Paletta Et Al v. The Queen, Case Study

Paletta et al v. The Queen, Case Study1

In a recent case, the Tax Court of Canada was faced with deciding if the taxpayer's investment in a Hollywood film was "make believe" or real. In other words, did the complex series of transactions reflect the true intentions of the parties or were they a "sham".

Angelo Paletta and a family-owned corporation, Paletta International Corporation, (respectively, the individual and corporate "Taxpayers") claimed approximately CDN$200 million in business losses from investing in two limited partnerships (the "LPs") established to acquire, exploit and monetize two feature films produced by Twentieth Century Fox Film Corporation ("Fox"). The LPs purchased the copyright in the two films through capital contributions by the Taxpayers of about CAD$8 million with the balance funded by loans arranged through a complicated series of circular transactions. Fox agreed to distribute the films and the LPs agreed to incur the costs of over CAD$200 million in respect of prints and advertising expenses ("P&A Expenses") for these films.

A critical part of the commercial arrangement involved the LPs granting Fox an option to reacquire the LPs that owned the films before, during or after commercial release of the films, for an aggregate amount of the cost of the films, plus the P&A Expenses, less 3% of the P&A Expenses.

The Canada Revenue Agency (the "CRA") disallowed the losses on several bases, the key one being an allegation that the transactions were a sham. The CRA alleged that the films were never transferred to the LPs, whose sole purpose was to enable the Taxpayers to benefit from tax savings and for Fox to benefit from the 3% discount which amounted to its fee for participation. The Taxpayers' tax savings would arise from the fact that the P&A Expenses would be fully deductible in computing income, while only one-half of the capital gain realized on the sale of the LPs to Fox would be included in income.

The Court began its analysis of sham by citing previous precedents to arrive at the guiding principles. The original statement of what constitutes sham is derived from the English case Snook v. London & West Riding Investments Ltd .2, where the presiding judge held that sham means

"...acts done or documents executed by the parties to the "sham" which are intended by them to give third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal...