Timothy W. Clarke, for the Appellants

Notes

Indexed as:
Hughes Homes Inc. v. Canada
Between
Hughes Homes Inc., Appellant, and
Her Majesty the Queen, Respondent
And between
Lopa Enterprises Ltd., Appellant, and
Her Majesty the Queen, Respondent
[1997] T.C.J. No. 1003
Court File Nos. 95-2202(IT)G, 95-2208(IT)G
Tax Court of Canada
Vancouver, British Columbia
McArthur T.C.J.
Heard:July 9, 1997
Judgment:September 23, 1997
(8 pp.)

Timothy W. Clarke, for the Appellants.

Linda Bell, for the Respondent.

JUDGMENT:--The appeals from the assessments made under the Income Tax Act for the 1991 and 1992 taxation years are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

REASONS FOR JUDGMENT

1 McARTHUR T.C.J.:—These appeals, heard on common evidence, are from reassessments for the 1991 and 1992 taxation years.They concern whether Hughes Homes Ltd. ("Hughes Homes") and Lopa Enterprises Ltd. ("Lopa") were deemed associated corporations by virtue of subsection 256(2.1) of the Income Tax Act (the "Act").

Background:

2 Hughes Homes was originally incorporated in 1986 by both Mr. and Mrs. Hughes working as a team, each owing 50% of its shares.Hughes Homes started off with Mr. Hughes being the directing mind behind the building, negotiating, bidding, and supervising of sites, and Mrs. Hughes performing all the office functions such as data entry, answering phones, and the like.Over the years Hughes Homes evolved from a house builder to a management company that carried on the building business through five companies known as the Park Ridge Group. Mr. Hughes continued to be the directing mind of these companies. In the late 1980's Mr. Hughes adopted the marketing technique of constructing a show home in each subdivision where they constructed and sold homes.Mrs. Hughes became responsible for the furnishing and interior decorating of these show homes together with the colour coordination and finishings of the interior and exterior of all homes.In September 1989, Mrs. Hughes incorporated Lopa to provide the design and decorating services to Hughes Homes and the Park Ridge Group.At the time of incorporation of Lopa, Mrs. Hughes owned 50% of Hughes Homes and 100% of Lopa. Subsequently on August 24, 1990 Mrs. Hughes allowed a reduction in her equity in Hughes Homes from 50% to 10%. Throughout its 1991 and 1992 taxation years, Lopa provided its specialized design and decorating services exclusively to Hughes Homes and Park Ridge Group.

Analysis:

3 The legislation relied on by the Minister is an anti-avoidance section of the Act, specifically subsection 256(2.1), which reads:

(2.1) / Anti-avoidance For the purposes of this Act, where, in the case of two or more corporations, it may reasonably be considered that one of the main reasons for the separate existence of those corporations in a taxation year is to reduce the amount of taxes that would otherwise be payable under this Act or to increase the amount of refundable investment tax credit under section 127.1, the two or more corporations shall be deemed to be associated with each other in the year.

4 The issue to be decided under subsection 256(2.1) is whether one of the main reasons for the separate existence of Lopa in the 1991 and 1992 taxation years was to reduce the amount of taxes that would otherwise be payable if the operations carried on by Hughes Homes and Lopa were realized as one corporation.The onus is on the Appellants to prove that none of the main reasons for the separate existence of the two corporations was that of reducing taxes.In deciding on what significance is required to constitute a main reason' Decary, J. in Lenco Fibre Canada Corp. v. The Queen, 79 D.T.C. 5292 (F.C.T.D.), stated that:

...the word "main" must be given its significance.In the French language version of the statute, the corresponding word is "principaux".Not every reason will meet this standard.Thus, even where the reduction of taxes payable is a reason, a judgment must still be made as to whether it was a main or principal reason...

