Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298
Continental Bank Leasing Corporation Appellant
v.
Her Majesty The Queen Respondent
and
The Canadian Bankers’ Association Intervener
Indexed as: Continental Bank Leasing Corp. v. Canada
File No.: 25532.
1998: January 26; 1998: September 3.
Present: L’Heureux‑Dubé, Gonthier, Cory, McLachlin, Iacobucci, Major and Bastarache JJ.
on appeal from the federal court of appeal
Income tax -- Depreciable assets -- Recapture of capital cost allowance -- Rollover of assets into partnership -- Bank subsidiary entering into partnership and transferring assets to it pursuant to rollover provision -- Bank Act prohibiting banks from participating in partnerships -- Provincial partnerships legislation providing for dissolution of partnership upon happening of event making it unlawful for business of firm to be carried on or for members of firm to carry it on in partnership -- Whether partnership rendered invalid -- If so, whether subsidiary liable for recapture of capital cost allowance -- Income Tax Act, R.S.C. 1952, c. 148, ss. 13, 97(2) -- Bank Act, R.S.C., 1985, c. B-1, s. 174(2) -- Partnerships Act, R.S.O. 1980, c. 370, s. 34.
In 1986, Continental Bank of Canada (the “Bank”), which had decided to wind up its affairs, invited offers for the purchase of the shares or assets of its wholly owned subsidiary, Continental Bank Leasing Corp. (“Leasing”). Central Capital Leasing (“Central”), which had concerns about the creditworthiness of several of the leases and certain contingent tax liabilities of Leasing, proposed a transaction whereby Leasing would form a partnership with several Central subsidiaries to carry on the same business as Leasing, transfer its assets other than the excluded leases to the partnership using an election under s. 97(2) of the Income Tax Act, a rollover provision, distribute its partnership interest to the Bank at its cost base as part of its winding-up, and then have the Bank sell its interest to Central or its subsidiaries. A master agreement was signed setting out the various steps to be executed by the parties. The partnership was formed on December 24, 1986; all partners, except Leasing, gave representations and warranties that they were and would remain duly registered and qualified to carry on the business of the partnership. On December 27, Leasing and the Bank signed an indenture providing for the transfer of Leasing’s partnership interest to the Bank. On December 29, 1986, the Bank sold the interest in the partnership to subsidiaries of Central. Leasing filed its income tax return for 1987 based on these transfers. The Minister of National Revenue reassessed Leasing on the basis that the partnership transaction was invalid and that the true nature of the transaction was a disposition by Leasing of its leasing assets to Central, making the s. 97(2) election invalid and giving rise to recaptured capital cost allowance in the hands of Leasing. Under s. 174(2) of the Bank Act, a bank may not, directly or indirectly, participate in a partnership in Canada. Section 34 of the Ontario Partnerships Act provides that a partnership is “dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership”. The Tax Court of Canada allowed Leasing’s appeal of the reassessment. The Federal Court of Appeal reversed that decision.
Held (L’Heureux-Dubé and Bastarache JJ. dissenting): The appeal should be allowed.
Per Gonthier, Cory, McLachlin, Iacobucci and Major JJ.: While the other aspects of Bastarache J.’s reasons were agreed with, s. 34 of the Ontario Partnerships Act did not render the partnership between Leasing and its partners void. The business of a partnership is not rendered illegal merely because an investor holds shares in a corporate partner in the partnership when the law says it should not. The partnership must be distinguished from those who may invest in or support the partners that make it up. Prior to December 27, 1986, the Bank was not a partner. It merely held shares in one of the partners, Leasing, which was a separate and legally distinct corporation. Section 174 of the Bank Act accordingly did not make it unlawful for the partnership to carry on its business, or for Leasing to be a partner, prior to December 27. The partnership was not dissolved under s. 34 of the Partnerships Act simply because the Bank should not have held shares in one of the partners. Nor can Leasing’s participation in the partnership be considered unlawful within the meaning of s. 34 of the Partnerships Act by reason of the public policy component of the common law doctrine of illegality. A finding that Leasing’s participation should be void or unenforceable for public policy reasons does not necessarily mean that its participation was illegal or unlawful in the traditional sense of either term. Moreover, public policy requires that breaches of the Bank Act should not lead to the invalidation of contracts and other transactions. More importantly, s. 20(1) of the Bank Act, which stipulates that no act of a bank is invalid by reason only of a contravention of that Act, supports the view that Parliament never intended breaches of the Bank Act to render bank transactions null and void. Since the partnership was valid between December 24 and December 27, the election under s. 97(2) of the Income Tax Act was also valid.
Per L’Heureux-Dubé and Bastarache JJ. (dissenting): In cases such as this, where the parties have entered into a formal written agreement to govern their relationship and hold themselves out as partners, the courts should determine whether the agreement contains the type of provisions typically found in a partnership agreement, whether the agreement was acted upon and whether it actually governed the affairs of the parties. On the face of the agreements entered into, the parties created a valid partnership within the meaning of s. 2 of the Partnerships Act, which provides that partnership is the relation that subsists between persons carrying on a business in common with a view to profit. Moreover, the parties acted upon the agreements and the agreements governed their affairs. While it is true that between December 24 and December 27, 1986, no meetings were held, no new transactions were entered into by the parties and no decisions were made, there was no termination of Leasing’s contracts with its customers when Leasing’s business and assets were transferred to the partnership and the contracts continued during this period. The fact that no new business was created during the period of Leasing’s and the Bank’s involvement in the partnership does not negate the effect of the existing business that was continued during this time. As well, the business that was carried on was carried on by the partners in common. Leasing and the Bank held themselves out as partners, and conducted themselves as partners for the duration of their memberships in the partnership. The business was also carried on with a view to profit. The partnership agreement provided for the distribution of the profits from the leasing business being operated by the partnership and the partnership continued to carry on the business operated for profit by Leasing.
While the Bank contravened s. 174(2)(i) of the Bank Act by entering into a partnership, the prohibition in that provision does not make partnerships ultra vires the Bank. Under s. 18(1) of the Act, a bank has the “capacity and . . . the rights, powers and privileges of a natural person”. Section 20(1) states that “[n]o act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act”. While s. 20(1) is not a complete bar to the application of the doctrine of illegality in the appropriate case, the doctrine does not apply in the present circumstances. Section 20(1) is not in conflict with s. 34 of the Ontario Partnerships Act, however, which has the effect of dissolving the unlawfully formed partnership ab initio. Payment of the penalties set out in s. 174(16) of the Bank Act does not render lawful what the Bank Act prohibits. Any indirect participation by a bank, through a subsidiary company, for example, makes the carrying on of business in the partnership “unlawful” within the meaning of s. 34 of the Partnerships Act. Leasing’s participation in the partnership can also be considered “unlawful” by reason of the public policy component of the common law doctrine of illegality. While it may not be strictly contrary to the Bank Act for Leasing to enter into a partnership, in all of the circumstances it is contrary to public policy to allow the parties to benefit from their deliberate breach of the Act’s prohibitions. The collapse of the partnership scheme vis-à-vis Leasing does not change the fact that Leasing’s assets were transferred to Central’s subsidiaries on December 24, 1986. Because these assets were not transferred to a partnership pursuant to s. 97(2) of the Income Tax Act, Leasing cannot take advantage of that rollover provision and is therefore liable for the recapture of capital cost allowance on its depreciable assets pursuant to s. 13 of the Income Tax Act.
Cases Cited
By McLachlin J.
Referred to: Salomon v. A. Salomon and Co., [1897] A.C. 22.
By Bastarache J. (dissenting)
Continental Bank of Canada v. Canada, [1998] 2 S.C.R. 358; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Orion Finance Ltd. v. Crown Financial Management Ltd., [1996] 2 B.C.L.C. 78; Mahon v. Minister of National Revenue, 91 D.T.C. 878; Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336; Canada v. Antosko, [1994] 2 S.C.R. 312; Ashbury Railway Carriage and Iron Co. v. Riche (1875), L.R. 7 H.L. 653; Communities Economic Development Fund v. Canadian Pickles Corp., [1991] 3 S.C.R. 388; Cope v. Rowlands (1836), 2 M. & W. 149, 150 E.R. 707; Sidmay Ltd. v. Wehttam Investments Ltd. (1967), 61 D.L.R. (2d) 358, aff’d on other grounds, [1968] S.C.R. 828; Royal Bank of Canada v. Grobman (1977), 18 O.R. (2d) 636; Still v. Minister of National Revenue (1997), 221 N.R. 127; Neider v. Carda of Peace River District Ltd., [1972] S.C.R. 678; Menard v. Genereux (1982), 39 O.R. (2d) 55; Holman v. Johnson (1775), 1 Cowp. 341, 98 E.R. 1120; Hudgell Yeates & Co. v. Watson, [1978] 2 All E.R. 363.
Statutes and Regulations Cited
Bank Act, R.S.C., 1985, c. B-1, ss. 18(1), 20(1), 174(2)(i), (16), 246.
Canada Business Corporations Act, S.C. 1974-75-76, c. 33, ss. 15(1), 16(3).
Income Tax Act, R.S.C. 1952, c. 148 [am. 1970-71-72, c. 63], ss. 13 [am. 1976-77, c. 4, s. 3; am. 1980-81-82-83, c. 48. s. 5], 56(4), 85(1) [am. 1974-75-76, c. 26, s. 48; am. 1980-81-82-83, c. 48, s. 45; am. 1985, c. 45, s. 41], 88(1) [am. 1974-75-76, c. 26, s. 52; am. 1979, c. 5, s. 29; am. 1980-81-82-83, c. 48, s. 48], 97(1), (2) [am. 1974-75-76, c. 26, s. 61; am. 1980-81-82-83, c. 140, s. 58; am. 1985, c. 45, s. 49].
Partnerships Act, R.S.O. 1980, c. 370, ss. 1(1)(a) “business”, 2, 15, 34.
Authors Cited
Black’s Law Dictionary, 6th ed. St. Paul, Minn.: West Publishing Co., 1990, “unlawful”.
Cheshire, Fifoot and Furmston’s Law of Contract, 13th ed. London: Butterworths, 1996.
Contracts: Cases and Commentaries, 5th ed. Edited by Christine Boyle and David R. Percy. Scarborough, Ont.: Carswell, 1994.
Crawford and Falconbridge, Banking and Bills of Exchange: A Treatise on the Law of Banks, Banking, Bills of Exchange and the Payment System in Canada, vol. 1, 8th ed. Toronto: Canada Law Book, 1986.
Fridman, G. H. L. The Law of Contract in Canada, 3rd ed. Scarborough, Ont.: Carswell, 1994.
Lindley & Banks on Partnership, 17th ed. London: Sweet & Maxwell, 1995.
Manzer, Alison R. A Practical Guide to Canadian Partnership Law. Aurora, Ont.: Canada Law Book, 1994 (loose-leaf updated October 1997, release No. 3).
Manzer, Alison R. The Bank Act Annotated. Toronto: Butterworths, 1993.
Ogilvie, M. H. Canadian Banking Law. Scarborough, Ont.: Carswell, 1991.
Treitel, G. H. The Law of Contract, 9th ed. London: Sweet & Maxwell, 1995.
Wegenast, F. W. The Law of Canadian Companies. Toronto: Carswell, 1979.
