ANGELO PALETTA, Appellant, v. HER MAJESTY THE QUEEN,, 2019 TCC 205

Docket: 2013-225(IT)G 2013-2420(IT)G BETWEEN: ANGELO PALETTA, Appellant, and HER MAJESTY THE QUEEN, Respondent. Appeals heard on March 11-22, 2019 at Toronto, Ontario, May 28-31, 2019 at Vancouver, British Columbia, June 3, 2019 at San Jose, California, June 5-6, 2019 at Los Angeles, California, and June 10-12, 2019 at Vancouver, British Columbia. Before: The Honourable Justice Robert J. Hogan Appearances : Counsel for the Appellant: David R. Davies Alexander Demner Vivian Esper Counsel for the Respondent: Charles M.

Camirand Nicole Levasseur AMENDED JUDGMENT The Appellants’ appeals are allowed in part only and the assessments are referred back to the Minister for reconsideration and reassessment in accordance with the attached Reasons for Judgment. The parties will have until October 21, 2019 to arrive at an agreement for costs, failing which they must file written submissions on costs no later than October 21, 2019. Such submissions are not to exceed ten pages. Signed at Ottawa, Canada, this 7 th day of October 2019 “Robert J. Hogan” Hogan J.

Docket: 2013-4837(IT)G BETWEEN: PALETTA INTERNATIONAL CORPORATION, Appellant, and HER MAJESTY THE QUEEN, Respondent. Appeals heard on March 11-22, 2019 at Toronto, Ontario, May 28-31, 2019 at Vancouver, British Columbia, June 3, 2019 at San Jose, California, June 5-6, 2019 at Los Angeles, California, and June 10-12, 2019 at Vancouver, British Columbia.

Before: The Honourable Justice Robert J. Hogan Counsel for the Appellant: David R. Davies Alexander Demner Vivian Esper Counsel for the Respondent: Charles M. Camirand Nicole Levasseur AMENDED JUDGMENT The Appellants’ appeals are allowed in part only and the assessments are referred back to the Minister for reconsideration and reassessment in accordance with the attached Reasons for Judgment. The parties will have until October 21, 2019 to arrive at an agreement on costs, failing which they must file written submissions on costs no later than October 21, 2019. Such submissions are not to exceed ten pages.

Signed at Ottawa, Canada, this 7 th day of October 2019 “Robert J. Hogan” Hogan J. Citation: 2019 TCC 205 Date: 20220405 Docket: 2013-225(IT)G 2013-2420(IT)G BETWEEN: ANGELO PALETTA, Appellant, and HER MAJESTY THE QUEEN, Respondent, Docket: 2013-4837(IT)G AND BETWEEN: PALETTA INTERNATIONAL CORPORATION, Appellant, and HER MAJESTY THE QUEEN, Respondent. THIRD FURTHER AMENDED REASONS FOR JUDGMENT Hogan J. I. Overview [ 1 ] These appeals concern a complex series of transactions purportedly designed to finance investments in Hollywood film productions.

The Appellants characterize these transactions as bona fide investments made as part of an overall strategy to break into the film industry in a big way. The Respondent characterizes those same transactions as nothing more than shams and/or tax shelters. [ 2 ] The transactions are explained in more depth below. The following provides an overview of the structure, using the 2006 investment

as a guide. [ 3 ] In 2006, Paletta International invested US$8,013,895 cash in the Six Iron Productions Limited Partnership ( " “Six Iron Partnership” " ) to finance the alleged acquisition of a recently produced film entitled " “Night at the Museum” " ( " “Six Iron Film” " ). The film was produced for and on behalf of Twentieth Century Fox Film Corporation ( " “Fox” " ), which allegedly sold it to the Six Iron Partnership for US$128,310,000 through a complex series of transactions described below.

As part of the transactions, the Six Iron Partnership signed a distribution agreement ( " “Distribution Agreement” " ) with Fox and agreed to bear an amount of US$82,000,000 for the prints and advertising expenses ( " “P&A expenses” " ) with respect to the film. [ 4 ] Fox, or an affiliate, had the right to reacquire the film under a series of option agreements ( " “Option Agreements” " ) prior to, or within five days following the commercial release of the film. The option price was essentially the cost of the film, plus the P&A expenses allegedly incurred by the Partnership, less 3% of the P&A expenses.

The options were allegedly exercisable at the option holder’s sole discretion. Fox, through its affiliate, exercised the options and reacquired the film prior to its commercial release. This series of transactions led to the dissolution of the Six Iron Partnership. [ 5 ] The Six Iron Partnership reported a non-capital loss of US$82,763,192 for the P&A expenses, and Paletta International, as the sole limited partner, claimed the lion’s share of that amount.

In total, Paletta International reported a loss of CAD$96,109,415 from the Partnership. [1] Paletta International also reported a capital gain from the disposition of its partnership units and took advantage of the 5- year capital gains reserve. It further claimed other financing charges and expenses in connection with its investment in the Partnership. [ 6 ] A few years later, Angelo Paletta, along with other members of his family, invested in the Swilcan Bridge Productions Limited Partnership ( " “Swilcan Partnership” " ).

This Partnership allegedly acquired a second picture from Fox entitled " “The Day the Earth Stood Still” " ( " “Swilcan Film” " ). Like the Six Iron Partnership, the Swilcan Partnership also disposed of the film prior to its commercial release and realized a significant loss from the P&A expenses. Angelo Paletta deducted his share of the loss, as well as other expenses that were allegedly incurred. [ 7 ] The parties acknowledge that the Swilcan transactions are, in their entirety, virtually identical to the Six Iron transactions.

I therefore refer almost exclusively to the Six Iron transactions in this judgment, and my reasons should be taken to extend to the Swilcan transactions as well. I will reference the Swilcan transactions to make necessary clarifications to point out any differences. [ 8 ] The Minister of National Revenue ( " “Minister” " ) disallowed all of the losses and other expenses claimed by the Appellants in respect of their investments in the partnerships on the grounds that:

i) some of the transactions entered into by the parties were a sham; ii) the partnership interests acquired by the Appellants were unregistered " “tax shelters” " ; iii) the partnerships were not validly created; iv) the partnerships’ acquisitions of the films were ineffective; and

v) the Appellants realized business income rather than capital gains from the disposition of their partnership interests. [ 9 ] I will consider issues (iii) to (

v) only if I dispose of the first two issues in favour of the Appellants. [ 10 ] There are two subsidiary issues, one per appeal. In the Paletta International appeal - and this is an issue unrelated to the film transactions - the Appellant, Paletta International, disputes the characterization of real estate gains realized in its 2007 taxation year. When filing its return, the Appellant, Paletta International, reported the gains on income account. It now alleges that this was done in error and that the properties were capital in nature. In the case of Mr. Paletta’s appeal, Mr.

Paletta carried back part of his non-capital loss to his 2005 taxation year. The Minister’s denial of that carry-back occurred outside the normal reassessment period and is therefore statute-barred unless the Court finds that Mr. Paletta made a misrepresentation attributable to carelessness, neglect or wilful default. [ 11 ] For the most part, the appeals were heard on common evidence. [ 12 ] For the reasons that follow, with respect to the main issue, the appeals are dismissed.

