Western Smallware & Stationery Co LTD v. Minister of National Revenue, [1972] CTC 7, 72 DTC 6036

Cattanach, J:—These are appeals from the Minister’s assessment of the appellant to income tax for its 1964, 1966 and 1967 taxation years ending December 31 whereby the Minister disallowed the sums of $128,000, $6,300 and $6,100 in the appellant’s 1965, 1966 and 1967 taxation years and denied a resultant business loss of $10,798.52 in 1964 which foregoing sums the appellant had claimed as deductions as contributions to pension plans, commonly referred to as “Executive pension plans” or “top-hat pension plans” for the benefit of its president, vice-president and secretary.

The appellant is a joint stock company incorporated pursuant to the laws of the Province of Manitoba in 1942 and has been engaged in a successful business of wholesalers and distributors of housewares, toys, hobbies and like novelties to supermarkets from Sault Ste Marie, Ontario to Vancouver, British Columbia, as its principal customers.

The appellant had under consideration for some time a pension plan for its three executive officers. It discussed a variety of plans with different insurance companies but the appellant was reluctant to deplete its working capital by laying out the requisite costs.

In 1965 the appellant’s auditor, who was aware of self-administered pensions, devised a plan, no doubt after discussion with a firm of pension consultants familiar with these matters, which was eminently suitable to the appellant and tailored to its needs. Basically the plan was that the appellant should enter into three separate trust agreements under which trustees would administer a pension plan for the benefit of the president, the vice-president and secretary of the appellant. The contributions to the pension plans by the appellant would be invested in insurance policies on the life of the particular beneficiary and the balance of the contributions would be invested in 5% non- cumulative, non-voting, non-participating redeemable Class “B” shares of the appellant to be created. The initial liability for past service of these three officers was calculated to be in the amount of $131,752. The annual future liability for past service contributions on behalf of these three officers was calculated to be $5,491. These payments would be in addition to the premiums on the life insurance policies.

The auditor advised the appellant that a lump sum payment for past service would be deductible for income tax purposes as would the current contributions to the pension plans.

The officers of the appellant were dubious. The advice given. to them sounded too good to be true. In effect they would have the best of two worlds. The officers of the appellant would be provided with pensions as they had desired, the contributions of the appellant to those plans would be tax exempt and the appellant would not be deprived of working capital, which circumstance it was anxious to avoid, because the contributions would find their way back into the coffers of the appellant by way of the purchase of its redeemable Class “B” preferred shares.

To reassure the officers of the appellant and dispell their apprehensions the auditor was sent to the head office of the Department of National Revenue in Ottawa to submit these proposed pension plans and trust agreements (which had been drafted but not executed) to officers of the Department for consideration and approval and to advise those officers that it was the intention of the proposed trustees to invest the contributions to the plans in preferred shares of the appellant, as yet to be created. The purpose of the auditor’s visit was to ascertain what changes, if any, might be required in respect of the objectives of the appellant. It is apparent that verbal approval was given to the proposals without change because subsequently written approval to the plans was given when application for approval of the executed material was made.

The president of the appellant was Morley Leonard Bell, the vice- president was Dick Daniel Bell and the general manager and secretary was Alan Omson who were also the controlling shareholders of the appellant.

After having received verbal approval from the officers of the Department three separate pension plans and trust agreements were entered into each of which was dated November 30, 1965 and to be effective as of that date.

Other than providing for three different beneficiaries, slightly different benefits in amounts and different sets of three trustees, the beneficiary in each case was one of the trustees and the other two common to all three trust agreements and plans were the appellant’s auditor and solicitor, the terms and conditions of the three trust agreements and plans were identical in all respects.

Basically under the terms of the trust agreements the trustees were to manage the plans and their duties were limited to carrying out the terms of the agreements and administering the plans and to conform to the directions of the appellant given in accordance with the terms of the trust agreements. The appellant reserved the right to amend the provisions of the trust agreements subject to prior vested rights. In the event that the appellant terminated the plans the fund held by the trustees were to be paid to the member of the plans in a manner to be approved by the appellant. Under the trustee agreements, the trustees were authorized to invest in any security which they considered advisable. The appellant had the right to disapprove of any investment made by the trustees in which event the trustees were then required to sell such investment.