APPEAL from a judgment of the Federal Court of Appeal, [1996] 3 F.C. 713, 199 N.R. 9, 25 B.L.R. (2d) 149, 96 D.T.C. 6355, [1997] 1 C.T.C. 13, [1996] F.C.J. No. 710 (QL), allowing the Crown’s appeal from a decision of the Tax Court of Canada, [1995] 1 C.T.C. 2135, 94 D.T.C. 1858, [1994] T.C.J. No. 585 (QL), allowing the taxpayer’s appeal from a reassessment. Appeal allowed, L’Heureux-Dubé and Bastarache JJ. dissenting.
H. Lorne Morphy and Kent E. Thomson, for the appellant.
Larry R. Olsson, Q.C., and S. Patricia Lee, for the respondent.
Harry Underwood and Ira Nishisato, for the intervener.
//Bastarache J.//
The reasons of L’Heureux-Dubé and Bastarache JJ. were delivered by
Bastarache J. (dissenting) --
I. Introduction
1 This appeal and a related appeal (Continental Bank of Canada v. Canada, [1998] 2 S.C.R. 358) concern events arising out of the winding-up of Continental Bank of Canada (the “Bank”) and its subsidiary, Continental Bank Leasing Corporation (“Leasing”). The broad issue is the validity of a transaction by which Central Capital Leasing (“Central”) ultimately became the owner of leasing assets formerly held by the Bank and Leasing. The transaction involved the formation of a partnership into which Leasing transferred its leasing assets in return for a 99 percent interest in a partnership. Leasing transferred that partnership interest to the Bank, which subsequently sold it to Central’s subsidiaries. These transactions ultimately permitted Leasing to file an election pursuant to s. 97(2) of the Income Tax Act, R.S.C. 1952, c. 148, as amended; this election was rejected by the Minister of National Revenue.
II. Factual Background
2 The Bank was incorporated by an Act of Parliament in 1977 and commenced operations in 1979. In October 1981, the Bank amalgamated with IAC Limited (“IAC”) and became the successor corporation to IAC. Prior to the amalgamation, IAC carried on a sales finance and leasing business which involved, among other things, the purchase of depreciable assets by IAC, including heavy equipment and aircraft, which were then leased for a term of years to corporations that required the use of the assets in their businesses. In 1981, Leasing was incorporated as a subsidiary of the Bank pursuant to amendments to the Bank Act in 1980 which permitted chartered banks to carry on leasing businesses through wholly owned subsidiaries. In 1986, the Bank, no longer being viable, made a decision to wind up its affairs. On October 31, 1986, the Bank entered into an asset purchase agreement with Lloyds Bank plc of London (“Lloyds”) whereby Lloyds agreed to purchase all of the Bank’s assets except the shares of Leasing, the remaining leases still held directly by the Bank and its international loan portfolio. The Bank invited offers for the purchase of either the assets of Leasing or its shares.
3 Pursuant to an agreement accepted by the Bank on October 15, 1986, Central agreed to purchase the shares of Leasing from the Bank. The October 15th agreement was made on the understanding that any leasing assets held directly by the Bank would be transferred to Leasing prior to the completion of the sale of the shares of Leasing. The October 15th agreement was conditional on certain due diligence to be conducted by Central.
4 On November 1, 1986, the Bank transferred the leasing assets held directly by it to Leasing, in contemplation of the share sale. The share sale transaction, however, was never completed. After conducting due diligence in respect of the October 15th agreement, Central expressed concern with regard to certain tax liabilities of Leasing and the creditworthiness of seven lessees. Given that the Bank was in the process of winding-up, it was not prepared to assume the contingent tax liabilities and the parties were at an impasse.
5 In December 1986, Central proposed an alternative transaction which was structured to replicate the economic consequences of the October 15th agreement, but would exclude the seven leases about which Central had expressed concern and would avoid the contingent tax liabilities. This transaction is the one giving rise to this appeal. In essence, Central proposed that Leasing form a partnership with several Central subsidiaries to carry on the same business as Leasing, transfer its assets into the partnership using an election under s. 97(2) of the Income Tax Act, distribute its partnership interest to the Bank at its cost base pursuant to s. 88 of the Income Tax Act, and then have the Bank sell its interest to Central or its subsidiaries.
6 The transaction was governed by the provisions of a Master Agreement that was signed on December 23, 1986 by the Bank, Leasing, Central, Central Capital Management Inc. (“CCMI”), 693396 Ontario Limited (“693396”), 693397 Ontario Limited (“693397”) and 153587 Canada Limited (“153587”). CCMI, 693396 and 693397 were wholly owned subsidiaries of Central. 153587 was a shelf company. The Master Agreement set out the following steps that were executed by the parties:
(a) On December 23, 1986, Leasing acquired certain additional leasing assets that were to be included at the request of Central in the agreement.
(b) On December 24, 1986, Leasing and 153587 amalgamated and continued as one corporation under the name Continental Bank Leasing Corporation (“Leasing”). The Bank was the sole shareholder of the corporation. This created a new year end for Leasing on December 23, 1986.
(c) On December 24, 1986, Leasing formed a partnership, known as Central Capital Leasing (the “Partnership”), with 693396 and CCMI. Leasing contributed its leasing business to the Partnership in return for a 99 percent interest in the Partnership, and filed an election pursuant to s. 97(2) of the Income Tax Act. 693396 and CCMI each contributed $656,929 to the Partnership and each received one-half of a 1 percent interest. Under the Partnership Agreement, 693396 and CCMI gave representations and warranties that they were and would remain duly registered and qualified to carry on the business of the Partnership and enable it to own or lease property, that they could fulfill their partnership obligations without violating the terms of their constating documents or other agreements, and that their forming the Partnership would not result in the breach of any law or agreement. Leasing declined to give such representations.
(d) The first fiscal period for the Partnership ended on December 27, 1986.
(e) On December 27, 1986, as part of its winding-up, Leasing and the Bank signed an indenture providing for the transfer of Leasing’s 99 percent partnership interest to the Bank pursuant to s. 88 of the Income Tax Act.
(f) On December 29, 1986, the Bank purchased secured notes and subordinated convertible debentures of Central for a total amount of $130,071,985. This amount was credited to Central on the books of the Bank.
(g) On December 29, 1986, the Bank sold the interest in the Partnership to 693396 and 693397 for a total purchase price of $130,071,985. Pursuant to the Partnership Interest Purchase Agreement and Assignment Agreement, 693396 purchased 1/11 of the partnership interest and 693397 purchased 10/11 of the partnership interest. The agreements were signed on December 24, 1986 and were effective December 29, 1986.
7 On February 4, 1987, 693397 sent a cheque to Leasing from the Partnership in the amount of $130,726 in respect of Leasing’s net earnings as the 99 percent partner of Central Leasing for the fiscal year December 24 to 27, 1986.
8 Leasing filed its income tax return for 1987 on the basis that pursuant to s. 97(2) of the Income Tax Act, it transferred all of its leasing assets, with the exception of the seven excluded leases, to the Partnership on December 24, 1986 in return for its interest in the Partnership and that it transferred its interest in the Partnership to the Bank as part of its winding-up pursuant to s. 88(1) of the Income Tax Act.
9 On October 12, 1989, the Minister of National Revenue issued a Notice of Reassessment for the 1987 taxation year. Revenue Canada reassessed Leasing on the basis that the partnership transaction was invalid and that the true nature of the transaction was a disposition by Leasing of its leasing assets to Central, making the s. 97(2) election invalid and giving rise to recaptured capital cost allowance in the hands of Leasing.
III. Relevant Statutory Provisions
10 The following statutory provisions are relevant to this appeal:
Bank Act, R.S.C., 1985, c. B-1
18. (1) A bank has the capacity and, subject to this Act, the rights, powers and privileges of a natural person.
20. (1) No act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act.
174. . . .
(2) Except as authorized by or under this Act and in accordance with such terms and conditions, if any, as are prescribed by the regulations, a bank shall not, directly or indirectly,
. . .
(i) acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or limited partnership;
. . .
(16) A bank that contravenes any of paragraphs (2)(a), (c), (f), (h), (i) or (j) is guilty of an offence and liable on summary conviction to a fine not exceeding five hundred dollars in respect of each contravention.
Partnerships Act, R.S.O. 1980, c. 370
2. Partnership is the relation that subsists between persons carrying on a business in common with a view to profit. . . .
34. A partnership is in every case dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.
Income Tax Act, R.S.C. 1952, c. 148, as amended
85. (1) Where a taxpayer has after May 6, 1974 disposed of any of his property that was a capital property (other than real property, an interest therein or an option in respect thereof, owned by a non-resident person), a Canadian resource property, a foreign resource property, an eligible capital property or an inventory (other than real property) to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation, if the taxpayer and the corporation have jointly so elected in prescribed form and within the time referred to in subsection (6), the following rules apply:
(a) the amount that the taxpayer and the corporation have agreed upon in their election in respect of the property shall be deemed to be the taxpayer’s proceeds of disposition of the property and the corporation’s cost of the property;
88. (1) Where a taxable Canadian corporation (in this subsection referred to as the “subsidiary”) has been wound up after May 6, 1974 and not less than 90% of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another taxable Canadian corporation (in this subsection referred to as the “parent”) and all of the shares of the subsidiary that were not owned by the parent immediately before the winding-up were owned at that time by persons with whom the parent was dealing at arm’s length, notwithstanding any other provision of this Act, the following rules apply:
(a) . . . each property of the subsidiary that was distributed to the parent on the winding-up shall be deemed to have been disposed of by the subsidiary for proceeds equal to,
. . .
(iii) in the case of any other property, the cost amount to the subsidiary of the property immediately before the winding-up;
. . .
(f) where property that was depreciable property of a prescribed class of the subsidiary has been distributed to the parent on the winding-up and the capital cost to the subsidiary of the property exceeds the amount deemed by paragraph (a) to be the subsidiary’s proceeds of disposition thereof, for the purposes of sections 13 and 20 and any regulations made under paragraph 20(1)(a),
(i) notwithstanding paragraph (c) the capital cost to the parent of the property shall be deemed to be the amount that was the capital cost thereof to the subsidiary, and
(ii) the excess shall be deemed to have been allowed to the parent in respect of the property under regulations made under paragraph 20(1)(a) in computing income for taxation years before the acquisition by the parent of the property.
97. (1) Where at any time after 1971 a partnership has acquired property from a taxpayer who was, immediately after that time, a member of the partnership, the partnership shall be deemed to have acquired the property at an amount equal to its fair market value at that time and the taxpayer shall be deemed to have disposed of the property for proceeds equal to that fair market value.
(2) Notwithstanding any other provision of this Act, other than subsection 85(5.1), where at any time after November 12, 1981 a taxpayer has disposed of any capital property, a Canadian resource property, a foreign resource property, an eligible capital property or an inventory to a partnership that immediately after that time was a Canadian partnership of which the taxpayer was a member, if the taxpayer and all the other members of the partnership have jointly so elected in prescribed form and within the time referred to in subsection 96(4), the following rules apply:
(a) the provisions of paragraphs 85(1)(a) to (f) apply to the disposition as if
(i) the reference therein to “corporation's cost” were read as a reference to “partnership’s cost”,
(ii) the references therein to “other than any shares of the capital stock of the corporation or a right to receive any such shares” and to “other than shares of the capital stock of the corporation or a right to receive any such shares” were read as references to “other than an interest in the partnership”,
(iii) the references therein to “shareholder of the corporation” were read as references to “member of the partnership”,
(iv) the references therein to “the corporation” were read as references to “all the other members of the partnership”, and
(v) the references therein to “to the corporation” were read as references to “to the partnership”;
(b) in computing, at any time after the disposition, the adjusted cost base to the taxpayer of his interest in the partnership immediately after the disposition,
(i) there shall be added the amount, if any, by which the taxpayer’s proceeds of disposition of the property exceed the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property, and
(ii) there shall be deducted the amount, if any, by which the fair market value, at the time of the disposition, of the consideration (other than an interest in the partnership) received by the taxpayer for the property so disposed of by him exceeds the fair market value of the property at the time of the disposition; and
(c) where the property so disposed of by the taxpayer to the partnership is taxable Canadian property of the taxpayer, the interest in the partnership received by him as consideration therefor shall be deemed to be taxable Canadian property of the taxpayer.