The parties agreed from the start that Fox would reacquire the films before their commercial release by exercising its option to acquire all of the partnership interests. Consequently, the Appellants and the partners knew that they would never generate income from the films. I find that the Option Agreements in each appeal were a sham. [ 13 ] Paletta International’s appeal is allowed with respect to two of the nine real estate dispositions. I find that the Doble/Bluffs disposition and the “ " eco-gift " ” disposition were on account of capital. The disposition of the remaining properties were on income account.

The appeals are dismissed in respect of these properties. II. Facts [ 14 ] Paletta International was created by Pasquale " “Pat” " Paletta, who controlled it during the years under appeal. Pat Paletta, the recently deceased patriarch of the Paletta family was widely regarded as a very successful self-made business person. Paletta International carried on several businesses during the years under appeal. These businesses included real estate and farming, as well as film and foreign exchange dealings. [ 15 ] Pat Paletta’s son, Angelo Paletta ( " “Mr.

Paletta” " ), began working in Paletta International’s real estate and other businesses in the late 1980s. He eventually took over the day-to-day operations of the company in the early 2000s.

[ 16 ] Messrs. Warren Nimchuk and Warren Fergus presented Mr. Paletta with an opportunity to allegedly acquire ownership of a major motion picture. The details of these film transactions are set out below. [ 17 ] On a matter unrelated to the film transactions, Paletta International claims that it realized its accountants had misreported gains from the disposition of long-term real estate holdings as business income instead of capital gains. The facts relating to this aspect of the appeal are discussed in the relevant analysis

section below. A. Film Transactions [ 18 ] The series of transactions for each film deal was complex and there were many individuals and entities involved. The following is a brief

summary of the relevant individuals and entities in the Six Iron transactions:

i) Studio: Fox is a large international fully integrated film studio. It was involved in each of the film transactions. Fox purportedly had discussions with Mr. Nimchuk regarding its interest in selling its copyright to certain films after production and in the lead-up to theatrical release. ii) Lending trust ( " “Fintrust” " ): Standard Finance Trust borrowed money from the Royal Bank of Canada ( " “RBC” " ) and lent it to Paletta International. iii) Corporate Trustee for Fintrust ( " “Fintrustee” " ): 0774339 B.C. Ltd. was Fintrust’s trustee in the Six Iron transactions.

The parties did not call Adrian Ward, an entertainment industry leader, who was the director of 0832307 B.C. Ltd. (the Fintrustee for the Swilcan transactions). iv) Partners of the Partnerships: i . General Partner: Six Iron Productions Inc. and Swilcan Bridge Productions Inc. were respectively the general partners in each of the transactions. Both of these corporations were controlled by Mr. Fergus. ii . Limited Partners: Paletta International was the limited partner in the Six Iron transactions.

Angelo Paletta, along with his parents Pasquale and Anita and his brothers Remigio, Paul and Michael were the Limited Partners in the Swilcan transactions.

v) Option -Holding Companies: In both transactions, Fox entered into secondary option agreements with related parties, through which Fox transferred the option granted by the partners on their partnership interest. In the Six Iron transactions, the second option agreement was with Wordsmith Inc. ( " “Wordsmith” " ), [2] which was a wholly owned subsidiary of Fox. Wordsmith then assigned its interest in the film by transferring the option to its Canadian subsidiary, Faultline Productions Inc. ( " “Faultline” " ). [3] vi) Warren Nimchuk: Mr. Nimchuk was a chartered accountant.

During the relevant years for the transactions under appeal, he was a senior manager and then a partner at PricewaterhouseCoopers ( " “PwC” " ) in the field of entertainment tax. He stated in his testimony that he started working in the film industry in the mid-90s and had worked with all of the major studios on a variety of finance and tax credit facilitations in Canada and elsewhere. From his testimony, I found that Mr. Nimchuk had a great deal of knowledge about, and experience in, the film industry, particularly in the areas of film financing and film tax planning.

He was involved with engineering the tax structure and setting up the partnerships. The Appellants admit that Mr. Nimchuk structured the film transactions in consultation with Mr. Fergus. Mr. Nimchuk also negotiated the contracts, including the copyright purchase price, the P&A expenses, the option price and the distribution fees, with Fox. Mr. Nimchuk himself testified that his role in these transactions was to assist the studio to sell the copyright in the films to a partnership. vii) Warren Fergus: Mr. Fergus was a former chartered accountant. Mr. Fergus had a history in film financing.

He was the director of the general partner in each of the film transactions. Mr. Fergus and Mr. Nimchuk together created and marketed to the Appellants the tax structure at issue. viii) Isaac Tamssot: Mr. Tamssot was the director of the Fintrustee in the Six Iron transactions. During the time of these transactions, in 2006, Mr. Tamssot worked as an investment advisor at CIBC, a role that he had held since 1998. In this position, Mr. Tamssot was responsible for meeting with high-net-worth and sometimes ultra-high-net-worth individuals to provide financial planning and investment planning advice. Mr.

Tamssot testified that he became involved in the Six Iron transactions through his connection with Mr. Fergus – Mr. Tamssot’s brother had gone to school with Mr. Fergus and they had remained close friends. [ 19 ] Following the flow of funds in the transactions makes it clear that the cash flow was circular. The transactions are described in detail below. However, to summarize, the flow of funds occurred as follows:

i) Fintrust obtains a loan from RBC ( " “Daylight Loan” " ); ii) Fintrust loans the Daylight Loan funds to the partners; iii) The partners use the Daylight Loan funds, plus their own additional cash, to purchase the partnership units; iv) The partnerships then direct the Daylight Loan funds to be paid to Fox as payment of both the purchase price of the copyright and the P&A expenses;

v) Fox receives part of the Appellant Paletta International’s proceeds as payments of the fee; vi) Fox directs that the Daylight Loan funds be paid to Fintrust; and vii) Fintrust directs that the Daylight Loan funds be repaid to RBC.

[ 20 ] Additionally, Fox allegedly paid the partnerships an advance in respect of Australian receipts; meanwhile, the Appellant Paletta International’s cash investment in the partnerships is used to pay Fox an amount equal to 3% of the P&A expenses and to pay fees to the promoters of the transactions. [ 21 ] The essential transactions and documents for the Six Iron transactions are explained in detail below:

(1) Daylight Loan [ 22 ] The Six Iron Fintrust borrowed US$212,000,000 from RBC under the Daylight Loan. This initial advance from RBC had a structuring fee of 0.1285%, which was payable at closing. [4] [ 23 ] RBC complied with its own internal policies and guidelines in providing the Daylight Loan. However, in the internal RBC document, RBC’s employee made notations stating, “ " [a]lthough the transaction is not labelled by the tax lawyers as a ‘tax shelter’, it does present significant tax benefits to the investor " ”, [5] as well as the “ " taxing authorities will likely view this as aggressive tax planning.

" ” [6] [ 24 ] As security for the Daylight Loan, Fintrust provided to RBC a promissory note for the full amount of the loan. This note was later cancelled once the Daylight Loan was repaid. [ 25 ] The Daylight Loan was repaid by Fintrust using funds it received as a loan from Fox.

