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

Introduction

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...