IV. Judicial History
Tax Court of Canada, [1995] 1 C.T.C. 2135
11 Bowman J.T.C.C. allowed Leasing’s appeal of the reassessment. Dealing first with illegality under s. 174(2)(i) of the Bank Act, Bowman J.T.C.C. recognized that Leasing’s entering into the Partnership was a breach of the Bank Act, given that this resulted in indirect participation of the Bank in a partnership. Bowman J.T.C.C. held, however, that the breach of the Bank Act was not sufficient to invalidate the scheme because the Bank Act provides a penalty for the breach and because s. 20(1) preserves the validity of the impugned act.
12 Bowman J.T.C.C. concluded that the scheme, in substance, was a single transaction designed to sell Leasing’s assets and that the Partnership was merely a means to an end. He held that neither the Bank nor Leasing had intended to enter into a long‑term partnership with Central. In his opinion, the scheme had been designed to enable the Bank to divest the leasing assets at a tax cost roughly equivalent to the cost of a share transaction. However, in his opinion, the scheme was not a sham. He held that the Bank and Central had been at arm’s length and that their legal relationships had been real and binding. He held that the parties would not have been able to tell a third party that they were not partners and had not disguised another type of legal relationship. In his opinion, a sham requires a different, real, legal relationship behind a legal facade. Bowman J.T.C.C. concluded that the legal reality was the same as the apparent legal relationships; therefore, there had been no sham.
13 Bowman J.T.C.C. held that the requirement to consider “substance over form” in income tax law does not mean that the legal effect of a transaction is irrelevant, nor does it mean that one is entitled to treat substance as synonymous with economic effect. He held that he could not ignore the form of the legally binding relations in this case because the essential nature of a transaction cannot be altered for income tax purposes by nomenclature. Bowman J.T.C.C. concluded that the ultimate purpose of the transactions did not warrant a disregard of the legal relations created by the scheme; therefore, the parties had formed a valid partnership.
14 With respect to the sale of the partnership interest in the final step of the scheme, Bowman J.T.C.C. held that the Bank had not traded its partnership interest in the same way that a speculator or trader would trade land or securities. He held that the Bank’s partnership interest had been a capital asset and that any characterization of the disposition of the partnership interest had to consider the context in which the transaction had occurred. The reasons for disposing of the partnership interest, in the context of a composite transaction forming an integral part of the winding up of Leasing, were sufficient to dispel any inference that the Bank had been engaged in a profit-making scheme. He noted that when subsidiaries are wound up, their assets are often transferred at cost to their parents to be immediately resold. He also noted that under s. 85 of the Income Tax Act, assets that are not inventory may be rolled into a corporation at their cost amount and immediately resold by the corporation at a profit without becoming inventory, because of the rapidity of the resale. Bowman J. rejected the Crown's argument that the Bank's gain on the sale of its partnership interest was income from an adventure in the nature of trade.
15 Bowman J. rejected the Crown's argument that the transactions violated the object and spirit of s. 97(2) of the Income Tax Act. He held that the words of a statute are of primary importance when determining the statute's “object and spirit”, but that any interpretation of a provision inconsistent with the obvious purpose of the provision should be avoided. He held that s. 97(2) is intended to defer tax by permitting an asset transfer without triggering an immediate tax result when the transfer is to a partnership. He held that the premise underlying s. 97(2) is that a taxpayer's real economic position is not enhanced because the assets are merely being held in a different vehicle. He held that a taxpayer does not contravene s. 97(2) by taking advantage of it.
Federal Court of Appeal, [1996] 3 F.C. 713
16 The Court of Appeal rendered two separate judgments. The judgment relevant to this appeal is that dealing with the liability of Leasing for the recapture of the capital cost allowance. In this judgment, Linden J.A. for the court concluded that no valid partnership had been created or, if one had been created, that it was void or ultra vires the Bank. Linden J.A. held that Leasing had sold its assets to Central and had recaptured capital cost allowance; therefore, it had to pay tax on the recapture.
17 Linden J.A. agreed that the transaction had not been a sham because no element of deceit had been involved and because the scheme had formed legally binding relationships. However, he held that to achieve the desired tax results the substance of the tax transaction must be considered, the partnership scheme must be real, and its form must not be fanciful. Linden J.A. reviewed the evidence and held that the parties had not intended to carry on business with a view to profit; therefore, s. 97(2) could not be relied upon by the parties.
18 Linden J.A. held that any involvement by the Bank in a partnership through Leasing would have been legally invalid, void and illegal because it would have contravened s. 174(2)(i) of the Bank Act, which prohibits banks from indirectly participating in partnerships through subsidiaries. He also held that s. 34 of the Partnerships Act would have dissolved any partnership that might have been established because a violation of s. 174(2)(i) of the Bank Act would be illegal and criminal within the meaning of s. 34. He also held that a partnership was ultra vires the Bank. He rejected arguments that ss. 18(1) and 20(1) of the Bank Act offset the ultra vires doctrine. He held that the parties had been advised by counsel that signing the Partnership Agreement was a violation of the Bank Act, that flagrant violations of the Bank Act will not be ignored and that this is not a circumstance for which the Court of Appeal should grant relief under s. 20(1). He held the Court of Appeal was obliged to apply the doctrine of ultra vires and to view the scheme as invalid.
V. Issues
19 The following issues must be addressed to determine this appeal.
1. Was Leasing a member of a valid partnership with the subsidiaries of Central in December 1986 within the meaning of s. 2 of the Partnerships Act?
2. If Leasing was a member of a valid partnership within the meaning of s. 2 of the Partnerships Act, was the partnership rendered invalid by s. 174(2)(i) of the Bank Act, by s. 34 of the Partnerships Act, or by the common law doctrines of illegality or ultra vires?
3. If the partnership was invalid, was Leasing liable for recapture under s. 13 of the Income Tax Act as the person that disposed of its depreciable assets to the Central subsidiary?
VI. Analysis
1. Was Leasing a member of a valid partnership with the subsidiaries of Central in December 1986 within the meaning of s. 2 of the Partnerships Act?
20 In order to answer this question, it is necessary to consider the various legal requirements for the proper characterization of the transactions entered into by Leasing. The sham doctrine will not be applied unless there is an element of deceit in the way a transaction was either constructed or conducted. This requirement was outlined by Estey J. as follows in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, at pp. 545-46:
A sham transaction: This expression comes to us from decisions in the United Kingdom, and it has been generally taken to mean (but not without ambiguity) a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a facade of reality quite different from the disguised reality.
Both the trial judge and the Court of Appeal correctly held that the transactions entered into by the parties did not amount to a sham and the sham issue was not argued in this Court. However, the Court of Appeal, after holding that the transaction did not amount to a sham, stated that the present case is an example of a transaction “[w]here legal reality is found to be lacking” (p. 726). The Court of Appeal found that the trial judge erred in law by relying exclusively on documents and forms and did not give proper consideration to the reality of the situation.
21 After it has been found that the sham doctrine does not apply, it is necessary to examine the documents outlining the transaction to determine whether the parties have satisfied the requirements of creating the legal entity that it sought to create. The proper approach is that outlined in Orion Finance Ltd. v. Crown Financial Management Ltd., [1996] 2 B.C.L.C. 78 (C.A.), at p. 84:
The first task is to determine whether the documents are a sham intended to mask the true agreement between the parties. If so, the court must disregard the deceptive language by which the parties have attempted to conceal the true nature of the transaction into which they have entered and must attempt by extrinsic evidence to discover what the real transaction was. There is no suggestion in the present case that any of the documents was a sham. Nor is it suggested that the parties departed from what they had agreed in the documents, so that they should be treated as having by their conduct replaced it by some other agreement.
Once the documents are accepted as genuinely representing the transaction into which the parties have entered, its proper legal categorisation is a matter of construction of the documents. This does not mean that the terms which the parties have adopted are necessarily determinative. The substance of the parties’ agreement must be found in the language they have used; but the categorisation of a document is determined by the legal effect which it is intended to have, and if when properly construed the effect of the document as a whole is inconsistent with the terminology which the parties have used, then their ill-chosen language must yield to the substance.
22 Section 2 of the Partnerships Act defines partnership as “the relation that subsists between persons carrying on a business in common with a view to profit”. This wording, which is common to the majority of partnership statutes in the common law world, discloses three essential ingredients: (1) a business, (2) carried on in common, (3) with a view to profit. I will examine each of the ingredients in turn.
23 The existence of a partnership is dependent on the facts and circumstances of each particular case. It is also determined by what the parties actually intended. As stated in Lindley & Banks on Partnership (17th ed. 1995), at p. 73: “in determining the existence of a partnership . . . regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case”.
24 The Partnerships Act does not set out the criteria for determining when a partnership exists. But since most of the case law dealing with partnerships results from disputes where one of the parties claims that a partnership does not exist, a number of criteria that indicate the existence of a partnership have been judicially recognized. The indicia of a partnership include the contribution by the parties of money, property, effort, knowledge, skill or other assets to a common undertaking, a joint property interest in the subject-matter of the adventure, the sharing of profits and losses, a mutual right of control or management of the enterprise, the filing of income tax returns as a partnership and joint bank accounts. (See A. R. Manzer, A Practical Guide to Canadian Partnership Law (1994 (loose-leaf)), at pp. 2-4 et seq. and the cases cited therein.)
25 In cases such as this, where the parties have entered into a formal written agreement to govern their relationship and hold themselves out as partners, the courts should determine whether the agreement contains the type of provisions typically found in a partnership agreement, whether the agreement was acted upon and whether it actually governed the affairs of the parties (Mahon v. Minister of National Revenue, 91 D.T.C. 878 (T.C.C.)). On the face of the agreements entered into by the parties, I have found that the parties created a valid partnership within the meaning of s. 2 of the Partnerships Act. I have also found that the parties acted upon the agreements and that the agreements governed their affairs.
26 It should be noted that Leasing is the company whose tax liability is the subject of this appeal. In determining the proper effect to be given to the Partnership, the concern is whether Leasing was a partner in a valid partnership between December 24, 1986 and December 26, 1986. The main dispute between the parties concerns whether Leasing intended to carry on business in common with Central’s subsidiaries with a view to profit. In order for Leasing to take advantage of the rollover provisions in s. 97(2) of the Income Tax Act, it had to be a valid member of a partnership when it transferred its assets. The dispute does not surround the validity of the partnership with respect to Central’s subsidiaries who entered the Partnership on December 24, 1986 and continued to operate that Partnership long after Leasing and the Bank were no longer members.
27 The Partnership Agreement contains most of the standard provisions that appear in partnership agreements. The agreement provides for the carrying on of “leasing services and such other businesses as the Managing Partner may from time to time determine” (Art. 2.01); it also provides for the distribution of income or loss to “those Persons who are Partners on the last day of the fiscal year of the Partnership” (Art. 5.09) and sets out the liability of the partners (Art. 3.02). The agreement further provides for the Management of the Partnership (Art. IV), Accounts and Allocations (Art. V), Dissolution (Art. VIII) and other provisions common to partnership agreements. It is not surprising that the Partnership contains all of the provisions required to form a valid partnership. The parties intended to set up a partnership that would comply with s. 2 of the Partnerships Act and they succeeded.