(2) Loan from Fintrust to Paletta International [ 26 ] Fintrust then loaned the US$212,000,000, which it had borrowed from RBC, to Paletta International ( " “Fintrust/Paletta International Loan” " ). On an outstanding principal amount of US$175,000,000 or more, Paletta International was required to pay 9.5% interest per annum.

Once the principal dropped below US$175,000,000, the interest rate was lowered to 5% per annum. [ 27 ] Under this loan, Paletta International was also required to pay a credit facility fee of US$2,500,000 and a foreign exchange fee of US$3,305,753, both of which were partially or fully capitalized and added to the principal borrowings and were interest-bearing. Additionally, if Paletta International wanted to have the ability to prepay the loan, it was subject to a one-time prepayment fee in the amount of US$2,650,000, which was payable within 180 days following the advance of the loan funds.

This amount would also be capitalized and added to the principal of the loan and would bear interest. [ 28 ] The interest on the loan would accrue for 10 years, at which point Paletta International was require to pay all of the accrued and unpaid interest in full. [ 29 ] Paletta International was obligated to provide Fintrust with a “Collateral Security Agreement” along with the original unit certificates issued by the partnership as security.

(3) Partnerships [ 30 ] The Six Iron Partnership was purportedly created to acquire, exploit and monetize the rights to the Six Iron Film. It was initially created on November 17, 2006, with Six Iron Productions Inc. as the general partner. The original limited partner was an entity the sole shareholder and director of which was Mr. Fergus. This entity was replaced by Paletta International when it invested in the Six Iron transactions.

Thus, Paletta International became the sole limited partner. [ 31 ] Pursuant to the Limited Partnership Agreement, [7] the business of the Six Iron Partnership was limited to purchasing the film, entering into a distribution agreement whereby Fox would exploit the film, promoting the film and paying the costs associated therewith, as well as lending excess funds of the Partnership to such parties as the general partner decided. [ 32 ] To finance its investment, Paletta International used the US$212,000,000 that it had borrowed from Fintrust plus an additional US$6,121,475 of its own cash resources to subscribe for Class B units of the Six Iron Partnership.

Thus, the aggregate subscription price for Paletta International’s units of the Six Iron Partnership was US$218,121,475. [ 33 ] Paletta International’s total cash investment in the Six Iron deal was in the amount of US$8,013,895. It provided this amount to the Six Iron Partnership for the balance of the acquisition price of the partnership units and for financing fees payable by Paletta International to Fintrust. [ 34 ] The Six Iron Partnership used the subscription proceeds to purchase the film and pay the P&A expenses.

The Partnership had US$7,811,475 remaining plus the US$1,000,000 Australian advance (discussed below). The Partnership directed these funds to be used, in part, for paying Fintrust and paying Fox upon closing. The Six Iron Partnership retained the remainder of the funds to pay other partnership expenses. [ 35 ] The Swilcan Partnership was purportedly created to acquire, exploit and monetize the rights to the Swilcan Film. Mr. Paletta was one of the limited partners and Swilcan Bridge Productions Inc. was the general partner.

In similar fashion to what was done in the Six Iron Partnership, the Swilcan partners used their own cash resources and a loan from Fintrust to subscribe for the partnership units. [ 36 ] The film transactions were materially identical for both the Six Iron Partnership and the Swilcan Partnership (together the " “Partnerships” " ). I will mostly refer to the film and parties involved in the Six Iron transactions.

Unless otherwise stated, my findings in respect of the Six Iron Partnership will apply equally to the Swilcan Partnership. [ 37 ] Pursuant to the Limited Partnership Agreement, the general partner is entitled to a reasonable fee as compensation for the services provided and is also responsible for paying all of the operating expenses of the partnership.

(4) Kagan Media Appraisals [ 38 ] Kagan Media Appraisals ( " “Kagan” " ) is a company that specializes in film cash flow projections. Kagan was retained to prepare cash flow projections (“ " Kagan Report " ”) for the films. According to the Appellants, a satisfactory Kagan Report was a condition of closing. [ 39 ] According to Mr. Derek Baine, a long-time employee of Kagan, Mr. Nimchuk commissioned the Kagan Reports for both transactions. The Appellants were never in contact with Kagan. [ 40 ] Kagan has a proprietary database of motion picture information.

This database includes items such as film budgets, genres and P&A expenses. [ 41 ] Mr. Baine testified that, at the time of the Kagan Reports, his colleague Mr. Wade Holden was responsible for extrapolating the required numbers and information from Kagan’s database. Mr. Baine would order the numbers from Mr. Holden and then spend approximately one hour preparing the Kagan Report. Mr. Baine testified that, in preparing the Kagan Report, they primarily looked at budget, talent and genre with respect to the film. Kagan would not ask to view the film in order to prepare the report. [ 42 ] From Mr.

Baine’s testimony it became clear that the Kagan Report was merely a cash flow projection of how a film could do, based on the average success of films that had comparable budgets. This report was not at all a valuation of the film or an indication of its potential success. He stated that the report was not an indication of the investor’s rate of return. [ 43 ] In preparing a valuation, he would ascertain the cost of capital, create discounted cash flows and discounted gross profits and losses and add the terminal value for the film. Mr.

Baine stated, however, that a full valuation of a film would be more elaborate. [ 44 ] Here, the cash flow projections were not discounted. However, Mr. Baine testified that, since all of the expenses for the film had been included in the calculations, even if the amounts in the cash flow projections had been discounted, the ventures would still be profitable for the Appellants. [ 45 ] Additionally, Mr. Baine testified that he was not provided with the investment information package or the distribution agreement as part of his preparation materials.

Essentially, it appeared that the only information that he was provided with was the budget, the P&A expenses and the genre. The cast was not considered when conducting the analysis here.

(5) Purchase and Sale of Copyright [ 46 ] On November 21, 2006, Fox transferred the copyright and all rights in the Six Iron Film to its subsidiary, TX Productions Inc. ( " “TXP” " ). [8] [ 47 ] Also on November 21, 2006 ( " “Six Iron Closing Date” " ), [9] the Six Iron Partnership allegedly purchased the worldwide perpetual copyright from TXP. [10] The Six Iron Partnership paid US$128,310,000 for the film. It paid this amount using the subscription proceeds. [ 48 ] Under the sale agreement, TXP provided representations and warranties that it validly owned the copyright to the film, free and clear of any encumbrances. Fox guaranteed TXP’s representations and warranties.

(6) Distribution Agreement [ 49 ] As part of the series of transactions, the Appellants and Fox entered into a Distribution & Other Rights Acquisition Agreement ( " “Distribution Agreement” " ) on each closing date. [11] Pursuant to this agreement, the Partnerships grant Fox the rights to exploit the film on behalf of the Partnerships as the exclusive worldwide distributor for a term of 15 years.

Fox is granted exclusive and unqualified discretion as to the time, manner and terms of distributing, exhibiting and exploiting the films. [ 50 ] Fox is able to collect all royalties, fees and other revenues that the Partnerships would otherwise be entitled to collect.

Pursuant to the Distribution Agreement, the Partnerships do not have the ability to make separate claims or to collect any of the copyright revenues. [ 51 ] In the Six Iron transactions, following its acquisition of the film, Fox was obligated to spend a minimum of US$92,000,000 for " “Distribution Expenses” " in connection with the theatrical distribution of the film ( " “Fox’s P&A Commitment” " ).