Under the terms of each of the plans the appellant was to make past service contributions in respect of the member of each of the plans on a “hopes and expects” basis, that is, subject to the appellant having available funds for that purpose. On retirement a member was entitled to receive a past service annual pension to the extent that the appellant had purchased such past service annual pension.

On December 13, 1965 the pension plans and trust agreements were formally submitted to the Minister for approval by way of an application for registration together with an actuary’s report dated December 6, 1965 to the effect that, on the assumption that each annual pension at the normal retirement date under the plans would not exceed 70% of the average of the last 6 years’ earnings of each beneficiary or $40,000 each, the funds for the pension plans for the president, the vice-president and the secretary required to be augmented by the respective amounts of $46,726, $30,680 and $54,346 to ensure that the obligations of each of the three respective funds in respect of past services may be discharged in full, a total of $131,752.

By three letters dated December 23, 1965, December 29, 1965 and December 23, 1965 the appellant was advised that the pension plans had been accepted for registration with effect from November 30, 1965 under paragraph 139(1)(ahh) of the Income Tax Act and that the appellant’s contributions to the plans might be claimed as deductions in determining taxable income. In regard to special payments to the plan in respect of past service of employees the appellant was informed that advice had been requested of the Superintendent of Insurance under section 76 of the Income Tax Act upon receipt of which the appellant would be notified.

By three letters dated February 15, 1966 the appellant was advised that the Superintendent of Insurance had advised the Minister that he might approve the special payments to the plans under section 76 of the Act in respect of past service liability in the respective amounts of $46,726, $30,680 and $54,346 determined as of November 30, 1965 and that such payments may be claimed as deductions under section 76 of the Act.

In anticipation of the foregoing approvals being forthcoming the appellant had passed the requisite corporate resolutions and on December 21, 1965 had already made the special payment contributions aggregating $131,752 to the various trusts but contingent upon the pension plans being accepted for registration.

Also in anticipation of the plans being registered the appellant had applied by an application dated October 1, 1965 for supplementary letters patent increasing its authorized share capital by the creation of 2,000 Class “B” preference shares. Supplementary letters patent so increasing the authorized capital stock issued under date of November 24, 1965.

On December 21, 1965 the appellant issued the following cheques to the various trusts:

Total — $131,752

These cheques were negotiated by the three trusts and the proceeds deposited in bank accounts in the names of the three respective trusts.

Upon the foregoing funds being available to them the trustees of each trust forthwith invested in an insurance policy for each of the beneficiaries and subscribed for Class “B” preferred shares of the appellant. The trustees of the three trusts issued cheques to the appellant in the amounts of $45,500 on behalf of the president’s trust for 455 Class “B” preferred shares of the par value of $100 each of the appellant, $53,000 on behalf of the secretary’s trust for 530 like preferred shares and $29,500 on behalf of the vice-president’s trust for 295 preferred shares.

On December 22, 1965 the appellant issued those shares to the respective trusts in accordance with the subscriptions therefor.

In addition the three trusts also acquired insurance policies and paid the premiums thereon.

In the 1966 taxation year the appellant contributed further amounts to the three trusts aggregating $9,991 as follows:

These amounts were deposited in the bank accounts of the respective trusts by the trustees who forthwith subscribed and paid for further Class “B” preferred shares of the appellant to the total of $6,300 as follows:

President’s trust, 19 preferred shares for $1,900 Secretary’s trust, 24 preferred shares for $2,400

Vice-president’s trust, 20 preferred shares for $2,000

The appellant issued the shares as subscribed for.

Again in the appellant’s 1967 taxation year the same thing happened. The appellant contributed further amounts to the three trusts aggregating $9,991 of which $6,100 was used by the trustees to purchase Class “B” preferred shares, 19 shares for $1,900 for the president’s trust, 22 shares for $2,200 for the secretary’s trust and 20 shares for $2,000 for the vice-president’s trust.