(a) Was There a Business?
28 By s. 1(1)(a) of the Partnerships Act, “business” includes “every trade, occupation and profession”. There is no doubt that equipment leasing constitutes a business within the meaning of the Partnerships Act. The activities carried on by Leasing that were subsequently transferred to the Partnership included sales financing and leasing, which involved, among other things, the purchase of depreciable assets including heavy equipment and aircraft, which were then leased for a term to corporations that required the use of the assets in their business.
(b) Was the Business Carried On in Common?
29 If a partnership is to exist, it must be shown that two or more people carried on the business. It is also fundamental that the business is carried on in common (Lindley & Banks on Partnership, supra, at pp. 9-10). The respondent argues that no active business activity was conducted between December 24 and December 29, the period in which Leasing and subsequently the Bank were members of the Partnership. Therefore, according to the respondent, the Partnership did not carry on business within the meaning of s. 2 of the Partnerships Act. Further, s. A.9(a) of the Master Agreement set out that new transactions were prohibited between December 24 and December 29 without unanimous consent. Moreover, the three days over the 1986 Christmas holiday that were chosen for the purported involvement of Leasing in the Partnership ensured that no business would be conducted.
30 The issue of whether an equipment leasing operation constitutes a business for the purposes of the Income Tax Act was before this Court in Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336. In that case, L’Heureux‑Dubé J., with whom the majority agreed on that point, found that a leasing business was in fact carried on by a company to which a subsidiary transferred its leasing assets, in circumstances where the parent’s sole business activity was the passive receipt of rent. At p. 359, she held:
Where machinery is rented out, the essential core operations may at times be limited to accepting rental revenue and assuming the business risk and other obligations. At any time during that period, any client could demand the execution of any of the contractual obligations, such as fixing an engine, for example. Where, because a rental business is fortunate enough to experience no mechanical breakdowns or accidents during a period of time, it “passively” accepts rental revenue and assumes business risk and obligations, it does not necessarily follow that it is not carrying on a business during that period. Holding otherwise would imply that rental businesses are “intermittent”, that is, that they carry on a business only when something goes wrong in the operations. Such a proposition is unacceptable.
31 In the present instance, it is true that between December 24 and December 27, 1986, no meetings were held, no new transactions were entered into by the parties and no decisions were made. However, that is not determinative of the fact that no business was carried on by the Partnership. Prior to its entering the Partnership, Leasing carried on business. This business and its assets were transferred to the Partnership on December 24, 1986. There was no termination of Leasing’s contracts with its customers and the contracts continued during the period of December 24 to December 27.
32 Evidence that the business previously carried on by Leasing was carried on by the Partnership is contained in a letter dated December 24, 1986 from Air Canada, one of the Bank’s customers. In the letter, Air Canada acknowledges that “[Leasing] intends to sell and assign its interest in the Purchase Agreements, the Aircraft and the Leases to an Ontario partnership . . .”. Air Canada consented to the “sale and assignment of the Purchase Agreements, the Aircraft and the Leases” from the Bank to Leasing and consented “to the sale and assignment of the Purchase Agreements, the Aircraft and the Leases by [Leasing] to the Partnership”.
33 The fact that no new business was created during the period of Leasing and the Bank’s involvement in the Partnership does not negate the effect of the existing business that was continued during this time. The existence of a valid partnership does not depend on the creation of a new business. It is common that partnerships are formed when two parties agree to carry on the existing business of one of them, while the other contributes capital.
34 In addition, I am satisfied that the business that was carried on was carried on by the partners in common. Under the Partnership Agreement, the Partners “delegate to the Managing Partner full power and authority to manage, control, administer and operate the business and affairs of the Partnership and to represent and enter into transactions which bind the Partnership” (Art. 4.01). The fact that the management of the Partnership was given to the Managing Partner does not mandate a conclusion that the business was not carried on in common. Nor does the fact that Central, acting alone, was negotiating transactions relating to the lease portfolios prior to December 29, 1986. The respondent argues that the exclusion of Leasing and the Bank from any of those activities negates any claim that the Central entities and the Continental entities were actually carrying on business in common during that period. As Lindley & Banks on Partnership, supra, point out, at p. 9, one or more parties may in fact run the business on behalf of themselves and the others without jeopardizing the legal status of the arrangement.
35 If any of the negotiations that Central was involved in had resulted in a decision by Central’s subsidiaries who were members of the Partnership during the relevant period to follow through with the transaction, under the Partnership Agreement, the Partnership would have been bound by these agreements. By entering the Partnership Agreement, Leasing and the Bank recognized that any partner had the authority to bind the firm.
36 It is also relevant that during the brief term that Leasing and the Bank were parties to the Partnership Agreement, they held themselves out as partners. Various supporting documents, including correspondence with third parties, tax returns, financial statements and assignments of leases effected during this period, are consistent with the carrying on of a business in common. While this alone would not have the effect of validating the Partnership, because holding out affects liability as against third parties and not the essential validity of the arrangement (s. 15, Partnerships Act), it is nonetheless evidence of the parties’ intention to carry on business in common under the Partnership.
37 Bowman J.T.C.C. was correct in emphasizing that the members of the Partnership could not hold themselves out to third parties as not being partners. In the Partnership Agreement, art. 3.02 sets out the liability of the partners. It provides in part: “[s]ubject to Article XI, the Partners shall, as between themselves, be liable for the obligations, liabilities and losses of the Partnership in the same proportion as their respective Interests.” The Partnership was involved in the leasing of aircraft. If, during the period in which Leasing and the Bank were members of the Partnership, liability of the lessor was engaged because of an event involving a leased aircraft, Leasing and the Bank could not have denied that they were members of the Partnership and, according to art. 3.02, would have been liable for 99 percent of the loss incurred by the lessee.
38 The Bank and Leasing conducted themselves as partners for the duration of their memberships in the Partnership. Throughout that period, they were subject to all of the rights and obligations of partners and carried on the business of leasing in common with the other partners. There is no evidence to show that the leasing business carried on as defined in Hickman, supra, was not carried on by Leasing and the Central subsidiaries.
(c) Was the Business Carried On in Common with a View to Profit?
39 The Court of Appeal held that the parties intended to conduct a sale of assets through a device they chose to call a partnership. This intention did not include a view to profit and in fact “the idea to share profits was an afterthought when the parties originally put the deal together” (p. 731). This characterization by the Court of Appeal ignores the fact that the Partnership Agreement provided for the distribution of the profits from the leasing business being operated by the Partnership and that the Partnership continued to carry on the business operated for profit by Leasing. There is no evidence of any expectation other than that profits would continue to be generated during the predetermined term of Leasing’s involvement in the Partnership. The Court of Appeal also relied heavily on the fact that Leasing was not legally entitled to a share of the profits of the first fiscal year because its partnership interest had already been transferred to the Bank by the time the year end was triggered on December 27, 1986. This, however, is irrelevant to the determination of the issue.
40 To determine whether the business was carried on with a view to profit, it is necessary to look to the provisions of the Partnership Agreement governing the distribution of profits.
5.06 Allocation of Net Income or Loss. The net income or loss for each fiscal year of the Partnership shall be allocated to the current accounts of the Partners in proportion to their respective average capital accounts for the period for which the allocation is made.
5.09 Allocation of Income and Loss for Tax Purposes. The income or loss of the Partnership for the whole of a fiscal year for the purposes of the Income Tax Act shall be allocated to those Persons who are Partners on the last day of the fiscal year of the Partnership in the proportions set out in section 5.06. The income or loss of the Partnership which is allocated to those Partners shall be allocated among those Partners as of the time and in the proportions set out in this article.
41 These provisions clearly contemplate the distribution of profits in accordance with a partner’s interest in the Partnership. Profit was accumulated by the Partnership during the period of Leasing’s membership in that partnership and that profit was distributed. Leasing received a cheque dated February 4, 1987 for $130,726 that was described in a financial statement dated January 11, 1988 as a 99 percent share of partnership income for the period December 24 to December 27, 1986. Because Leasing had already transferred its partnership interest to the Bank by December 27, 1986, it was not entitled to receive the partnership income under the Partnership Agreement as it was no longer a partner at year end. This however, does not change the fact that a generation of profit and profit sharing was contemplated and effected under the Partnership Agreement. Whether the entitlement belonged to Leasing or to the Bank at the end of the year is of no consequence. The important consideration is that the 99 percent partnership interest owned initially by Leasing and then the Bank carried with it a right to share in the profits of business carried on by the Partnership.
42 It is not disputed that the ultimate objective of the series of transactions entered into by the parties and in particular the Partnership was to duplicate the tax consequences of the original share transaction with Central. The Bank’s main intention and by extension, Leasing’s main intention was to get rid of its leasing assets for the purpose of winding up. As Bowman J.T.C.C. held, at p. 2151:
One thing is clear. Notwithstanding the pious assertions of a number of witnesses that they intended to enter into a partnership with the other parties, [the Bank’s] and [Leasing’s] intention was patently not to go into the leasing business in partnership with [Central]. . . . The whole object of the exercise was precisely the opposite — to get out of that business. The partnership was merely a means to that end.
43 Simply because the parties had the overriding intention of creating a partnership for one purpose does not, however, negate the fact that profit-making and profit-sharing was an ancillary purpose. This is sufficient to satisfy the definition in s. 2 of the Partnerships Act in the circumstances of this case. At pp. 10-11, Lindley & Banks on Partnership makes the following observation:
. . . if a partnership is formed with some other predominant motive [other than the acquisition of profit], e.g., tax avoidance, but there is also a real, albeit ancillary, profit element, it may be permissible to infer that the business is being carried on “with a view of profit.” If, however, it could be shown that the sole reason for the creation of a partnership was to give a particular partner the “benefit” of, say, a tax loss, when there was no contemplation in the parties’ minds that a profit . . . would be derived from carrying on the relevant business, the partnership could not in any real sense be said to have been formed “with a view of profit.”
44 This is not a case where the disentitlement of one partner to a share of the profits was agreed to by the parties; nor is it a case where no profits were anticipated during the term of a partner’s involvement. During the period in which Leasing and the Bank were partners in the business, the Partnership earned a profit from its leasing operations and that profit was distributed at year end.
45 The respondent argues that intending to constitute a valid partnership is not the same thing as intending to carry on business in common with a view to profit. I agree. The parties in the present case, however, set up a valid partnership within the meaning of s. 2 of the Partnerships Act. They had the intention to and did carry on business in common with a view to profit. This conclusion is not based simply on the parties’ subjective statements as to intention. It is based on the objective evidence derived from the Partnership Agreement entered into by the parties. As Millett L.J. held in Orion Finance, supra, at p. 85:
The question is not what the transaction is but whether it is in truth what it purports to be. Unless the documents taken as a whole compel a different conclusion, the transaction which they embody should be categorised in conformity with the intention which the parties have expressed in them.
46 I do not see anything in the documentation that is inconsistent with the intention of the parties to create a partnership within the meaning of the Partnerships Act.