Distribution Expenses are defined in the documents as the aggregate of the " “Distribution Costs” " [12] , the distribution expenses for home video and on-demand reproduction materials, as well as the subdistributor distribution costs. The distribution and exploitation provision effectively transfers to the copyright owners (i.e., the Partnerships) liability for costs which are typically included in distribution expenses. [ 52 ] Under its Distribution Agreement, the Six Iron Partnership agrees to incur US$82,000,000 in P&A expenses in the lead-up to the release of the film.

The Six Iron Partnership paid this amount using the subscription proceeds. Each partnership claimed its P&A expenses in full and allocated that amount to its partners as a loss for its initial fiscal period. [ 53 ] The Distribution Agreement also sets out the terms governing how payments from Fox are to be made to the Partnerships.

Section 12 of the agreement states that Fox shall pay the Partnerships the amount of " “Gross Receipts” " [13] after deducting the " “Distribution Fees” " and the " “Release Costs” " . The " “Distribution Fees” " are defined as being various rates that Fox shall be entitled to retain as its fee for distributing the film. The " “Release Costs” " are defined as meaning " “Distribution Expenses” " [14] , except that the advertising administrative fee is to be based on 15% of costs instead of 10% of costs. Importantly,

section 12 also provides that while Fox’s obligation to pay the Partnerships arises as and when any " “Gross Receipts " ” are earned, Fox may defer the payment until May 31, 2007. Fox may also further defer payment if the Partnerships are in breach of any terms of the agreement or any other agreement entered into with Fox in respect of the film.

[ 54 ]

Section 12A of the Distribution Agreement provides that the Partnerships are to earn US$1,000,000 as a non-recoupable advance for the Partnerships’ share of home video receipts from Australia. Mr. Nimchuk testified that he negotiated this fee with Fox to ensure that Australia would not be ignored with respect to distribution expenses. Mr. Fergus also testified that, since distributions occur over an extended period of time, this fee was intended to ensure that Fox would remain engaged in the worldwide distribution of the film.

(7) Option Agreements [ 55 ] As a condition of the Six Iron transactions, Fox required the partners to grant it an option to acquire their units of the Six Iron Partnership ( " “Option 1” " ). According to Mr. Nimchuk, Fox was adamant about incorporating the option into the deal. [ 56 ] Under the Option Agreement, [15] the price payable for the option, if the option was exercised, was US$218,093,121. Mr.

Nimchuk testified that he negotiated this amount with Fox. [ 57 ] Option 1 in the Six Iron transactions expired on the earlier of December 25, 2006 or five days after the theatrical release of the film. [ 58 ] Under Option 1, the Partnerships were required to grant Fox a first-ranking mortgage and security interest in respect of their assets. [ 59 ] Fox then assigned its option to acquire the partnership units. In the case of the Six Iron transactions under the " “Assignment and Option Agreement " [16] " ” " Fox assigned Option 1 to Wordsmith.

In return, Wordsmith granted an irrevocable option back to Fox ( " “Option 2” " ), which allowed Fox to acquire the Six Iron Partnership’s interest in the film upon Wordsmith exercising Option 1. In consideration of Option 2, Fox was required to pay US$214,521,000 to Wordsmith. The assignment agreement provided that if Fox exercised Option 2 Wordsmith would be required to exercise Option 1. Wordsmith agreed that upon Fox assigning Option 1 to it, Wordsmith would assume all of Fox’s obligations under the Option Agreement.

Wordsmith also agreed to deliver to the Partners a second-ranking security agreement containing a security interest with respect to all of its present and after-acquired property as security for its payment of the option price if it exercised Option 1.

Additionally, as security for their obligations to Wordsmith (as the assignee of Fox), the partners were required to cause the Six Iron Partnership to grant to Wordsmith a second-ranking security (subject to the first- ranking security granted to Fox) providing a security interest in respect of all of the Six Iron Partnership’s present and after-acquired personal property. [ 60 ] Wordsmith later assigned Option 1 to Faultline, which also assumed the obligations of Wordsmith.

Through the delivery of a promissory note, Faultline paid Wordsmith US$2,430,000 in order to acquire Wordsmith’s rights and interests. [ 61 ] The Appellant provided evidence and arguments in the hope of demonstrating that, at the time of closing, Fox had given no assurances or indications that it would exercise its option.

(8) Loan from Partnership to Fintrust [ 62 ] The Partnerships and Fintrust entered into the Partnership/Fintrust Loan Agreement ( " “Partnership/Fintrust Loan” " ). [17] From their remaining subscription proceeds, the Partnerships loaned US$6,000,000 to Fintrust. The agreement indicates that this loan was made to allow Fintrust to repay the Daylight Loan from RBC. Mr. Nimchuk tried to convince the Court that the structure was created with room for excess funds, such as this $6,000,000, in order to provide resources for marketing costs after the film had been released.

He alleged in this regard that the Partnerships had always intended to retain ownership of the films. [ 63 ] The loan was advanced on the closing date and was to be repaid either on the tenth closing date anniversary or at the Partnerships’ demand. The interest rate on the loan was 9.5% per annum.

(9) Loan from Fox to Fintrust [ 64 ] On the closing date, Fox and Fintrust entered into the Distributor/Fintrust Loan Agreement ( " “Fox/Fintrust Loan” " ). [18] As regards the Six Iron transactions under this agreement Fox agreed to provide a credit facility to Fintrust in the amount of US$206,850,000. According to the agreement, this credit facility was made available partly to allow Fintrust to repay the Daylight Loan.

The 5% per annum interest rate on the loan was to be paid on each closing date anniversary for 10 years, at which point all accrued and unpaid interest was to be paid in full. [ 65 ] An important feature of this loan is that repayment in full of the loan was to be made at the earlier of the tenth closing date anniversary or at Fox’s demand.

(10) Security Agreements (

a) Partnership/Fox Security Agreement [19] [ 66 ] This Partnership/Distributor Security Agreement ( " “Partnership/Fox Security Agreement” " ) is between Fox as the secured party and the Six Iron Partnership.

Here, the Six Iron Partnership and its general partner agreed to grant Fox a security interest in certain collateral in consideration of Fox entering into the Distribution Agreement, the Option Agreement, the Assignment and Option Agreement, and the Fox/Fintrust Loan Agreement ( " “Transaction Documents” " ). [ 67 ] As collateral, the general partner and the Six Iron Partnership granted a fixed and floating charge to Fox over all of their present and after-acquired personal property.

The collateral includes the Six Iron Partnership’s property (including all rights to the film) and all accounts receivable (including all amounts that are due or owing to the partnership). The collateral also includes all proceeds from any of the other collateral property. The general partner also provided a security interest in its interest in the Six Iron Partnership. [ 68 ] The security granted under this agreement had to be at all times a first-ranking priority charge.

[ 69 ] Under

section 8 of the agreement, Fox could collect the accounts receivable " “in such manner, upon such terms and conditions and at such time or times, whether before or after default, as may seem to it advisable and without notice to Partnership” " . [20] This provision also requires that all monies collected or received by the partnership from any accounts receivable be held in trust for Fox and immediately paid to Fox.

