Canada: Ain't That A Shame - That Ain't A Sham

Last Updated: December 21 2018
Article by John Sorensen


Owen J of the Tax Court of Canada ("TCC") visited the sham doctrine twice this Fall, first in Cameco Corporation v. The Queen[1] and then in Lee v. The Queen.[2] The sham argument advanced on behalf of the CRA in both cases was perplexing and rejected by the TCC. Lee included another unsupportable argument, namely, "ineffective transaction". Despite the futility of the arguments, Lee affirms the limited scope of the sham and ineffective transaction doctrines, confirms that tax saving is a valid objective and reminds practitioners of the ever-present need for meticulousness in executing transactions.

The tax plan that was attacked in Lee was the so-called Quebec Truffle, a tax saving structure that was eventually legislated out of existence. In accordance with the planning, the Paul Lee Spouse Trust ("Trust") elected to be taxed federally on income it distributed to its beneficiary, but did not elect in Quebec. The beneficiary spouse was not resident in Quebec, so no provincial tax was paid, but the Trust enjoyed the federal abatement, resulting in a net tax advantage. The taxpayer, V. Paul Lee, was reassessed by the CRA on the bases that: (1) the Trust did not exist either because it was a sham or the transfer of property to the Trust was a sham; or (2) the Trust was not properly constituted at law.

Sham and Ineffective Transactions

The classic sham definition was set out in Snook v. London & West Riding Investments, Ltd.[3] According to Snook, "it means acts done or documents executed by the parties to the 'sham' which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create." Further, "all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating." In Stubart Investments Ltd. v. The Queen,[4] the Supreme Court of Canada ("SCC") cited deceit as a requirement for sham. That said, not all judicial guidance on sham is clear. In Bronfman Trust v R,[5] the SCC stated in obiter:

If, for example, the trust had sold a particular income-producing asset, made the capital allocation to the beneficiary and repurchased the same asset, all within a brief interval of time, the courts might well consider the sale and repurchase to constitute a formality or a sham designed to conceal the essence of the transaction, namely that money was borrowed and used to fund a capital allocation to the beneficiary.

This statement is plainly at odds with every other judicial definition of sham and resembles the step transaction doctrine, which does not exist in Canada. With respect, this piece of SCC obiter is plainly wrong and, happily, it has not been adopted.

The concept of incomplete or ineffective transaction is not complicated. Before the application of a taxing provision comes into play, liminal questions include whether an entity came into existence or a transfer actually occurred as a matter of law. The incomplete or ineffective transaction argument boils down to this: did the transaction have legal substance and were all steps effectively and completely constituted?

No Sham or Ineffective Transaction in Lee

In Lee, the parties filed a 53 paragraph partial agreed statement of facts and the testimony, including excerpts from witness testimony, was summarized over a further 38 paragraphs. Nothing in the agreed facts or summary evidence leapt out as supporting any conclusion that there was either a sham or an ineffective creation of the Trust. Excerpts of the cross-examination of the trustee suggest that the Crown's case was geared off of the extent to which the structuring and tax outcomes were preordained and, at a high level, were comparable to Antle v The Queen,[6] where the TCC found there was an ineffective transaction, since the trust was not validly constituted. However, the TCC held that Antle and Lee were factually distinguishable and that "the two cases have little in common other than the existence of a tax plan".

In Lee, the TCC found that the funds to settle the Trust were delivered to the trustee on December 8, 2003, the trustee and settlor executed the Trust deed on December 10 and on December 11 the funds were deposited into a bank account opened for the Trust, over which the trustee had exclusive signing authority. The TCC described the trustee as both experienced and willing to engage expert advisors to assist as required. According to the TCC, the trustee was independent and exercised his discretion to follow the strategy recommended by KPMG after deliberating and concluding that was in the best interests of the beneficiary. In comparison, in Antle the sequencing of events and signing of documents were disorderly, the settlement funds never came into the possession of the trust and the trustee was inexperienced and had never met the settlor. Further, in Antle the steps were preordained but the TCC found that the trustee had been stripped of discretion. Not so in Lee. In Lee, the trustee was aware of the steps required to implement a Truffle transaction, but the TCC found that he retained discretion: he followed a recommended course of action after properly deliberating and taking steps in the best interests of the beneficiary, which was "perfectly in keeping with the role of a trustee of a discretionary trust". Consequently, there was no basis to conclude either that the Trust or transfer of assets to the trusts were shams, or to assert that the Trust was not validly constituted as a matter of law.

The doctrines of sham or ineffective transaction are judicial anti-avoidance doctrines that the CRA may rely upon to attack a tax result. However, facts matter. Whether a transaction or arrangement lacks legal substance is a factual determination, rooted in evidence. In Lee, the Crown put the legal cart before the factual horse, but the TCC very reasonably asserted that "[c]reating legal (or equitable) relationships to give effect to a tax plan is not the perpetration of a sham".

Inasmuch as tax planning is never a series of happy accidents, the Crown`s apparent concern that the tax outcomes for the Trust and beneficiary were actually planned in advance is odd. It is also odd, if not entirely unexpected, that the CRA would target tax planning that offends the Minister's delicate olfactory sense, even if it meant trying to stretch inapplicable legal doctrines around the wrong set of facts. Lee affirms that careful tax planning and diligent execution should not be overwhelmed by unsupported assertions that tax planning is naughty, thus a sham.


[1] 2018 TCC 195.

[2] 2018 TCC 230 ("Lee").

[3] [1967] 1 All E.R. 518 ("Snook").

[4] [1984] 1 S.C.R. 536 ("Stubart").

[5] {1987] 1 SCR 32.

[6] 2009 TCC 465 ("Antle") (aff`d on this point: 2010 FCA 280).

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