The test as to whether none of the main or principal reasons for the separate existence of the corporations were for reducing taxes is a question of fact to be based on the testimony of the Appellants' witnesses as well as upon the evidence adduced.What this test must be based upon, was set out by Marceau, J. in The Queen v Covertite Ltd., 81 D.T.C. 5353 (F.C.T.D.) at page 5355:

The onus on the taxpayer appellant is complete and the role of the Court is clear. All that may appear simple but it is so only in theory and not in practice. The difficulty stems from the very nature of the conclusion of the Minister that it is put into question and must be verified. It is indeed a conclusion of fact as opposed to a conclusion of law, but one of a purely psychological content, since it refers to the state of mind and the intention of those responsible for the creation and the continued separate existence of the two entities. It is obviously a conclusion that cannot be the object of direct evidence, at least in the absence of a clear prior statement of the parties concerned or an admission made by them afterwards. It must necessarily be based on inferences drawn from a series of material facts directly ascertainable. The Minister has inferred from a certain number of facts that the saving of taxes, which was actually realized, was not a mere side effect but rather one of the main goals contemplated by the individuals acting behind the corporations. In verifying the conclusion, the Court cannot but adopt an approach similar to that followed by the Minister. The mere denial of the taxpayer, whether or not accompanied by a simple indication of the other causes that could have prevailed, can be given no weight. Being a mere assertion of a negative fact, and a fact which has to do with the state of mind of the witness, it can have no convincing probative force; it cannot constitute the proof required to annihilate the conclusion of the Minister.To succeed, the taxpayer must:
a) / disprove the facts assumed by the Minister in reaching his conclusion: or
b) / convince the Court that the inferences drawn by the Minister from the facts assumed were unreasonable and unwarranted; or
c) / add further facts capable of changing the whole picture and leading to different inferences pointing to the conclusion that the other reasons alleged have actually been prevalent.

5 In the case at hand, I believe the Appellants' witnesses' assertions that tax saving was not one of the reasons why the separate corporation Lopa was created and existed in the taxation years in question.I find credible the Appellants' witnesses' statements that they were not aware of the rules of association under the Act and that Lopa was incorporated without any tax advice.However, the witnesses' statements alone do not carry enough probative force to meet the burden of proof to negate the Minister's conclusion.What is required is something more concrete than mere assertions. To satisfy this burden, the Appellants must be able to support their assertions with objective facts such that the inferences drawn by the Appellants are credible to the point where they meet the test set out under subsection 256(2.1) that "it may reasonably be considered" that tax planning was not one of the main reasons for the separate existence.

6 In following the test set out in the decision of Covertite, supra, it is apparent that the Appellants' evidence must be considered in light of meeting part (c) of that test. Based on the facts assumed by the Minister, it is reasonable to draw the inference that the reduction of tax could have been one of the main reasons for the separate existence of Lopa.Accordingly, it is for the Appellants to bring forward additional facts to permit this court to draw the inference that reasons other than tax savings were the main reasons for the Appellant's actions.According to the Appellants' contentions at trial, the main reasons for the incorporation of Lopa were to create a separate business entity for Mrs. Hughes, and to accomplish asset protection for her endeavours, as well as for Mr. Hughes' endeavours.

Separate Business Activity:

7 Mr. and Mrs. Hughes working as a team carved out a significant notch in the home construction business in the lower mainland areas of Langley and Surrey in southern British Columbia.While they worked as a team, I have no difficulty in finding that Mrs. Hughes had a division or business of her own.She is gifted with a flare and talent for decorating and directed her energies towards that important facet of the business.It is sufficient to say that while she operated a business that complemented her husband's activities, the scope of her activities were adequately separate and distinct.Mr. Hughes dealt with the financing, construction and sales of single family homes, while Mrs. Hughes furnished and decorated the showhomes as well as colour coordinating the design of the interior and exterior of all the homes.Mr. Hughes was the directing mind of Hughes Homes and Mrs. Hughes was the directing mind of Lopa.

8 On the basis of this evidence, I am satisfied that Lopa was created with a sufficient business purpose and existed as a distinct and separate business from that of Hughes Homes.Although it was put forward by the Respondent that Lopa almost exclusively provided its services to Hughes Homes and was not seeking to get work from other builders and should therefore not be considered separate and distinct, I do not find it unreasonable to believe that such a company with so great a work load would foster its existing business relations by not seeking work with the competition.Each business was exclusively doing its own thing, with neither business encroaching on the field of the other.