Importantly, the provision also states that " “all moneys collected or received by [Fox] in respect of the Accounts Receivable or other Collateral may be applied on account of such parts of the indebtedness and liability of Partnership to [Fox] as [Fox] deems best.” " [21] [ 70 ]

Section 11 of the agreement lists the events constituting default which include default by the Six Iron Partnership, any of the partners, Fintrust, Wordsmith or Faultline under any of the Transaction Documents. Pursuant to a " “Pledge of Copyright Transfer Documents” " [22] the general partner and the Six Iron Partnership are required to attach to the pledge document two undated assignment documents and to authorize Fox to complete the documents in the event of any default under

section 11 of the Partnership/Distributor Security Agreement. However, Mr. Nimchuk stated that the pledge document was put in place to effect the transfer of the copyright if Fox chose to exercise the option. (

b) Partners/Fox Security Agreement [23] [ 71 ] The Partners/Distributor Security Agreement ( " “Partners/Fox Security” " ) is between the general and limited partners of the Six iron Partnership and Fox. Under the agreement, the partners grant Fox a security interest in each partner’s rights to and interest in the Six Iron Partnership.

The " “security interest” " includes any interest in the partnership units, the film, the Distribution Agreement, the Transaction Agreements [24] (or any agreements referred to therein), and the income and rights accruing to each partner as a holder of the partnership units. [ 72 ] The security interest under this agreement is in addition to, and not in substitution for, any other security interests granted to Fox. Furthermore, except for the " “Permitted Encumbrances” " in

Schedule B of the agreement, the security interest granted under the agreement must at all times be first in priority. Unless Fox provides written consent, no additional security interest can be granted which does or could rank pari passu with any security interest created by the agreement. [ 73 ]

Section 8 states that in the event of a default under the agreement or a breach under the Option Agreement or the Assignment and Option Agreement, all distributions on account of the partnership units owned by a partner will be applied to the obligations of that partner to Fox. Additionally, any proceeds received by the partner in respect of the partnership units will be added to and form part of the collateral. [ 74 ]

Section 9.1 of the agreement enables Fox to " “receive any increase in profits on the Collateral” " regardless of whether default has occurred. [ 75 ] Finally,

section 10 of the agreement states that all amounts collected or received by Fox will be applied on account of the partners’ indebtedness in the manner that Fox deems best or, at the option of Fox, such amounts may be held unappropriated in a collateral account or released to the Six Iron Partnership, all without prejudice to the liability of the partners or the rights of Fox under the agreement. (

c) Other Security Agreements [ 76 ] These complex transactions contained numerous other security agreements, some of which I will mention here. [ 77 ] The November 21, 2006 Partner/Fintrust Security Agreement ( " “Partner/Fintrust Security” " ) [25] was provided as security for the loan from Fintrust to Paletta International. Under this agreement, Paletta International granted a security interest in its units in the Six Iron Partnership.

Section 9 of this agreement is identical to

section 9 of the Partners/Fox Security Agreement, except that the party benefiting from the security is Fintrust. [ 78 ] In accordance with the Partnership/Fintrust Loan, Fintrust granted a security interest in all of its present and after-acquired personal property to the Six Iron Partnership under the Fintrust/Partnership Security Agreement ( " “Fintrust/Partnership Security Agreement” " ). [26]

(11) Escrow Agreements [ 79 ] To accommodate the parties exercising their options sometime after the closing dates, the parties signed on the Six Iron Closing Date certain documents consequential upon the option exercises and placed those documents in escrow ( " “Escrowed Documents” " ) with Davis & Company, the law firm acting as escrow agent. The escrow terms were set out in a written document. Pursuant to this document, the Escrowed Documents were to be executed and only released from escrow in accordance with the " “Conditions of Post-Closing” " . [27]

(12) Exercise of Options [ 80 ] In each of the transactions, Fox exercised its option near the release date of each film. The theatrical release date for the Six Iron Film was December 22, 2006. Prior to that, on December 18, 2006, Fox exercised Option 2 for the Six Iron transactions, [28] which forced Wordsmith to exercise Option 1. [29] On the same day, the Escrowed Documents were released from escrow.

The aggregate price for Option 1 was US$218,093,121 and the price payable to Paletta International for its units under Option 1 was US$218,091,000. [ 81 ] Wordsmith then assigned to Faultline all of its interest in the underlying copyright on the film, its interest in the related agreements, and its obligation to pay the option price to the former partners of the Six Iron Partnership. [ 82 ] According to the Appellants, once the options were exercised, the Partnerships ceased to exist as a matter of law. The Appellants

claim that time that the Partnerships realized a loss for tax purposes because of the deductibility of the P&A expenses. These losses were denied by the Minister.

(13) Defeasance Transactions [ 83 ] As explained above, under the Fox/Fintrust Loan, Fox agreed to provide a credit facility to Fintrust in the amount of US$206,850,000. [ 84 ] Following the exercise of Option 1 and the assignment of the obligations thereunder to Faultline, Paletta International had an amount receivable from Faultline and an amount payable to Fintrust.

Both were interest-bearing. [ 85 ] Immediately after the closing, Fintrust owed US$206,850,000 to Fox. [30] After Fox exercised Option 2, Fox owed US$214,521,000 to Faultline. [ 86 ] Pursuant to the Assumption of Obligations Agreement, [31] Fintrust paid the outstanding amount of the Fox/Fintrust Loan (i.e.,US$206,850,000) by assuming Fox’s indebtedness to Faultline (i.e.,US$214,521,000). This is where the " “defeasance” " occurs.

Following this defeasance, Fintrust had a greater liability than it started with. [ 87 ] The difference between the principal amount of the Fox/Fintrust loan and the Fox/Faultline debt was US$7,671,000. The Appellants submit that this can be treated as a loss or deduction.

The Appellants submit that this amount almost entirely offsets Fintrust’s income – being the loan fees, the credit facility fee and the foreign exchange fee – which amounts to US$8,455,753. [ 88 ] The Appellants also submit that the Fintrusts did not have tax liabilities because the income they earned, in the form of loan fees or interest income, was offset by the loss realized in connection with the defeasance transaction. III.

Preliminary Issue [ 89 ] From the outset of the trial it became clear that one of the important questions to be determined by me was whether Fox had pre- agreed to exercise its option to acquire the partnership interests such that there would be a return of the films to Fox . In short, were the options shams designed to mask the parties’ pre-agreement that the films would be reacquired by Fox prior to their commercial release? [ 90 ] During argument, the Appellants’ counsel raised an issue as to whether the Respondent failed to properly allege sham in relation to the Option Agreements.

I invited both counsel to address this point as a matter of procedural fairness because I planned to address the issue in my reasons. After the hearing, both parties filed additional written submissions setting out their views on the matter. [ 91 ] In her Replies, the Respondent does not explicitly state that the options were shams. In her statement of facts, the Respondent admits the Appellant’s statement that Wordsmith exercised the option. Moreover, the Respondent assumes as a fact that Fox exercised its options.

By contrast, the Respondent’s assumptions of fact clearly identify the Daylight Loan, the " “Partners Loan Agreement” " , the Purchase and Assignment of Rights Agreement and the Distribution Agreement as shams. The Respondent uses the words " “purported” " or " “purportedly” " in describing the transactions she alleges to be shams. [ 92 ] The Respondent does, however, make several assumptions about the Option Agreements.