(d) Duration of the Partnership
47 In the present case, the Partnership Agreement provided for a fixed term of membership for Leasing and the Bank in the Partnership. It also provided that the Partnership would continue indefinitely after Leasing and the Bank were no longer members (Article XI, Initial Transactions). There is no authority for the proposition that a valid partnership cannot be formed for fixed or relatively short and predetermined periods, nor is there authority for the proposition that a person cannot be a member of a partnership for a single transaction. The respondent recognized that there is no set minimum period of time required for a partnership to exist and accepted that a partnership may be formed for a predetermined period. The respondent argues, however, that a partnership, being a relationship that “subsists” and that pertains to the “carrying on” of a business in common with others, has a temporal quality. In the present case, the respondent argues, no business was carried on between December 24, 1986 and December 26, 1986, the period that Leasing was a member of the Partnership.
48 The duration of Leasing’s membership in the Partnership is not relevant in this case. I found above that business was carried on in common with a view to profit through the leasing activities of the Partnership between December 24 and December 27. This satisfies the definition of partnership under the Partnerships Act. It is not necessary for Leasing to show that it carried on business over a long period of time in the Partnership. The Partnerships Act does not limit the ability of a person to enter into a partnership for a single transaction. As long as the parties do not create what amounts to an empty shell that does not in fact carry on business, the fact that the partnership was created for a single transaction is of no consequence.
49 Section 85(1) of the Income Tax Act is a rollover provision for corporations similar to the provision for partnerships contained in s. 97(2). Corporations are frequently created for the single purpose of deferring tax liability by using s. 85(1) of the Income Tax Act. As long as the corporation is validly formed, there is no requirement that the taxpayer demonstrate that the corporation was formed for anything other than the single purpose of deferring tax liability. Similarly, as long as the definition in s. 2 of the Partnerships Act is satisfied, a person is permitted to create a partnership for the purpose of using s. 97(2) of the Income Tax Act. It is recognized that the definition of a partnership requires that business actually be carried on and that there is no such requirement for a corporation. However, that does not detract from the principle that a person should be permitted to create a partnership for a single transaction.
50 The Court of Appeal held, in effect, that because the ultimate objective of the Bank in proceeding with the partnership transaction was to effect a sale of its leasing business to Central, neither Leasing nor the Bank could have had the requisite intention to form a valid partnership. The result of this reasoning is that unless the only motive underlying the formation of a partnership is to carry on business in common with a view to profit, a valid partnership cannot be formed. The underlying premise of this reasoning is also that a transaction that is motivated by the securing of tax benefits is not a valid transaction. This reasoning cannot be supported.
51 A taxpayer who fully complies with the provisions of the Income Tax Act ought not to be denied the benefit of such provisions simply because the transaction was motivated for tax planning purposes. In Stubart Investments, supra, this Court unanimously rejected the “business purpose test” and affirmed the proposition that it is permissible for a taxpayer to take advantage of the terms of the Income Tax Act by structuring a transaction that is solely motivated by the desire to minimize taxation. Similarly, in Canada v. Antosko, [1994] 2 S.C.R. 312, Iacobucci J., for a unanimous Court, found, at p. 328:
In this appeal, despite conceding that these factual elements are present, the respondent is asking the Court to examine and evaluate the transaction in and of itself, and to conclude that the transaction is somehow outside the scope of the section in issue. In the absence of evidence that the transaction was a sham or an abuse of the provisions of the Act, it is not the role of the court to determine whether the transaction in question is one which renders the taxpayer deserving of a deduction. If the terms of the section are met, the taxpayer may rely on it, and it is the option of Parliament specifically to preclude further reliance in such situations.
Iacobucci J. went on to say, at p. 330:
This transaction was obviously not a sham. The terms of the section were met in a manner that was not artificial. Where the words of the section are not ambiguous, it is not for this Court to find that the appellants should be disentitled to a deduction because they do not deserve a “windfall”, as the respondent contends. In the absence of a situation of ambiguity, such that the Court must look to the results of a transaction to assist in ascertaining the intent of Parliament, a normative assessment of the consequences of the application of a given provision is within the ambit of the legislature, not the courts.
52 Having found that the transaction was not a sham, the Court of Appeal should not have found that the parties lacked the requisite intention to form a valid partnership simply because the transaction was motivated by a resulting tax benefit. The Court of Appeal proceeded on the basis that the predominance of fiscal motives or the absence of a concurrent business purpose justifies or compels the court to disregard the legal form of the transaction which the parties intended.
53 The legal and commercial reality in the present case is that Leasing intended to and did enter into a partnership with Central within the meaning of s. 2 of the Partnerships Act. The Court of Appeal erred by ignoring the substance of a legally effective transaction.
2. If Leasing was a member of a valid partnership within the meaning of s. 2 of the Partnerships Act, was the partnership rendered invalid by s. 174(2)(i) of the Bank Act, by s. 34 of the Partnerships Act, or by the common law doctrines of illegality or ultra vires?
54 Section 174(2)(i) of the Bank Act states that a bank “shall not, directly or indirectly . . . acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership”. There is no dispute that the entry into a partnership constitutes a breach by the Bank of s. 174(2)(i) of the Bank Act. The Bank therefore contravened the Bank Act by indirectly investing or participating in a partnership. The dispute concerns the effect of ss. 18(1) and 20(1) of the Bank Act, the applicability of the ultra vires doctrine, the effect of the doctrine of illegality and the effect of s. 34 of the Partnerships Act.
(a) Ultra Vires
55 The ultra vires doctrine was developed by the courts in the mid-19th century to restrict the legal capacity of corporations created under the Companies Act and its successor statutes. The doctrine provided that a corporation had the legal capacity to perform only those acts authorized by its articles. Any acts not authorized by the articles were void for want of legal capacity (Ashbury Railway Carriage and Iron Co. v. Riche (1875), L.R. 7 H.L. 653).
56 The doctrine was meant to limit the scope of activities of a corporation in order to protect the interests of its creditors and shareholders. It came to be recognized that the doctrine produced inconvenience and occasional hardship for the public who were expected to take notice of all limitations on the corporation’s capacity as revealed through public documents. The doctrine was characterized by Iacobucci J. in Communities Economic Development Fund v. Canadian Pickles Corp., [1991] 3 S.C.R. 388, at p. 406, as “a protection to no one and a trap for the unwary”.
57 In 1974, the Canada Business Corporations Act, S.C. 1974-75-76, c. 33 (“CBCA”), abolished the ultra vires doctrine in the context of Canadian corporations by attributing to corporations the capacity of a natural person. Section 15(1) of the CBCA provided that “[a] corporation has the capacity and, subject to this Act, the rights, powers and privileges of a natural person”. The CBCA also provides at s. 16(3) that “[n]o act of a corporation, including any transfer of property to or by a corporation, is invalid by reason only that the act or transfer is contrary to its articles or this Act”.
58 In 1980, the Bank Act was amended to provide, in s. 18(1), that “[a] bank has the capacity and, subject to this Act, the rights, powers and privileges of a natural person”. Section 20(1) states that “[n]o act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act”. These amendments parallel the amendments to corporations Acts and their aim is also to abolish the ultra vires doctrine. As a result of s. 18(1), banks were given the legal capacity to perform any act, even if it would constitute an offence under the Bank Act. M. H. Ogilvie, Canadian Banking Law (1991), states, at p. 35:
When a bank engages in any conduct — including the transfer of property to or by a bank — which is contrary to the Bank Act, the conduct is not invalid, rather merely contrary to the Act. At common law, when a company had been found to have engaged in an ultra vires transaction, the legal effect was to render that transaction void and unenforceable. Since 1980, that is no longer the case in relation to transactions with banking corporations. Legal rights and duties created in transactions prohibited to banks by the Act and conferred on third parties are valid and no longer subject to disturbance by judicial avoidance of the original prohibited transaction. Rather, the bank is subject to the penalties set out in the Bank Act, and probably also those existing in the general law, for engaging in prohibited actions.
59 Crawford and Falconbridge, Banking and Bills of Exchange (8th ed. 1986), vol. 1, states a similar principle, at p. 94:
It will be noted that the Bank Act bestows on the banks the capacity of a natural person, without limitation or qualification. The reference to the other provisions of the Act qualifies only the rights, powers and privileges of the banks. In other words, the banks now have the legal capacity to perform any act, even though it may constitute an offence under the Bank Act or some other law. Like man, in Milton’s view, they have been created capable of standing, but free to fall. A good illustration of this is provided by sub-s. 174(2), which prohibits the banks from engaging in the activities therein described. A violation of one of those prohibitions by a bank would not result in the transaction involved being void — or even necessarily voidable. . . . It would, however, subject the bank, and possibly also the directors, to the penalties set out in sub-ss. 174(17) to (20) and sub-s. 54(2) respectively.
60 The doctrine of ultra vires has been abolished with respect to banks. Banks now have the capacity of a natural person. The Court of Appeal came to the wrong conclusion in this regard because it misapplied the Canadian Pickles case by relying on it to hold that the ultra vires doctrine is not abolished, but merely curtailed by s. 18(1) of the Bank Act. The Court of Appeal erred by failing to recognize the distinction between the statutory provisions in Canadian Pickles and the relevant provisions of the Bank Act.
61 In Canadian Pickles, this Court held that the doctrine of ultra vires has been abolished for corporations incorporated under most business corporations legislation. The Court held, however, that the doctrine was still alive with respect to the Communities Economic Development Fund of Manitoba. The Court stated that the doctrine continues to apply to corporations created by special Act for public purposes. At pp. 406-7, Iacobucci J. held:
However, in spite of the general trend towards abolition of the doctrine of ultra vires, the limited aspects of the doctrine, as seen from the above review, may be present with respect to corporations created by special act for public purposes. Not only is there a long line of cases supporting the principle, but one may argue that this protects the public interest because a company created for a specific purpose by an act of a legislature ought not to have the power to do things not in furtherance of that purpose. Of course, it is open to the legislature to rebut this presumption because, for example, the legislature may provide for other remedies short of invalidity for acts contrary to the statute.
62 Banks are not analogous to the Economic Development Fund described in the Canadian Pickles case. The Bank was not created by a special Act for public purposes. It was incorporated under a general Act of Parliament to engage in the ordinary commercial business of banking. Parliament has provided for other remedies short of invalidity for acts of banks that are contrary to the statute. The Bank Act contains penalties for breaches and, pursuant to s. 246 of the Act, the Inspector General of Banks is empowered to “take charge on the premises of the assets of the bank or any portion thereof, if the need should arise, for the purposes of satisfying himself that the provisions of this Act . . . are being duly observed”.
63 The Bank, by virtue of its capacity, rights, powers and privileges, had the capacity to participate in a partnership. The prohibition in s. 174(2)(i) of the Bank Act does not make partnerships ultra vires the Bank. The questions remain, however, whether the Bank’s participation in the Partnership is void on the basis of the doctrine of illegality or by virtue of s. 34 of the Partnerships Act.
(b) The Doctrine of Illegality
64 Under the doctrine of illegality, a contract prohibited by statute or for an illegal purpose will be declared void even if it conforms to all other requirements of a valid transaction. A classic case concerning statutory illegality is Cope v. Rowlands (1836), 2 M. & W. 149, 150 E.R. 707, where Parke B. held (at p. 710):
. . . where the contract which the plaintiff seeks to enforce, be it express or implied, is expressly or by implication forbidden by the common or statute law, no court will lend its assistance to give it effect. It is equally clear that a contract is void if prohibited by a statute, though the statute inflicts a penalty only, because such a penalty implies a prohibition.
