its correspondence, indicated that the plan had met, and was meeting, its obligations as late as June 1969; and although there was at the moment a deficit of $173,000 for past services, the actuary gave evidence that this was within the range of amortization over the period of time that would be necessary for the fund to reach its potential and by the time the first payment out of the fund would be required. The evidence is—and again it is uncontradicted and remains unshaken by learned cross-examination—that the Quebec Pension Board could have, and unquestionably would have, taken action against this plan had it not been satisfied that it was a bona fide scheme to benefit, eventually, the members of the plan.
Also, the question of the trustees has been raised in issue. These trustees were three in number, two of whom were Vézinas and the third their accountant, and I do not consider him to be independent. Nevertheless, subsequently the Act required that, where an employer contributes to such a pension plan, the employer or an officer of the employer must be a member of the trustee committee. It is not so much the position of the trustees vis-a-vis the company that is important as it is the actions of the trustees vis-a-vis the company and what the company can do to fetter the actions of the trustees. In this case, the pension plan could be terminated at any time by the company. They had, by virtue of Article 9 of the plan, the power to amend or discontinue at any time. However, the same article provides, and I paraphrase, that all amendments to the plan shall not affect in any way the amounts and the conditions of payment already established and earned, and should it be necessary for the company to discontinue the plan, the assets will be attributed—or maybe distributed is a better word—to the members. In addition, Article 6 provides that the company will disburse the total cost of past service and will also contribute for present service the maximum allowed by the Income Tax Act, as amended from time to time.
This is different from the clauses that have been contained in the other cases cited, that is, in the inland Industries case, the Cam Gard case and the Mittler case. Mr Justice Walsh puts it very succinctly when he says, at pages 284-5 [5230] of his reasons in the LDG Products case:
The fact that the payments already made to the plan are irrevocably vested in it and belong to the members and cannot be returned to the company is a common feature of all pension plans, but this is not sufficient to find that the company has made payments irrevocably vested in the plan sufficient “to ensure that all the obligations of the fund or plan to the employees may be discharged in full” within the meaning of Section 76 of the Act. Further light on this can be found in two recent and as yet unreported judgments. In the case of Mittler Bros of Quebec Ltd v MNR, [1973] CTC 182; 73 DTC 5158, a judgment of the Associate Chief Justice, payments made on account of past service contributions were invested partly in preferred shares of the company and partly in a loan to the company, which preferred shares were redeemed and the loan eventually repaid. While in that case it is true that the plan used the words “may make” with respect to past service contributions and provided for a pension of “up to” 70% of the average of the employee’s best six years of salary and therefore, as in the case of the Inland Industries judgment (supra) provided no specific amount of pension, the remarks of the learned Associate Chief Justice in his reasons for judgment at page 186 [5161] might well be applied to the present case. He states:
“Here also the only obligations to a member were to use in the prescribed manner the funds paid into the plan and no obligation had been created, either on the fund or on the company, to furnish the members with the benefits which were intended to be provided by the special payments.”
In his own words, Mr Justice Walsh goes on to say:
In the present case, while the plan may have incurred specific obligations towards the members with respect to the amount of the pension to be paid, the fact that no specific amount was provided for current service contributions, but merely a maximum, and that the plan could be suspended or terminated at any timejby the company, together with the evident inability or unwillingness of the trustees to oblige the company to fulfil its obligations under the plan, all indicate that the plan would be unable to fulfil its obligations to the members unless the company chose to continue to make its necessary contributions to the plan.
Further down on page 285 [5231] he refers to the Cam Gard Supply Limited case and the judgment of Mr Justice Cattanach, where the amount of pension to be paid was specified, unlike the Inland Industries case and like the case before me now, where 2% per year of service was to be paid, that is, a person working twenty years for the company would receive 40% of his best six years’ average salary, and, with regard to the Cam Gard case, Mr Justice Walsh goes on to say that
on the advice of the actuary as to the amount required, the appeal was nevertheless dismissed because in reference to the proposed payments into the plan the words “the company intends to contribute subject to the funds for such purposes being available” were used.