She assumes that the Appellant knew that Fox would exercise the options and that no income would be realized while the Partnerships had an interest in the films that the options were preordained to be exercised and that the films were preordained to be transferred back to Fox.

The Respondent also assumes that " “[t]here was never any intention by Fox or any other party to allow the [partnership] to actually own, control and exploit the Picture.” " [32] [ 93 ] The Appellant initially agreed that the absence of the identification of the options as shams in the Replies did not preclude the Court from deciding the issue and that the error raised only a question of onus: JUSTICE: Are you saying in your review of the pleadings that the Crown missed the option in alleging sham? MR. DAVIES: I am, Your Honour, yes.

JUSTICE: And you’re saying that some of the broader allegations that they make doesn’t allow the Court to consider the impact of that option agreement and whether it was a facade or not? MR. DAVIES: Well, I wouldn’t go that far, but certainly to the extent that the assumptions made by the Minister placed the onus of proof on the appellants, then we have to overcome it to the extent of those assumptions, but not beyond. JUSTICE: Right, but if the Court is preoccupied by the option and impact of the option and whether it was a true option or not, you’re simply saying the onus goes to the Crown at that point. MR.

DAVIES: Yes. And clearly that’s part of the same transactions that are at issue in this case. And I think it becomes a question of onus. [33] [ 94 ] At this point, the Appellants had submitted their initial written submissions. The submissions refer to the options throughout, and in doing so they deal as well with the allegation of sham. They allege that " “Fox gave no assurances or indications that it would exercise its option at the time of closing.” " [34] In a

section titled " “The Facts Related to the Alleged Sham”, " the Appellants state that the " “option exercise was not preordained nor was the fact of the exercise made known to any of the other participants in the transaction prior to its actual exercise.” " [35] The Appellants also argue the issue of the validity of the options in the " “Effectiveness of Transfer” "

section by comparing the transaction structure to that of the Ingenious Film Partners transactions, which were a similar series of transactions that

Fox entered into with another party: Further, the Ingenious transactions show that Fox is not hesitant to build in a compulsory reacquisition mechanism. They could have structured the transactions with Ingenious to incorporate a call option as well, but they did not. Its use in the Six Iron transactions is thus more noteworthy, and should be respected as valid . [36] [Emphasis added.] [ 95 ] The Appellants deal with the options in their tax shelter submissions arguing that the testimony of Messrs.

Paletta, Nimchuk and Fergus indicates there was a lack of certainty that the options would be exercised. [37] They also provide submissions regarding the options and the question of whether the partnership units were held on account of income or capital: Fox’s requirement that the option be granted as part of the transactions sounded as “a negative” to Angelo, since he run [ sic ] the risk of having the film rights taken back from him (or his Company) after going through all the work and effort.

However, this requirement did not seem unusual to Angelo, who was familiar with several real estate transactions where options were granted. In the Appellants’ view, there was a 50/50 per cent chance of Fox exercising the option. . . . The option agreement was completely in the control of Fox. Angelo would not have the knowledge of which factors would lead Fox to exercise the option.

The fact that the option had been exercised by Fox in other transactions had no bearing on the likelihood of Fox doing so in respect to the Palettas and Paletta International Corporation investments because, according to Angelo, every transaction is separate and different, the timing is different, conditions are different, people are different, the company purpose and direction is different, etc… [38] [Footnotes omitted.] [ 96 ] These submissions reflected the evidence adduced at trial and the framing of the case by the Appellants in their written Opening Statement.

The Opening Statement contains numerous references to the Option Agreements.

It repeats the statements from the Appellants’ Written Argument that Fox gave no assurances or indications that it would exercise its option, and that any one of a number of factors could have prompted Fox to forego exercising the option. [39] The Opening Statement provides explanations and justifications for Fox’s insistence on the option and the factors that would have influenced Fox in choosing to exercise the option. [40] The Opening Statement also describes the Minister’s position as alleging " “that the transactions as a whole were a sham” " [41] [ 97 ] The Appellants led evidence at trial which demonstrates an understanding that the validity of the options was at issue.

Counsel for the Appellants questioned several of its own witnesses in examination-in-chief on the likelihood of the options being exercised. Mr. Paletta testified at length as to his belief that there was a 50-50 chance of the options being exercised. Messrs.

Nimchuk and Fergus also testified extensively as to their understanding of the likelihood of the options being exercised and concerning any information they received from Fox in that regard. [ 98 ] Although the Appellants initially raised the issue regarding the Replies in the context of burden, the following day they argued that the Respondent had admitted the validity of the options and was therefore precluded from challenging their validity. This is when I asked for further written submissions on the issue. [ 99 ] The Appellants frame the issue very narrowly in their submissions.

According to them, the Respondent failed to plead that the options were shams or certain to be exercised and that the Respondent in fact admitted the validity of the options. The only solutions, in the Appellants’ view, are to withdraw the admission and/or amend the Respondent’s pleadings, neither of which is appropriate at this stage. [ 100 ] I do not agree with the Appellants’ view of this matter. [ 101 ] The Respondent did not admit that the options were valid. Even if she did, in the circumstances such admission would not bind the Court.

Furthermore, there is no unfairness to the Appellants in deciding these appeals on the basis that the options are shams. A. There is no judicial admission that binds the Court [ 102 ] A judicial admission (also known as a formal or express admission) is a concession by a party that a certain fact or issue is not in dispute. [42] In civil cases, a judicial admission is normally conclusive and binds the Court, even if contradicted by the evidence.

However, it is not necessarily the same in tax cases. [ 103 ] The Respondent’s admission of the Appellants’ statement that the option was exercised is not an admission that the option was valid. It is an admission that the documentary requirements with respect to the option occurred when and as described by the Appellants. The essence of sham is that the legal rights and relations set out in the documents are not the legal rights and relations the parties intended to and did create. On its face, the option was exercised.

A sham would arise, however, if such exercise was preordained and the parties had pre-agreed from the very outset that Fox would reacquire the films prior to their commercial release. [ 104 ] The Minister’s assumptions clearly state that exercising the options was preordained. The Appellants argue that those assumptions are deficient because they inaccurately describe the parties to the option as the Six Iron Partnership and Fox, when the parties were in fact Paletta International and the general partner. The Appellant argues that this misdescription led to the erroneous assertion that the option was preordained.

Firstly, the misdescription is not as clear as the Appellants assert. Secondly, I fail to see how it affects the assumption that the option exercise was preordained. To the extent that the Minister misstated the parties to the option, the Minister has

the burden of proving who the parties were.

Further, the Appellants fail to address the last sentence of the relevant paragraph of theReply, in which it is stated that "“the Picture itself was preordained to be transferred back to Fox.”" [43] The Reply also states that "“theAppellant knew that Fox would exercise its option to reacquire the Picture”". [44] Thus it is clear that the Respondent assumed that therewas no doubt the options would be exercised. [105] Even if I am wrong and the Respondent has admitted that the Option Agreements were valid and not shams, I do not think that theCourt is bound by this admission in the circumstances. In Hammill v.

The Queen [45] the Federal Court of Appeal held that the TaxCourt is not bound by an admission which is shown to be contrary to the facts where the party benefitting from the admission hasadduced evidence going beyond the admission. [46] This decision was followed in Fiducie Alex Trust v. The Queen [47] as well as inDoiron v.