65 It should follow, therefore, that the absolute prohibition of a contract by a statute renders the contract void and of no effect. However, as G. H. L. Fridman points out in The Law of Contract in Canada (3rd ed. 1994), at p. 348:
It might be thought . . . that the doctrine was clear and uncomplicated, that whenever a statute prohibited a certain course of conduct, or required a particular course of conduct, the failure to observe which resulted in a penalty of some kind, a contract which infringed the statutory prohibition or requirement would be illegal and therefore void. This situation is not as straightforward as that. . . . in some instances a statute while involving illegality, in the sense of prescribing penalties for certain conduct, will not have the effect of rendering void a contract entered into in breach of the statute.
66 In fact, the rigidity of the doctrine of illegality first gave rise to exceptions which dealt with the return of property transferred under an illegal contract (Fridman, supra, at p. 424). This development was nevertheless considered insufficient. In Sidmay Ltd. v. Wehttam Investments Ltd. (1967), 61 D.L.R. (2d) 358 (Ont. C.A.), aff’d on other grounds, [1968] S.C.R. 828, Laskin J.A. (as he then was) held that the court must take into account the harmful effect on the parties for whose protection the law making the bargain illegal exists before deciding to enforce or rescind the bargain. This approach was also adopted by Krever J. (as he then was) in Royal Bank of Canada v. Grobman (1977), 18 O.R. (2d) 636 (H.C.), at pp. 652-53.
67 The doctrine of illegality was recently examined by the Federal Court of Appeal in Still v. Minister of National Revenue (1997), 221 N.R. 127. Robertson J.A. noted at the outset that the doctrine of illegality is divided into two categories: common law illegality and statutory illegality. With regard to statutory illegality, he noted that the classic approach affirmed in Neider v. Carda of Peace River District Ltd., [1972] S.C.R. 678, had given rise to many avoidance techniques in the courts, particularly where the illegality resulted from the performance of the contract rather than its formation. On the issue of formation, Robertson J.A. was prepared to expand the modern approach to illegality further, stating, at p. 139, that “a finding of illegality is dependent, not only on the purpose underlying the statutory prohibition, but also on the remedy being sought and the consequences which flow from a finding that a contract is unenforceable”.
68 The Court of Appeal held that not all findings of invalidity are prohibited by s. 20(1) of the Bank Act. This approach is supported by Crawford and Falconbridge, supra, and Ogilvie, supra. Crawford and Falconbridge state, at p. 97:
But it should be noted that s. 20 refers to invalidity “by reason only” of acts in contravention. That leaves open the possibility that vestiges of the common law sanctions upon unlawful conduct might still apply. For example, the modern approach of the courts could not be relied upon to validate or enforce an agreement consciously and deliberately entered into in violation of the Bank Act. . . .
69 The appellant’s position is that s. 20(1) of the Bank Act has the effect of eliminating the continued application of the doctrine of illegality. A construction of s. 20(1) that completely ousts the Court’s jurisdiction to find an act of the bank invalid would impose a requirement that a court recognize all acts as valid, no matter how egregious the illegality. The respondent argues that to find that no act done by a bank that is contrary to the Bank Act is invalid is to render the prohibitions set out in s. 174(2) of the Act meaningless. In answer to this, the appellant submits that the proper effect to be given to the prohibitions in the Bank Act is that the penalties set out in the Bank Act amount to a mere licence fee for doing what the Bank Act prohibits.
70 The consequence of prohibiting certain transactions under the Bank Act can be disastrous for third parties who may be unaware of the limitations on a bank’s rights. The consequences are the same as those identified by courts and Law Reform Commissions which criticized the rigid application of a declaration of invalidity under the doctrine of illegality as it relates to statutory prohibitions. I agree with the Court of Appeal, however, that s. 20(1) on its face does not limit all findings of invalidity. Section 20(1) states that no act of a bank is invalid by reason only that the act is contrary to the Act. This section serves, in particular, to relieve the hardship for unsuspecting third parties of the effects of a rigid application of the doctrine of illegality but does not eliminate the doctrine entirely. A. R. Manzer, in an annotation to this section in The Bank Act Annotated (1993), at p. 29, states:
This provision is for the benefit of third parties dealing with a bank by preventing actions of the bank from being declared null and void and consequently of no effect, only because they are contrary to the bank’s incorporating instrument or the Bank Act.
71 There is no conflict between the doctrine of ultra vires and a finding that s. 20(1) does not eliminate all findings of illegality. The apparent conflict between the doctrine of illegality and the doctrine of ultra vires must be addressed by referring to the foundations of those doctrines. It is not the capacity of the bank to enter into a partnership that is limited by a finding of invalidity. Rather, it is the right of the bank to participate in certain activities that may be limited. The distinction between capacity under the ultra vires doctrine and illegality was explained by F. W. Wegenast in The Law of Canadian Companies (1979), at pp. 136-37, where he stated:
It must be borne in mind also that the entire absence of the ultra vires rule would not mean that there were no limitations on the legal rights of a corporation. Just as a natural person is capable of doing things that are unlawful, so the capacity of a corporation may be broader than its rights. It has been said that “ultra vires and illegality represent totally different ideas,” although a prohibition may be in such form that it renders the prohibited act both illegal and ultra vires. But an act which is ultra vires is not necessarily either malum in se or malum prohibitum. On the other hand, although it may be true, generally speaking, that a corporate act expressly forbidden by statute is ultra vires, it is also clear that an act may be illegal without being ultra vires, and remedies are available to enforce the legal limitations of corporations without invoking the plea of ultra vires. In many cases, indeed, it would be quite immaterial whether the question were raised as one of right or of capacity. Thus in the case of a shareholder seeking an injunction to restrain the company from any particular act it would be a sufficient ground to say that the company had not the right to do the act, without saying that it was not capable. The same could be said as regards action on behalf of the Crown by way of scire facias or otherwise. [Emphasis in original.]
72 Section 20(1) is a saving provision. It is not a provision allowing a bank to do what it is prohibited from doing. Since it is a saving provision, the same principles that guide the modern doctrine of illegality should guide a finding of invalidity under the Bank Act. In the present case, a declaration that the bank’s participation in the Partnership is prohibited does not harm any third party. The bank deliberately contravened the Bank Act and it appears from the evidence that it did so with the knowledge of the other partners. However, a finding of invalidity on the basis of illegality in the present case would deprive s. 20(1) of any effect. The doctrine of illegality would be triggered by the prohibition set out in s. 174(2)(i) of the Bank Act. To find that the Partnership is invalid on this basis alone amounts to a finding on invalidity by reason only of an act in contravention of the statute.
73 It does not follow, however, as the appellant argued, that the prohibitions set out in the Bank Act amount to a licensing scheme. These are clear restrictions on the Bank’s right to enter into transactions. Section 20(1), in this context, precludes a finding of invalidity that is based only on a breach of the statute. There are other remedies, in the Bank Act in particular, to enforce the prohibitions set out in the Bank Act. For example, pursuant to s. 246 of the Bank Act, the Inspector General of Banks is empowered to “take charge on the premises of the assets of the bank or any portion thereof, if the need should arise, for the purposes of satisfying himself that the provisions of this Act . . . are being duly observed”.
74 Although I accept that s. 20(1) is not a complete bar to the application of the doctrine of illegality in the appropriate case, I do not think that it applies in the present circumstances. I will now examine the application of s. 34 of the Partnerships Act on the validity of the partnership created on December 24, 1986.
(c) The Partnerships Act
75 The Court of Appeal held that s. 34 of the Partnerships Act expressly dissolved any partnership that may have been created in the present case because s. 174(2)(i) of the Bank Act made it unlawful within the meaning of s. 34 for members of the firm to carry on the Partnership. Section 34 provides:
34. A partnership is in every case dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.
76 The appellant argues that the Court of Appeal erred because the penalty imposed by s. 174(16) of the Bank Act represents what has been described as “the price of a licence for doing what the statute apparently forbids.” Therefore, it does not compel the conclusion that either the Bank or Leasing was incapable of becoming a member of a valid partnership or that the Partnership was automatically dissolved after its formation on the basis of unlawfulness, pursuant to s. 34.
77 Both the Court of Appeal and the appellant rely on Lindley & Banks on Partnership, supra, at p. 135, where it states:
. . . although a statute may appear to prohibit certain activities and impose a penalty for failure to observe its provisions, it does not follow that conduct which would attract the penalty is necessarily illegal. If the statute can genuinely be classed as prohibitory, as will be the case if the penalty is imposed for the protection of the public, then such conduct will be illegal. Per contra if, on a true construction of the statute, the penalty merely represents, as Lord Lindley put it, “the price of a licence for doing what the statute apparently forbids.”
78 The penalty provision in the Bank Act dealing with the participation in a Canadian partnership contrary to s. 174(2)(i) is contained in s. 174(16). It reads as follows:
174. . . .
(16) A bank that contravenes any of paragraphs (2)(a), (c), (f), (h), (i) or (j) is guilty of an offence and liable on summary conviction to a fine not exceeding five hundred dollars in respect of each contravention.
79 It is argued that s. 34 of the Partnerships Act and s. 20(1) of the Bank Act are in conflict because s. 20(1) ensures that all acts done contrary to the Bank Act are not invalid by reason only of a contravention of the statute. The effect of s. 20(1), it is argued, is that no acts done contrary to the Bank Act are unlawful. By paying the “licence fee” set out in s. 174(2) of the Bank Act, a bank is permitted to enter into a partnership. For s. 34 of the Partnerships Act to then render the participation of a bank in a partnership unlawful is contrary to the Bank Act as it prohibits what the Bank Act allows. What is argued, in effect, is that the Bank Act, as a federal statute, must prevail over the Partnerships Act, which is a provincial statute.
80 The wording of the penalty provision contained in s. 174(16) makes it clear that the prohibitions contained in s. 174(2) do not amount to a regulatory scheme providing that licence fees be paid for what the Bank Act prohibits. To interpret the section in this manner ignores the clear wording of the Bank Act. Section 174(16) labels a contravention of the Act an “offence” subject to “summary conviction” and sets out what amounts to a fine. Moreover, even if the combination of ss. 18(1) and 20(1) serves to preserve the validity of the transaction that is prohibited by the Act, the action is no less “unlawful” within the meaning of s. 34 of the Partnerships Act because it is an action that is contrary to the clear wording of the Bank Act.
81 As I do not accept that the penalties outlined in s. 174(16) represent a licence fee for doing what the Bank Act clearly prohibits in s. 174(2), I do not find that s. 20(1) of the Bank Act and s. 34 of the Partnerships Act are in conflict. The effect of s. 34 of the Partnerships Act is clear: the unlawfully formed partnership is dissolved ab initio. The stipulation in s. 20(1) of the Bank Act, that no act of a bank is invalid by reason only of a contravention of that Act, is of no consequence; the act is not invalid by reason only of the prohibition in s. 174(2)(i), but rather by reason of the effect of the contravention on the validity of the partnership under another statute, the Partnerships Act. Payment of the penalties set out in s. 174(16) of the Bank Act does not render lawful what the Bank Act prohibits.
82 The respondent submits that s. 34 of the Partnerships Act should be construed to render invalid any partnership entered into by the Bank or its subsidiary. It can be argued, however, that the effect of dissolving the Partnership under s. 34 of the Partnerships Act, when Leasing became a partner, is to make Leasing subject to the prohibitions in the Bank Act. If Leasing were subject to the prohibitions in the Bank Act, it would be unlawful for it, as a partner, to carry on the business of the Partnership and would therefore be contrary to s. 34 of the Partnerships Act. The argument is that the Bank is subject to the prohibitions and penalties set out in the Bank Act, but that Leasing’s activities are not made unlawful because of the Bank’s breach of the statute. To hold otherwise would amount to lifting the corporate veil to determine who are the investors who hold shares in a corporate partner and to determine if the investor has been involved in any unlawful activity.