In each instance the appellant issued its cheques to the respective trusts which the trustees deposited the proceeds to the credit of the bank account of each trust and then issued their cheques to the appellant in payment for the shares subscribed for.

The Minister’s action in assessing the appellant for the taxation years under review can be expressed in summary form as follows:

The sums of $128,000, $6,300 and $6,100 which were disallowed by the Minister represent the amounts expended by the trusts in the respective taxation years to acquire Class “B” preferred shares of the appellant.

During the taxation years under review there was no federal law, regulation, administrative limitation or Departmental policy that restricted the trustees of a pension plan from investing the funds under their control as they deemed advisable including the investment in shares of the contributing company and in the present case the appel- lant did pay dividends upon its Class “B” preferred shares held by the three pension trusts.

As I understood the submissions made by counsel for the Minister they were basically that the contributions made by the appellant to the three pension plans are not properly deductible in computing the appellant’s income because the contributions in question did not comply with the conditions outlined in section 76 of the Income Tax Act which reads as follows:

76.(1) Where a taxpayer is an employer and has made a special payment in a taxation year on account of an employees’ superannuation or pension fund or plan in respect of past services of employees pursuant to a recommendation by a qualified actuary in whose opinion the resources of the fund or plan required to be augmented by an amount not less than the amount of the special payment to ensure that all the obligations of the fund or plan to the employees may be discharged in full, and has made the payment so that it is irrevocably vested in or for the fund or plan and the payment has been approved by the Minister on the advice of the Superintendent of Insurance, there may be deducted in computing the income of the taxpayer for the taxation year the amount of the special payment.

More particularly counsel for the Minister contended first that no special payments were made by the appellant which irrevocably vested in the pension plans.

Looking at the transactions, as a whole, whereby the appellant issued cheques payable to the trusts, the trustees issued cheques payable to the appellant in substantially the same amounts and the appellant issued Class “B” preferred shares to the trusts in exchange for these cheques, all in accordance with a predetermined plan, counsel for the Minister submitted that in substance the payments were illusory and that the intention of all parties by these exchange of cheques was not to transfer the sums to the pension plans and did not result in a real payment. What the pension plans received in reality were preferred shares of the appellant through the machinery of an exchange of cheques and that the shares did not have a value equivalent to their par value because the appellant was a private company with restrictions upon the transfer of its shares and their redemption could only be effected following corporate acts by the appellant. It was the further contention on behalf of the Minister in this respect that the trustees were under the direction and control of the appellant so that the appellant did not part with dominion over the funds and accordingly there was no irrevocable vesting of the payments in the pension plans.

Secondly, counsel for the Minister submitted that the validity of the actuarial opinion, as expressed in the certificate, is dependent upon there being at law an absolute obligation on the appellant, pursuant to the plans to make a payment or payments to the trustees in respect of past services of the beneficiaries. If no such obligation exists then the actuary lacks jurisdiction to form an opinion as to the amounts by which the resources of the funds or plans require to be augmented. Further it was submitted that the appellant, at the most, was authorized, but not compelled to make payments to the pension plans so that pensions might be purchased by the trustees in respect of past services of the respective beneficiaries and since the beneficiaries were entitled to no greater pensions than those which might be purchased with the amounts paid into the pension plans by the appellant it follows that resources of the plans required no augmentation to ensure that the obligations of the plans may be discharged in full.

Thirdly, the Minister submitted that the deductions claimed by the appellant of $128,000, $6,300 and $6,100 in its 1965, 1966 and 1967 taxation years are prohibited by subsection 137(1) of the Income Tax Act which reads as follows:

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

On the other hand, counsel for the appellant contended that the transactions whereby the appellant issued its cheques to the pension plans and received from the pension plans their cheques in payment for Class “B” preferred shares issued by the appellant to the pension plans were real transactions conducted in accordance with commercial reality with the result that the payments were real payments that irrevocably vested in the pension trusts, and that even if this should not be so then the payment was a payment in the Class “B” shares of the appellant and that payment was a payment in law equivalent to the par value of the shares so issued.