The Queen. [48] [106] The Federal Court of Appeal held that due to the public nature of a tax appeal, the normal rule applicable to admissions in the civilcontext does not apply where a party itself places evidence in the record over and above what was agreed to: [29] Specifically, the appellant argues that the Tax Court Judge was bound by the facts as admitted, even if contraryevidence was adduced at trial. Sopinka, The Law of Evidence in Canada, 2nd ed, Butterworths, 2004 at page 1051; Urquhartv. Butterfield (1887), 37 Ch. D. 357, at 369 and 374; Copp v.

Clancy (1957), (NB CA), 16 D.L.R. (2d)415, at 425, are relied upon in this regard. [30] In my view, these authorities which derive from private party civil proceedings are of no assistance to the appellant inthe context of this appeal. While the admission reflected in the Agreed Statement of Facts was favourable to the appellant,he was not satisfied to have his appeal disposed of on that basis.

The appellant chose to place extensive evidence before theCourt, over and beyond what had been agreed to, about the nature and extent of the scam. [31] In an appeal against an assessment under the Act, the outcome does not belong to the parties. Public funds are involvedand the Tax Court is given, in the first instance, the statutory mandate to confirm or vary the assessment based on the facts,proven or admitted. In this respect, while the Court will not generally look behind a formal admission, the parties cannot byagreement dictate the outcome of a tax appeal.

The Tax Court is not bound by an admission which is shown, throughproperly tendered evidence, to be contrary to the facts. [32] In this case, the relevant evidence was tendered by the appellant himself, and the Tax Court Judge concluded from thisevidence that he had been the subject of a fraud from beginning to end, a conclusion which precludes the existence of abusiness.

In my view, the Tax Court Judge could not pronounce on the validity of the reassessments while turning a blindeye on the evidence placed before him. [33] Moreover, there is no basis for the appellant's contention (made during the hearing of the appeal) that this finding wasnot open to the Tax Court Judge because the statutory period for reassessing had expired when it was made (Pedwell v. TheQueen, (FCA), 2000 D.T.C. 6405 (F.C.A.)).

The decision of the Tax Court Judge on this point confirmsthe reassessments on the primary basis on which they were issued (paragraph 18(1)(a)) and results in no taxes being payablebeyond those originally assessed (compare Anchor Pointe Energy Ltd. v. The Queen, 2003 D.T.C. 5512 (F.C.A.) atparagraphs 39 and 40). [49] [Emphasis added.] [107] As described above, the Appellants addressed the validity of the options as an issue from the start of the trial. They led extensiveevidence on it.

Even if I thought that the Respondent had admitted the validity of the options, this is a situation in which the Court wouldnot be bound by the admission, given the evidence in the record. B. There is no procedural unfairness to the Appellants [108] Although I find that the Respondent did not admit that the options were valid, I acknowledge that it is clear from the Replies thatthe Respondent based her theory of the case on the idea that the means of transferring the films from Fox to the Partnerships were shamsfrom the outset.

According to that theory, it is not necessary to conclude that the options were shams inasmuch as the films had not infact been transferred. Given this, I do not think there is any unfairness to the Appellants in deciding that the options were shams. [109] There is a wealth of jurisprudence regarding the interplay between the Repondent’s Reply, new or alternative arguments andtaxpayers’ rights.

The Supreme Court of Canada in Continental Bank of Canada v Canada held that the Minister cannot raise a newargument that has the effect of creating a new basis of reassessment after the limitation period has expired. [50] The Court was concernedby the fact that the evidence necessary to support the new argument was not adduced at trial and that the new argument amounted to assessing beyond the limitation period. [51] The case prompted Parliament to enact subsection 152(9) of the Income Tax Act (the "“Act”")which clearly allows the Minister to advance new arguments at any stage of a proceeding, subject to a provision regarding evidentiaryprejudice to the taxpayer. [110] In these appeals, the Respondent assessed the Appellants inter alia under paragraph 18(1)(

a) of the Act, denying the deduction ofthe partnership losses on the basis that the amounts were not incurred for the purpose of earning income from a business. As noted, theRespondent’s theory of the case is that the transactions prior to the option were shams and/or not legally effective. The Respondentnevertheless assumed that the options were preordained and that it was known to the Appellants that they would be exercised.

In light ofthe evidence adduced at trial, to decide that it is the option rather than the preceding transaction or transactions that is the sham does notchange the basis of the reassessments. So deciding does not involve reliance on unpleaded assumptions. Nor does it result in more taxbeing payable by the Appellants. It is a determination that the amounts claimed by the Appellants are not deductible under paragraph18(1)(

a) as they are not expenses incurred for the purpose of earning income from a business. Accordingly, there is no new basis ofassessment.

[ 111 ] I will now consider the question of prejudice to the Appellants.

I do so not only in the event that I am wrong about whether deciding that the options were shams would amount to a new basis of assessment but also because litigation on subsection 152(9) can get bogged down in what Rothstein J.A., as he then was, termed " “semantical argument” " . [52] I do not wish to dispose of the issue on technicalities: the heart of the matter is fairness to the Appellants. [ 112 ] Fairness in this context means notice of the case to be met and the corresponding ability to adduce relevant evidence. [53] [ 113 ] The Appellants argue that they presented their case on the basis that the options were not alleged to be shams and, as a result, the Court does not have before it a full factual record on which to decide the question.

They allege that they would have called additional witnesses, specifically from Fox, and the witnesses who actually were called would have been questioned differently or on additional matters. Therefore, the Appellants maintain, they have suffered prejudice. [ 114 ] I do not agree that the Appellants suffered evidentiary prejudice. [ 115 ] Recently, in Bakorp Management Ltd. V.

The Queen , the Federal Court of Appeal dismissed the taxpayer’s procedural fairness and natural justice argument in circumstances where the Respondent did not, in her Reply, indicate that she was relying on the provision that limits a taxpayer to claiming non-capital losses only once. [54] The taxpayer argued that the Tax Court could not rely on that provision to deny the taxpayer’s claim for non-capital losses in one tax year on the basis that they had been claimed for another tax year.

The Federal Court of Appeal noted that it was " “obvious” " from reading the taxpayer’s notice of appeal that it understood the losses could only be claimed once. The taxpayer had also cited the relevant section, though not the specific paragraph. Furthermore, the Minister had relied on an assumption that the maximum amount of non-capital losses available was a particular dollar amount.

The Federal Court of Appeal held that the reference to the paragraph by the Tax Court judge " “did not introduce a new legal principle that was unknown to Bakorp” " and that the " “alleged breach of procedural fairness [was] without any merit.” " [55] [ 116 ] In the current case, the Appellants cannot claim to be taken by surprise by the Respondent’s theory. The validity of the options has been a focus of the trial from the outset. The Appellants led considerable evidence on the matter.

When they raised this issue in argument, they initially took the position that any issues with respect to the options would not preclude the Court from ruling on the options, but would only be taken into account with respect to the question of burden. [ 117 ] It was not until the following day that counsel took the position that the Respondent was precluded from arguing that the options were shams.