83 I do not accept that a finding that the Partnership is unlawful under s. 34 necessitates a finding that Leasing is subject to the prohibitions in the Bank Act. Section 34 of the Partnerships Act states that a partnership is dissolved upon the happening of an event that makes it unlawful “for the business of the firm to be carried on or for the members of the firm to carry it on in partnership” (emphasis added). The prohibitions in the Bank Act clearly make it unlawful for a bank to “indirectly” participate in a partnership. Any indirect participation by a bank, i.e., participation through a subsidiary company, makes the carrying on of business in the partnership “unlawful” within the meaning of s. 34 of the Partnerships Act.
84 With regard to the second part of s. 34, under the reasoning that it cannot be unlawful for Leasing to be a member of the Partnership because it is not subject to the prohibitions of the Bank Act, the unlawful event must have occurred when the Bank, which is clearly subject to the Bank Act, became a partner on December 27, 1986. The Partnership would therefore have been dissolved on December 27, 1986. I do not accept, however, that the “unlawful” event under s. 34 of the Partnerships Act occurred only when the Bank directly became involved in the Partnership on December 27, 1986. In my view, Leasing’s participation in the Partnership on December 24, 1986 can still be considered “unlawful” within the meaning of s. 34 of the Partnerships Act by reason of the public policy component of the common law doctrine of illegality.
85 The public policy component of the common law doctrine of illegality was not specifically pleaded in the present case; however, the respondent did plead that the Partnership was rendered invalid by s. 34 of the Partnerships Act because of the Bank’s or Leasing’s involvement in the Partnership. Moreover, as Krever J. (as he then was) set out in Menard v. Genereux (1982), 39 O.R. (2d) 55 (H.C.), at p. 64:
It is, however, well established that whether or not they are pleaded, if facts are shown in the course of a trial which may render an agreement unenforceable by reason of illegality or public policy a court must take these facts into consideration and, depending on the circumstances, act upon them if necessary by refusing to lend its assistance to a party seeking to enforce his or her rights by relying on the agreement.
86 I have discussed the doctrine of illegality as applied to contracts prohibited by statute. The common law doctrine of illegality and its effect on the validity of a contract must also be considered with regard to acts contrary to public policy. The development of the law in this area can be traced to Holman v. Johnson (1775), 1 Cowp. 341, 98 E.R. 1120, where Lord Mansfield stated, at p. 1121:
The principle of public policy is this; ex dolo malo non oritur actio. No Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action appears to arise ex turpi causâ, or the transgression of a positive law of this country, there the Court says he has no right to be assisted. It is upon that ground the Court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff.
87 Since Holman, the courts have examined many transactions which involve what the courts considered to be immoral or illegal acts. The public policy in the present case is similar to the public policy recognized in the case law where the courts have refused to uphold a contract to commit a crime. To enforce a contract of this type is to recognize that it is valid to agree to circumvent the law for economic gain. As Cheshire, Fifoot and Furmston’s Law of Contract (13th ed. 1996), explains, at p. 375: “An allied rule of public policy is that no person shall be allowed to benefit from his own crime.”
88 While it may not be strictly contrary to the Bank Act for Leasing to enter into a partnership, the parties to the agreements are, in effect, asking that they be permitted to benefit from a deliberate breach of the provisions of the Bank Act. In this case, it is clear that, by virtue of s. 174 of the Bank Act, the Bank is prohibited from directly or indirectly participating in a partnership. The parties to the Master Agreement and the Partnership Agreement were aware of this prohibition, but proceeded to enter into the Partnership with this knowledge. It is worth reiterating that Leasing declined to give the representations and warranties regarding qualification to carry on the business of the Partnership that had been requested of all proposed members.
89 The Bank negotiated the terms of the Master Agreement and set up a transaction that it hoped would allow it to circumvent the terms of the Bank Act and avoid the consequences of the dissolution section in s. 34 of the Partnerships Act. To find that the Partnership is dissolved when the Bank directly becomes involved on December 27, 1986 but not when Leasing, acting for the Bank, became involved in the Partnership on December 24, 1986 is to give effect to a transaction that offends public policy. To sanction the participation of Leasing in the Partnership is to sanction the agreement to circumvent the provisions and penalties of the Bank Act and the Partnerships Act.
90 Is the finding that the transaction offends public policy sufficient to label the transaction illegal? As noted earlier, Still, supra, sets out the modern approach to this area of the law. At p. 138, Robertson J.A. explains the differences between the classical model of illegality and the modern approach. He states that the modern approach to illegality recognizes that a contract will not be considered void ab initio simply because it is prohibited. Under the modern approach, the contract can be declared illegal, and relief may be granted as an exception, or the contract can be held not to be illegal, and therefore enforceable. Enforceability of a contract depends upon an assessment of the purpose and objects of the prohibition, in the context of the case.
91 Similarly, C. Boyle and D. R. Percy, eds., in Contracts: Cases and Commentaries (5th ed. 1994), state, at p. 719:
One way of conceptualizing this area might be to focus on the instances where public or communitarian concerns override the contracting parties’ interests in ordering their private affairs as they choose. . . . This approach is well-expressed in the early case of Maddox v. Fuller (1937), 173 So. 12 at 16: “The true test . . . is whether the public interest is injuriously affected in such substantial manner that private rights and interests should yield to those of the public.”
92 Boyle and Percy go on to state that “[o]n the other hand, it is possible to see the enforcement of certain contracts as reflecting public policy concerns just as much as the non-enforcement of other contracts”. The proper question therefore, in my view, is whether it is in the interests of public policy to recognize the validity of the Partnership or whether it is in the interests of public policy to refuse to give effect to the transaction. In all of the circumstances, I conclude that it is contrary to public policy to allow the parties to the transaction to benefit from their deliberate breach of the prohibitions set out in the Bank Act. No third party will be harmed by the refusal to give effect to the transaction. All of the parties to the Master Agreement and the Partnership Agreement were aware that they were assisting the Bank in breaching the statute. The only hardship that may result from a finding that the formation of the Partnership on December 24, 1986 is illegal at common law on the grounds of public policy is that Leasing will not benefit from the deferred tax payment under s. 97(2) of the Income Tax Act.
93 Even though I have found that Leasing’s participation in the Partnership is illegal on the ground of public policy, it is not necessary in this case to consider the effect of a finding of illegality at common law and the possible remedies set out in G. H. Treitel, The Law of Contract (9th ed. 1995), at pp. 438-66; Cheshire, Fifoot and Furmston’s Law of Contract, supra, at pp. 385-406. The result of a finding that Leasing’s participation in the Partnership is contrary to public policy is that it is “unlawful” within the meaning of s. 34 of the Partnerships Act and that the Partnership is dissolved.
94 In closing on this issue, I wish to add that a finding that the Bank was prohibited from participating in the Partnership, directly or indirectly, therefore rendering the transaction invalid, does not render invalid the participation of the other parties in the Partnership. The other two subsidiaries of Central (693396 and CCMI) were valid participants in the Partnership and in my view created a valid partnership at law between themselves on December 24, 1986. After Leasing and subsequently the Bank are removed from the Partnership, it continued as a valid entity. This proposition is supported by Hudgell Yeates & Co. v. Watson, [1978] 2 All E.R. 363 (C.A.). In that case, a partnership was dissolved by operation of s. 34 of the Partnership Act 1890, the same provision as that contained in the Ontario Partnerships Act, because one member of a law firm’s practising certificate lapsed without the knowledge of the other partners. The partnership, however, was reconstituted as a partnership between the remaining partners.
3. Was Leasing liable for recapture under s. 13 of the Income Tax Act as the person that disposed of its depreciable assets to the Central subsidiary?
95 Having found that Leasing was not a member of a valid partnership and could not take advantage of s. 97(2) of the Income Tax Act, I must determine whether Leasing is liable for recapture of capital cost allowance as the vendor of the leasing assets. Since the transaction entered into by the parties did not involve the transfer of a partnership interest, it follows that what was transferred from the Continental group to the Central group was leasing assets. Leasing claims that a finding that the property that was transferred to Central was leasing assets, rather than an interest in a partnership, does not make Leasing the vendor of those assets and, therefore, liable for the recapture of capital cost allowance. The Court of Appeal, after finding that no valid partnership existed, did not make an express finding that Leasing sold the leasing assets to Central. It simply attributed the recapture to Leasing and upheld the Crown’s reassessment. Bowman J.T.C.C. did not make a finding on this issue because once he found that a valid partnership had been formed, it was not necessary to determine who would have disposed of the assets if no partnership had been formed.
96 Leasing argues that it was the Bank that disposed of the leasing assets and on that basis, it is not liable for the recapture of capital cost allowance. Leasing stressed that the original transaction with Central was to be a sale of the shares in Leasing and that the Bank would have been the vendor, given that it was the sole shareholder in the company. While this may be true, I do not think that it follows that the Bank was the vendor of the leasing assets.
97 Having found that the substance of the transaction was a sale of assets, the conveyance of those assets occurred when Leasing signed the Master Agreement on December 23, 1986. The s. 97(2) election showed all three of the Central subsidiaries as transferees under the conveyance of assets, not just the two subsidiaries that signed the December 24, 1986 Partnership Agreement. The three Central subsidiaries appeared to have a bona fide intention to carry on business in common with each other and there was no legal prohibition to prevent them from forming a partnership between themselves under the name Central Capital Leasing. The failure of Leasing ever to be a member of a valid partnership with any of them did not prevent the assets from being acquired by the Central subsidiaries and being held by them under the name Central Capital Leasing. Once the partnership scheme is collapsed vis-à-vis Leasing, what is left is a sale of Leasing’s assets to Central’s subsidiaries on December 24, 1986.
98 Leasing argues that the sale of the assets effectively took place on December 29, 1986, two days after the purported transfer of the 99 percent partnership interest from Leasing to the Bank. In other words, it is argued that the transfer from Leasing to the Bank on December 27, 1986 would in reality have been a transfer of the leasing assets if the partnership was invalid and would have made the Bank the owner of the assets on the date they were transferred to Central.
99 Section 13 of the Income Tax Act imposes the tax liability for recapture of capital cost allowance on the person who owned depreciable assets and disposed of those assets. The only person that can be liable for the recapture is Leasing because, as owner of the assets on December 24, 1986, Leasing transferred those assets to what it hoped to be a valid partnership. The Bank was not a party to the transfer.
100 What the appellant seeks to do is to characterize the Bank as having acquired Leasing’s assets when the 99 percent partnership interest was transferred to it on December 27, 1986. This would make the Bank the vendor of the assets which disposed of them to Central on December 29, 1986. To adopt this approach would require the invalid partnership interest that was transferred to the Bank by Leasing to be converted to a transfer of assets. This approach is flawed because, by December 29, 1986, Leasing was no longer the owner of the assets. The fact that the Partnership was not a valid one vis-à-vis Leasing and that consequently the s. 97(2) rollover was ineffective does not negate the consequence that the assets were transferred on December 24, 1986.
101 The proceeds of the sale of the assets were paid to the Bank on December 29, 1986 in the form of notes and debentures from Central. This, however, does not change the fact that Leasing was the vendor of those assets on December 24, 1986 and was entitled to the proceeds of the disposition. Income tax principles require that taxpayers be taxed on amounts that are receivable. The transfer of the “partnership interest” from Leasing to the Bank could arguably be characterized as a transfer of the proceeds that Leasing was to receive from the sale of its assets to Central subsidiaries. However, even characterized in this way, Leasing is liable for the recapture of capital cost allowance as the vendor of the assets. Subsection 56(4) of the Income Tax Act requires that where a taxpayer transfers rights to income that should have been included as income for the taxation year because the amount would have been receivable in that year, the taxpayer will be taxed on that income.