With respect to the contention on behalf of the Minister that the disbursements or expenses incurred by the appellant in these transactions would, if allowed, “unduly or artificially reduce the income” of the appellant within the meaning of subsection 137(1) of the Income Tax Act, it was the reply of the appellant that these were bona fide expenses incurred in furtherance of a legitimate business purpose and that any tax advantage was merely incidental.

The principal thrust of the argument on behalf of the appellant appeared to me to be that the pension plans were submitted to the Minister and accepted by him for registration. Under paragraph 139(1)(ahh) a registered pension plan means one that has been accepted by the Minister for registration for the taxation year under consideration. The Minister registered these plans and in no subsequent taxation year did he “unregister” the plans. The appellant sent its auditor to Ottawa to discuss the plans with Departmental officials, making full disclosure of all proposals and of the intention of the trustees of the plans to invest in preferred shares of the appellant. If it was objectionable to the Minister at some subsequent time for the plans to invest in the shares of the appellant, no opportunity was afforded the appellant to change those investments to ones that would be acceptable as could have been done under each trust agreement. In short the appellant says that the Minister has changed the rules in the middle of the game to the detriment of the appellant, in that the appellant will be obliged to pay the increased amount of tax together with interest thereon for late payment. Accordingly the appellant con- tends that the actions of the Minister preclude him from disallowing the deductions claimed by the appellant.

This argument is to me tantamount to invoking the doctrine of estoppel. The essential factors giving rise to an estoppel are (1) a representation intended to induce a course of conduct on the part of the person to whom the representation is made, (2) an act resulting from the representation by the person to whom the representation was made and (3) detriment to such person as a consequence of the act (see Greenwood v Martins Bank, [1933] AC 51).

In Phipson on Evidence, 8th ed, 667 it is stated that

Estoppels of all kinds, however, are subject to one general rule: they cannot override the law of the land. Thus, where a particular formality is required by statute, no estoppel will cure the defect.

Where a statute imposes a duty of a positive kind then it Is not open to the appellant to set up an estoppel to preclude the Crown from producing evidence to show that the duty was not performed (see Maritime Electric Co v General Dairies, [1937] AC 610).

In the present case subsection 76(1) of the Income Tax Act expressly requires that there shall be a recommendation by a qualified actuary that in his opinion the resources of the fund or plan are required to be augmented by an amount not less than the amount of the special payment “to ensure that all the obligations of the fund or plan to the employees may be discharged in full”. It follows that the existence of such an obligation on the part of the fund or plan to the employees is a statutory condition precedent to the right of the appellant to claim the amount paid to the plan as a deduction. To preclude the Minister from contending and establishing that such an obligation of the plan to the employee did not exist would nullify the provisions of subsection 76(1) of the Act and accordingly this argument is not available to the appellant.

At the time the matter was argued before me counsel did not have the advantage of having before them the judgment of the Supreme Court of Canada in MNR v Inland Industries Limited, [1972] CTC 27.

In that case the only item in dispute was a sum which the respondent claimed it was entitled to deduct under section 76 of the Income Tax Act as special payments made to the trustees of its pension plan in respect of the past services of its president.

Many reasons were given by the Minister in his reply to the notice of appeal for his decision to disallow the deduction claimed. Substantially the same reasons were given and argued in the present appeals.

Mr Justice Pigeon in delivering the unanimous judgment of the Supreme Court of Canada said at page 30:

. . . Those grounds were all raised again in this Court, but i do not find it necessary or desirable to express an opinion on any other than the following point which is, in my view, decisive of the case. This is that the deduction claimed was not allowable because there were no “obligations” of the Fund or Plan to Mr Lloyd Parker that required any special payment to ensure that they might be discharged in full . . .

Mr Lloyd Parker was the president of the company and the only Class “A” member of the plan. He goes on to say-(p. 31):

That there was no “obligation” of the pension fund to Mr Parker that “required” the special payments is readily apparent from the terms of the plan. The only obligations to a member were to use in the prescribed manner the funds that became available. In fact, it was not contended at the hearing that an obligation had been created, either on the fund or on the company to provide to Mr Parker the benefits which were intended to be provided by the special payments.