9 The second reason put forward by the Appellants for the separate existence of Lopa was that of asset protection.It was stated by the Appellants' witnesses that recent events had created the concern that the assets of Lopa should be insulated from that of Hughes Homes.Those events were the recent lawsuit by Mr. Kolb, and the lawsuit that almost put a fellow builder and friend into bankruptcy.It was stated at trial that the construction business of the sort engaged in by Hughes Homes, is a business with substantial risk for loss.This was Mr. Hughes' first lawsuit from his business dealings.Both events highlighted to Mr. and Mrs. Hughes that substantial risks could potentially arise from their business operations.I believe it to be true that these significant risks could substantially affect the business of Hughes Homes, and from any personal guarantees given, substantially affect the Hughes' personal assets as well. Given Mrs. Hughes' success in interior decorating, I find it reasonable that Mrs. Hughes would want to insulate herself from any risk that was attached to either Hughes Homes or to Mr. Hughes' estate.By separate incorporation, Lopa is a distinct entity from either Hughes Homes or Mr. Hughes, and is able to accumulate its own capital free of any encumbrances. In Lenco, supra, the court was presented with an analogous situation where a wife who was originally providing services to her husband's companies as a salaried employee, incorporated a company to provide these services.Decary, J. found that it was believable that the main reason for the separate existence of the taxpayer, the wife's company, was to protect the value of her services to the husband's companies from any claims against those companies.Decary J. states at page 5296:

I find from it (Mr. and Mrs. Mandelcorns' testimony) as well from the whole of the evidence that the main reason for the existence of the Plaintiff as an entity, separate from that of the two corporations owned by Leonard Mandelcorn in the years in question, was to enable Elaine Mandelcorn to realize, through a corporation of which she was the owner, the value of the services she was rendering to her husband's corporations free from any claims against them that might threaten the result of her efforts to build up the business if she simply continued to act as a salaried employee.

On the basis of the finding in Lenco, supra, and the testimony of Mr. and Mrs. Hughes in this case, I am satisfied that Lopa was incorporated so that Mrs. Hughes would be able protect her endeavours from any business risks that exist for Hughes Homes or any risks resulting from Mr. Hughes' personal guarantees. I am also satisfied that this was one of the main reasons why Lopa was incorporated.

Conclusion:

10 In conclusion, I am satisfied that of the main or principal reasons for the separate existence of Lopa in the taxation years under appeal, none of them were for the reduction of tax.I find this for two reasons.The first reason is that although Lopa was incorporated in 1989 and the assessment by the Minister is for the 1991 and 1992 taxation years, I find that the explanations put forward by the Appellants' witnesses as to why the separate existence of Lopa was created, continued to be the main reasons for its existence in the 1991 and 1992 taxation years.On the basis of the evidence before me, I am satisfied that the main reasons for Lopa's incorporation and separate existence in 1989 were to accomplish asset protection and provide Mrs. Hughes with a separate and distinct business entity so that she could undertake her efforts in her own business.I believe the Appellants' witnesses to be credible.Tax reduction was not a reason for Lopa's incorporation in 1989, and I find no evidence to lead me to an inference that tax reduction was one of the main reasons for its incorporation.

11 Second, is that although Mrs. Hughes' share reduction in 1990 resulted in a tax reduction for the 1991 and 1992 taxation years for Hughes Homes and Lopa, I do not find that I can reasonably consider that tax reduction became one of the main or principal reasons for Lopa's separate existence from Hughes Homes in those years.This share reduction, while it could accomplish asset protection if done completely, did accomplish disassociation between the corporations, previously associated under paragraph 256(1)(c) of the Act.It is a reasonable inference that one of the reasons for this share reduction was to accomplish tax savings for Lopa.What I do not find however is that I can draw the inference that this tax savings from the share reduction can reasonably be considered to be one of the main or principal reasons for Lopa's separate existence for 1991 and 1992.I find the share reduction, although accomplishing tax savings, was incidental to the reasons why Lopa kept a separate existence from Hughes Homes.