VII. Conclusion
102 Although the parties in this case set up a valid partnership within the meaning of s. 2 of the Partnerships Act, the participation of Leasing in that partnership was void by virtue of s. 34 of the Partnerships Act. The collapse of the partnership scheme vis-à-vis Leasing, however, does not change the fact that Leasing’s assets were transferred to Central’s subsidiaries on December 24, 1986. Because these assets were not transferred to a partnership pursuant to s. 97(2) of the Income Tax Act, Leasing cannot take advantage of that provision and is therefore liable for the recapture of capital cost allowance on its depreciable assets pursuant to s. 13 of the Income Tax Act. I would dismiss the appeal with costs.
//McLachlin J.//
The judgment of Gonthier, Cory, McLachlin, Iacobucci and Major JJ. was delivered by
103 McLachlin J. -- My colleague Justice Bastarache concludes that the Continental Bank Leasing Corporation (“Leasing”) cannot take advantage of s. 97(2) of the Income Tax Act, R.S.C. 1952, c. 148, as amended, because its participation in the partnership was void by virtue of the Partnerships Act, R.S.O. 1980, c. 370. While I agree with all other aspects of his reasons, I respectfully differ on this point and consequently on the disposition of this appeal.
104 The partnership in question was formed between Leasing and two wholly owned subsidiaries of Central Capital Leasing, 693396 Ontario Limited (“693396") and Central Capital Management Inc. (“CCMI”), on December 24, 1986. The trial judge found that it was a real and binding partnership. The partners would not have been able to tell a third party that they were not partners. On this basis, he found the arrangements set up to reduce tax were valid and held that Leasing was entitled to take advantage of s. 97(2) of the Income Tax Act.
105 The respondent on appeal argued that the partnership was not valid by reason of the combined operation of s. 174(2) of the Bank Act, R.S.C., 1985, c. B-1, and s. 34 of the Ontario Partnerships Act. The Bank Act states:
174. . . .
(2) Except as authorized by or under this Act and in accordance with such terms and conditions, if any, as are prescribed by the regulations, a bank shall not, directly or indirectly,
. . .
(i) acquire or hold an interest in Canada in, or otherwise invest or participate in Canada in, a partnership or limited partnership. . . .
The Partnerships Act states:
34. A partnership is in every case dissolved by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.
106 The reasoning underlying the respondent’s argument appears to be as follows:
1. Section 174 of the federal Bank Act prohibits the Continental Bank of Canada (the “Bank”) from acquiring or holding an interest, or otherwise investing or participating in, a partnership or limited partnership in Canada.
2. The Bank violated this provision when its wholly owned subsidiary, Leasing, entered into a partnership with 693396 and CCMI.
3. Section 34 of the Ontario Partnerships Act provides that a partnership is “dissolved” by the happening of any event that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on in partnership.
4. The partnership formed initially by Leasing and the two other corporations was dissolved under s. 34 because of the operation of s. 174 of the Bank Act either (a) because s. 174 made the partnership’s business unlawful; or (b) because s. 174 made it unlawful for the members of the firm to carry it on in partnership.
5. This effect prevails despite s. 20(1) of the Bank Act, which provides that “[n]o act of a bank, including any transfer of property to or by a bank, is invalid by reason only that the act or transfer is contrary to this Act”.
107 In my view, steps 4 and 5 of the argument are not made out.
108 The first question is whether s. 34 of the Partnerships Act is attracted because the Bank’s investment in a partner (Leasing) makes it unlawful for the business of the partnership to be carried on. If an investor holds shares in a corporate partner in a partnership when the law says it should not, is the business of the partnership thereby rendered illegal? I think not. The partnership must be distinguished from those who may invest in or support the partners that make it up. The investors are behind the scenes. They do not incur liability for partnership obligations. The law looks only to the partners to satisfy any liability that the partnership may incur. An investor may supply money to a partner which the partner then uses to carry on lawful business. The fact that the law says that the investor should not have supplied the money does not render the partnership business unlawful.
109 This is precisely the situation in the case at bar. Prior to December 27, 1986, the Bank was not a partner. It merely held shares in one of the partners, Leasing, which was a separate and legally distinct corporation. The Bank Act says that the Bank should not have held shares in Leasing if Leasing was a partner in a partnership. But this does not render illegal the business that Leasing carried on in the partnership. Leasing was a distinct and separate entity from the Bank, as was the partnership it entered into. The fallacy in the argument of the respondent is that it treats the Bank as if it were a partner in the partnership. But, prior to December 27th, it was not a partner. Leasing was the partner. And Leasing did not violate s. 174 of the Bank Act. Indeed, Leasing could not violate s. 174 of the Bank Act, because it was not a bank.
110 The next question is whether s. 34 of the Partnerships Act is attracted because s. 174 of the Bank Act made it unlawful for Leasing to be a partner in the firm. The same point disposes of this question. Leasing was a separate corporation from the Bank. It had its own identity. It was not a bank. So s. 174 does not touch it. There is nothing in s. 174 of the Bank Act that made it unlawful for Leasing to be a member of the partnership.
111 If these observations are correct, then, prior to December 27th, s. 174 did not make it unlawful for the partnership to carry on its business, or for Leasing to be a partner. It made it unlawful for the Bank to invest in Leasing, but that is an entirely different thing. It does not affect the legality of the partnership’s business or of Leasing’s participation in the partnership.
112 It follows that the partnership was not dissolved under s. 34 of the Partnerships Act because the Bank should not have held shares in one of the partners. To suggest that partnerships could be dissolved simply because a behind-the-scenes investor or supporter of one of the partners was legally prohibited from investing in the partnership is to assert a proposition novel to the law. In determining who may be partners and what the lawful business of the partnership is, the law looks to the partnership and the partners, not those who invest or hold shares in the partners. Where the partner is a corporation, as here, the general rule that the law does not pierce the corporate veil reinforces this conclusion: Salomon v. A. Salomon and Co., [1897] A.C. 22 (H.L.). Were it otherwise, one would never know whether a partnership is valid without investigating all those who may own shares or financially support the partners. This would make it difficult if not impossible to do business with partnerships with any sense of security. In the case at bar, the consequence of holding the partnership void is to defeat a transaction aimed at minimizing tax. However, in other cases it might affect innocent third parties relying on the partnership.
113 A further consequence of holding that an unlawful investment voids a partnership entered into by an investee is that the legal status of partnerships would vary with the shareholders in corporate partners. If a bank holds shares in a corporate partner, the partnership would be void. But if the bank sells those shares to a non-bank (and who is to know?) is the partnership reconstituted? The only sensible rule is what I apprehend to be the legal rule -- that the validity of a partnership depends on its members, not on who may hold shares in them.
114 This brings me to Bastarache J.’s argument that Leasing’s participation in the partnership on December 24, 1986 can be considered unlawful within the meaning of s. 34 of the Partnerships Act by reason of the public policy component of the common law doctrine of illegality. This argument posits that, despite the fact that Leasing’s participation in the partnership does not contravene the provisions of the Bank Act, it should be considered illegal for public policy reasons, namely because “[t]o sanction the participation of Leasing in the Partnership is to sanction the agreement to circumvent the provisions and penalties of the Bank Act and the Partnerships Act” (para. 89). In essence, Bastarache J. equates his conclusion that Leasing’s participation in the partnership is “illegal” under the doctrine of illegality with a finding that that participation is also “unlawful” under s. 34 of the Partnerships Act. In my view, the equation is not warranted.
115 I will not repeat the historical foundations for the doctrine of illegality, which have been ably summarized by my colleague, Bastarache J. I simply note that the meaning of the term “illegal” within the context of the doctrine of illegality does not always mean “unlawful” in the traditional sense of being “contrary to, prohibited, or unauthorized by law” (Black’s Law Dictionary (6th ed. 1990)). The need to exercise caution in the use of the term “illegal” in this area was underlined by C. Boyle and D. R. Percy, eds., in Contracts: Cases and Commentaries (5th ed. 1994), at p. 721:
A word of warning is necessary with respect to terminology. It will be evident already that the expressions “illegal” and “contrary to public policy” are used somewhat loosely and interchangeably. The approach of the British Columbia Law Reform Commission may be helpful. After recognizing that the word “illegal” is not always entirely appropriate, the Commission stated in its Report on Illegal Transactions (1983), at 2:
The term “illegal” is used as a convenient shorthand expression, signifying that the transaction so designated is one which a court will decline to enforce on the ground that it infringes some public policy, or the terms or object of an enactment. [Emphasis added.]
116 The fact that the court determines that a contract is void or unenforceable for public policy reasons under the doctrine of illegality does not render either the contract itself or the subject of the contract unlawful. As noted by G. H. Treitel in The Law of Contract (9th ed. 1995), at p. 399: “Such contracts are often called ‘illegal.’ It is sometimes said that they are only ‘void’ or ‘unenforceable’; but these statements only emphasise that no specific legal wrong is involved. So long as this point is borne in mind, no harm is done by using the traditional terminology in which these contracts are ‘illegal.’” (Emphasis added.)
117 It follows that a finding that Leasing’s participation in the partnership should be void or unenforceable for public policy reasons under the doctrine of illegality does not necessarily mean that its participation was illegal or unlawful in the traditional sense of either term. As a result, s. 34 of the Partnerships Act is not attracted.
118 This is sufficient to dispose of the argument that s. 34 of the Ontario Partnerships Act rendered the partnership between Leasing and its partners void. However, the question remains whether Leasing’s participation in the partnership should be deemed unenforceable as a result of the application of public policy principles under the doctrine of illegality, quite apart from s. 34 of the Partnerships Act. In my opinion, this question must be determined in the negative. Contrary to my colleague, I find that public policy requires that breaches of the Bank Act should not lead to the invalidation of contracts and other transactions. There is a good reason for this; to unravel commercial transactions on the basis that a corporate actor breached a statute is to introduce uncertainty into the affairs of individuals and businesses. This is especially true where the transactions at issue involve a subsidiary of the corporate actor.
119 More importantly, s. 20(1) of the Bank Act clearly states that “[n]o act of a bank . . . is invalid by reason only that the act or transfer is contrary to this Act”. Section 20(1) thus supports the view that Parliament never intended breaches of the Bank Act to render bank transactions, including investments in other corporations, like Leasing, null and void. This supports the argument that Parliament intended to create an offence punishable by fines, not to invalidate otherwise lawful transactions and that the doctrine of illegality should have no application in the case at bar.
120 I conclude that the partnership between Leasing, 693396 and CCMI was valid between December 24th and December 27th. It follows that the election under s. 97(2) of the Income Tax Act was also valid. It is not necessary, for the purposes of this first appeal, to consider the transfer of Leasing’s partnership interest to the Bank. That transfer and the subsequent transfer of the Bank’s partnership interest to 693396 and 693397 Ontario Ltd. are the subjects of the second appeal. I would allow this appeal with costs and refer the assessment back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons.
Appeal allowed with costs, L’Heureux-Dubé and Bastarache JJ. dissenting.
Solicitors for the appellant: Tory Tory Des Lauriers & Binnington, Toronto.
Solicitor for the respondent: George Thomson, Toronto.
Solicitors for the intervener: McCarthy Tétrault, Toronto.