The contention was that “obligation” was to be taken to mean what the actuary making a recommendation understood it to mean. It is to be noted first that in the memorandum from the Department of Insurance, the statement is not, as in the actuarial certificate, that the fund requires to be augmented “to ensure that all obligations of the Fund in respect of past services may be discharged in full” but that “the Fund requires to be augmented by an amount not less than the amount quoted above to ensure that the maximum possible benefits under the Plan may be provided”. This follows the statement that “the Plan does not provide a specific amount of pension but only sets a maximum limit to the total pension”. The difference between the wording of this memorandum and the wording of the actuarial certificate is quite substantial and it is somewhat surprising that, notwithstanding such advice, departmental approval was given to the payments on behalf of the Minister. However, it seems clear to me that the Minister cannot be bound by an approval given when the conditions prescribed by the law were not met.

lt was contended at the hearing that, in section 76, the word “obligation”, being used in the context of a provision relating to a certificate by an actuary, should not be taken in its ordinary meaning but in the special sense in which it would be understood by an actuary. Assuming this to be so, there is no evidence of such special meaning. The certificate and the testimony of its author at the hearing in the Exchequer Court do not show that the word “obligation” is generally understood among actuaries as having the meaning contended for. As a matter of fact, the memorandum from the Department of Insurance is cogent evidence to the contrary. Furthermore, subsection (2) of section 76 clearly shows that “obligations of the Fund or Plan to the employees” means ‘‘superannuation or pension benefits payable”. It is apparent that the situation intended to be met by the special payments provided for is that which arises when a pension plan specifies a scale of benefits payable.

Counsel for the company pointed out that in some other provisions of the Income Tax Act, for instance in paragraph 11(1 )(c) respecting the deduction of interest, the expression used is “a legal obligation”. He contended that the absence of the adjective “legal” in section 76 indicated the intention of not requiring a legal obligation. Even at that, the inference that section 76 was intended to apply when there was no obligation legal or otherwise could not be justified. Furthermore, ! would observe that in the Income War Tax Act, paragraph 5(1 )(b) respecting the deduction of interest said: “interest payable”. It could hardly have been intended by changing this to read in the Income Tax Act: “pursuant to a legal obligation to pay”, to alter completely the requirements respecting the special payments to pension plans with respect to obligations for past services, which requirements remained substantially unchanged (see paragraph 5(1 )(m) of the Income War Tax Act as enacted in 1942 by 6 Geo VI, c 28, subsection 5(5)).

As to the effect of the actuarial certificate which was said to be “‘a Subjective test”, assuming this to be so, this could not be true with respect to anything more than the quantum of the obligations. It cannot have been intended to be decisive of their existence. It is obvious that the author of the memorandum from the Department of Insurance had this distinction in mind. He clearly indicated that his advice was limited to the actuarial computations and assumptions refraining from any opinion as to the existence of any obligation. In my view, the actuarial certificate was not, any more than the approval on behalf of the Minister, decisive of the existence of any obligation of the fund towards the employee in respect of past services. 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.

I have carefully compared the pension plans and the pension trust agreements in the present appeals with the pension plan and pension trust agreement in MNR v Inland Industries Limited. Subject to those variations dictated by different participants and slightly different circumstances they are similar in content and language.

Paragraph 7 of the trust agreement herein provided:

The Trustees shall not be responsible for the adequacy of the Trust fund to meet and discharge pensions and other liabilities under the Fund.

Obviously this is the responsibility of the appellant.

In the pension plan herein it is provided in paragraph 2.2(c):

Payment of Pension

Upon a Participant attaining normal retirement age, or in the case of a Participant who elects to defer his retirement date, then upon such Participant actually retiring, all monies contributed by the Company to the Trust Fund, together with any interest accrued thereon, shall be used for the purpose of establishing a pension in one of the forms provided in Paragraph 2.5 hereof.