At page 119 [5138] of the Cam Gard judgment, Mr Justice Cattanach, I think quite rightly, held that this did not create an obligation but, if we look at Article 6 of the Vézina pension plan as I have just quoted it a few moments ago, it says the company will disburse the total cost. It doesn’t say anything about “it may”, or “if the funds are available it will do so”; it says the company will disburse the total cost and will also contribute to the maximum allowed by the Income Tax Act as amended from time to time. If section 76 is to have any meaning whatsoever, one must not make it impossible for employers to satisfy the obligation envisaged by the Inland Industries case.
In my view, there is a clear and unequivocal obligation on the appellant to do as Article 6 says as long as the plan is in existence; and if the plan is cancelled, there is an equally unequivocal obligation to pay the proceeds of the fund at that time to the members on the formula set out in the plan. There is no doubt at any time as to what is coming to a particular member of the fund in question.
Again, in drawing on Mr Justice Walsh’s decision, the question that so often comes up is whether or not we may look past the year under appeal (in this case 1965) to see if there is anything to assist us in determining the case at hand, and it is often argued, and it is accepted, that each taxation year must stand on its own. However, the purpose of any hearing is to arrive at the truth of what really was intended by the parties. In dealing with the question of what transpired subsequent to the year in question, Mr Justice Walsh points out, at page 287 [5232] of his reasons in the LDG Products case:
Appellant argued that the contributions called for were duly made in 1965 and 1966 and that the fact that they were later suspended cannot have a retroactive effect so as to indicate that the plan in those years should not be considered as a bona fide pension plan. While this may be true, what subsequently transpired is relevant in determining the motivation of the company in establishing the plan, and it certainly indicates that the company’s attitude was that if the payments were not to be deductible, it would not continue to make them, and the trustees’ attitude that they would not or could not force the company to make the necessary payments to enable them to fulfil the obligations incurred under the plan to the members to provide a retirement pension of 70% of their best average salaries less the sums received under the London Life plan.
Again, at pages 287-8 [5232]:
. . . While the intention of establishing the supplemental pension plan may perhaps have been as Mr Maurice Germain declared to provide additional pension for senior executives and long-term employees and to retain their interest in the company, it is evident that this was not nearly as important in the company’s view as the taxation advantages resulting from the establishment of such a fund. Whether or not the amounts so paid were reinvested in preferred shares of the company, which may not have been necessary in this case, the company nevertheless gained a 50% tax advantage by the deduction of these amounts from its taxable income, and when it found that it might not be able to do so it immediately stopped further payments.
I refer in this case to the exact converse of the situation that existed between the appellant and the Minister in the case before Mr Justice Walsh. The evidence is that the appellant in this case continued to make payments over the years, even to the present time— again uncontradictd. In fact it is supported by the evidence of a very learned actuary, a Fellow of the Royal Society of Canada, who states that in 1968 and 1971, the latter being after the reassessment, he prepared certificates required by the Act and that payments were made in accordance therewith.
It therefore appears to me that, on looking at the subsequent actions of the appellant company in this instance, there is support for my belief that the company’s sole intention was the establishment of a pension plan for the benefit of the members in later years. There is also support for my belief that Article 6 and Article 9 of the plan contain the very obligation that was envisioned by the Honourable Mr Justice Pigeon in the Inland Industries case, and that it is an obligation that would force the funds to be paid to the members, and that the company had lost control of those funds from the date of their payment in. The fact that the company has continued to make payments and that the fund now stands at some quarter of a million dollars again lends support to this belief.
On all the evidence, both viva voce and documentary, presented to me in this case, I am of the opinion that the appellant has satisfied the onus and has brought itself within the confines of section 76 of the Act. Its appeal must therefore be allowed and the matter referred back to the Minister for reassessment accordingly.
Appeal allowed.
[1972] CTC 27; 72 DTC 6013.