The amount of pension is provided in paragraph 2.3 as follows:

Amount of Pension

The Annual Pension payable to a Participant shall be as follows; —

(a) For each year of service subsequent to his date of entry into the Plan, each Participant will receive an annual pension equal to 2% of the average of the best six years earnings in the employ of the Company less any pension being purchased in respect to such service by the Company, and by any other registered pension plan of the Company.

(b) Subject to the funds being available the Company expects to purchase for each Participant an annua! pension equal to 2% of the average of the best six years earnings for each year of continuous service with the Company up to the date of entry into the Plan, less any pension being purchased in respect to such service by the employer under any other registered pension plan of the Company.

(c) Notwithstanding the provisions in (a) and (b) above, the total pension that would be purchased for any Participant will not exceed the lesser of $40,000.00 or 70% of the average of the best six years earnings in the employ of the Company. In the event that the total pension purchased on the basis of the formula defined in (a) and (b) above should exceed the maximum pension as just defined, the pension under (a) and (b) would be reduced in the ratios that the number of years service on which the pensions under (a) and (b) are based respectively bear to the total service as defined in Section 1.2 (1) hereof.

The contributions to be made by the appellant are provided for in paragraph 2.4(b) as follows:

(b) By the Company

i. In respect of each Participant the Company will contribute in respect of service rendered after the date of entry into the Plan an annual amount equal to $1,500.00 less any contributions which the Company may be making in respect of the Participant to any other registered pension plan of the Company. Reference to $1,500.00 shall be deemed to include any other maximum which may be permitted from time to time under the Income Tax Act.

ii. Subject to the recommendations of a qualified Actuary and subject to

funds being available for this purpose, the Company will also contribute on each anniversary date of the plan in respect of each Participant such amount as may be required to make up the difference between the pension required to be purchased under Section 2.3 (a) of the Plan less the pension being purchased by the Company contributions under Section 2.4 (b) (i).

The beneficiary does not contribute.

The normal form of pension is a monthly amount of annuity income for the life of the participant but in no event for less than 10 years.

This is provided in paragraph 2.5. In paragraph 3.3(a) it is provided:

Benefit Payments and Liability

(a) The amounts of annuity income payable hereunder shall only be paid to the extent that they are provided for by the assets held under the Trust Fund, and no liability or obligation to make any contributions thereto other than as set out herein shall be imposed upon the Company, the officer, directors or shareholders of the Company. . . .

It is readily apparent from the foregoing provisions that there was no obligation on the part of the appellant to make any contribution to the trust funds for the purchase of pensions for past services of the members. At the most it was an “expectation” to do so subject to funds being available.

It is equally apparent that the obligation on the trustees of the pension plans was only to purchase annuities to the extent that funds available in the plans permitted.

As Mr Justice Pigeon said (p. 32) in the conclusion of his remarks that I have quoted above and I repeat for the sake of emphasis:

. . . 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 to those sums unless and until the company chose to, and actually did, make the contemplated payments into the fund.

The actuarial certificate appears at pages 142 to 144 of Exhibit Book A.1. After reviewing the ages of the three participants, their length of service, their projected average salaries and such like relevant material he concludes by certifying, on page 144, that the lump sum cost of past service pension on behalf of the three participants is $30,680, $54,346 and $46,726 or a total of $131,752. I interpret such certification to being his opinion of the amount required to make up the quantum of the desired pensions but, as Mr Justice Pigeon pointed out, it cannot be decisive of the existence of any obligation of the plan towards the employee in respect of past services.

I might also add that Mr Justice Pigeon effectively disposes of any question of estoppel arising when he states at page 31:

. . . However it seems clear to me that the Minister cannot be bound by any approval given when the conditions prescribed by law were not met.

I think it is expedient to point out that the obligations contemplated by subsection 76(1) of the Income Tax Act are the obligations of the fund or plan to the employees. It is apparent that the situation intended to be met by special payments provided for in section 76 of the Act is that which occurs when the pension plan specifies a scale of benefits payable and when the resources available to the plan are insufficient to meet that scale. In that instance special payments may be made to cure that deficit and such payments are deductible, which is not the situation in the present appeals.

For the foregoing reasons the appeals are dismissed with costs.