This further indicates to the Court that the Appellants had not noticed the alleged deficiency in the Minister’s pleading until recently. [ 118 ] It follows that I cannot accept the Appellants’ argument that they suffered evidentiary prejudice. The Appellants contend that they would have called additional or different witnesses if they had known that the options were in issue. However, I have found that the Appellants clearly viewed the options as an issue from the start and led evidence on that issue in their examinations-in-chief of multiple witnesses.

The commission witnesses were finalized and subpoenaed after the first two weeks of trial had been completed, during which the options had been a focus of the Appellants’ evidence and the Court’s attention. When the Court suggested that a person from Fox’s business affairs department would have been a good witness, counsel for the Appellants responded that such person was no longer with Fox: JUSTICE: But she had very little knowledge, if any, of the business deal. MR.

DAVIES: Correct, she didn’t have much knowledge of the business deal but –- JUSTICE: But Fox’s purpose and objective was in terms of entering into the transaction, the business affairs person would have been a good witness in that regard. MR. DAVIES: Who is no longer with Fox. JUSTICE: I understand. [56] [ 119 ] Respectfully, the Appellants’ argument that they would have called different witnesses or questioned the ones they did call in a different manner reads as an attempt to have their cake and eat it too.

The Appellants led evidence on the options through their own witnesses because they believed the evidence being led was favourable to them. They chose not to proceed with the riskier strategy of calling Fox business affairs witnesses, who would then be subject to cross-examination. They also chose not to pursue a risky line of questioning with the witnesses they did call who did not necessarily have an interest in portraying the transactions as the Appellants would have liked them to have been portrayed. This was a strategic decision and I do not draw a negative inference from it.

I do not, however, think it fair to allow the Appellants to claim only the benefit of the upside of their strategy and disavow the downside. [ 120 ] I conclude that there is nothing in the pleadings to preclude me from considering whether the options were shams designed to mask the parties’ agreement that the films would be reacquired by Fox prior to their commercial release. IV. Sham A. The Law [ 121 ] There appears to be no dispute between the parties as to the meaning of sham. They both referred to the case of J. Snook v.

London & West Riding Investments, Ltd . [57] In Snook , Diplock L.J. stated that " “sham” " :

. . . 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.

One thing I think, however, is clear in legal principle, morality and the authorities . . . that for acts or documents to be a “sham”, with whatever legal consequences follow from this, 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.

No unexpressed intentions of a “shammer” affect the rights of a party whom he deceived. . . [58] [ 122 ] Canadian courts adopted the Snook definition of sham in 1972. [59] The Supreme Court of Canada reaffirmed and followed this definition of sham in Stubart Investments Ltd. V.

The Queen . [60] In Stubart , Justice Estey defined sham as: . . . 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. . . [61] [ 123 ] Two more recent decisions of Justice Noël of the Federal Court of Appeal discuss sham. In Antle v. The Queen , he said, in obiter: . . .

The required intent or state of mind is not equivalent to mens rea and need not go so far as to give rise to what is known at common law as the tort of deceit . . . . It suffices that parties to a Transaction present it as being different from what they know it to be . . . [62] [ 124 ] In 2529-1915 Québec Inc. v. The Queen, he said: [59] It follows from the above

definitions that the existence of a sham under Canadian law requires an element of deceit which generally manifests itself by a misrepresentation by the parties of the actual transaction taking place between them. When confronted with this situation, courts will consider the real transaction and disregard the one that was represented as being the real one. [63] [ 125 ] In a tax context, a Court will arrive at a finding of sham when the evidence shows that the parties misrepresented their arrangements in a bid to achieve a tax benefit that would be denied if the nature of their arrangements was properly disclosed.

In tax matters, the party that is deceived by the sham is the Canada Revenue Agency ( " “CRA” " ). [ 126 ] In considering sham, the Court must examine the objective reality surrounding the arrangements to discern whether the transaction documents truly reflect the parties’ intent. Direct evidence of sham is rare where a case proceeds to court; in the absence of an admission, the court is left to weigh circumstantial evidence. [ 127 ] Here, the evidence consists primarily of the transaction documents themselves and testimony – particularly the testimony of Messrs. Fergus and Nimchuk (the " “promoters” " ) and Mr.

Paletta. The factors that inform the objective reality of the arrangements include:

i) the circumstances surrounding the development of the transaction structure; ii) the Appellants’ due diligence, involvement and oversight, or lack thereof, in evaluating and participating in the transactions; iii) the ordinary business and investment practices of the Appellants; iv) the parties’ stated goals and reasons for entering into the transactions; and

v) the legal rights and obligations as defined in the transaction documents. [ 128 ] This list is non-exhaustive. Taken together, these factors inform a court’s analysis of whether the legal rights and obligations described in the transaction documents are consistent with the parties’ avowed intent. [ 129 ] I stress that searching for the objective reality of a transaction does not conflate sham (i.e.,misrepresentation and deceit) and the notions of " “economic substance” " or " “business purpose” " .

It is well established that a transaction is not a sham because it is devoid of economic substance, lacks a business purpose or serves a tax avoidance purpose. I shall look instead at whether the parties misrepresented the nature of their arrangements to the CRA. [ 130 ] One final point is that sham must be distinguished from abuse. Sham is not an overall scheme that is abusive; it is a matter of the parties having misrepresented the legal effect of a transaction. Accordingly, I must point to certain transactions that are misrepresented.

The structure in these appeals is complex and comprises many different transactions, and it is important not to combine all the transactions and steps into one, to paint every step as a sham – that would be to misconstrue what sham is. For example, the Respondent alleges that the Daylight Loan to Fintrust is a sham. I cannot agree. There is no evidence that the parties to the loan, who include RBC, intended anything other than what is indicated by the documents – a loan in the amount of US$212,000,000 (in the Six Iron appeal) to be repaid within 24 hours.

The circularity of the cash flow does not equate to a sham in the case of this loan. [ 131 ] However, once a transaction is identified as a sham, where that transaction forms part of a series of transactions it is not always easy to determine the effects of that sham transaction on transactions that follow (or perhaps precede). Here I identify the Option Agreements as shams – that is sufficient to dispose of these appeals. I also conclude that the Defeasance Transactions (defined below) that followed the option arrangements are shams.

B. Positions of the Parties [ 132 ] The Appellants assert that the record shows that the parties intended to abide by the arrangements that they entered into. They describe a history of family and corporate dealings in the media and communications industry. Their position is that Mr. Paletta encouraged the family to invest, first through Paletta International in the Six Iron Partnership, then as individuals in the Swilcan Partnership, in order to acquire and hold large newly produced films for long-term exploitation and profit.

They deny that the options were preordained, and are adamant that the exercise of the options was in each instance a negative outcome for them. [ 133 ] According to the Appellants, Fox was willing to enter into the arrangements to mitigate its risk during the films’ post-production, pre-release period. For Fox, the option arrangements were crucial to achieving this risk mitigation purpose. If Fox thought that the films would be a commercial success, it would exercise prior to commercial release the options to reacquire them. Fox would then receive all of the revenue associated with the films.

Fox would also retain cash equal to 3% of the P&A expenses incurred by the Partnerships. On the other hand, if Fox believed that the films would not be commercial successes, it could refrain from exercising the options. In that case, Fox would earn a return based on its entitlement under the Distribution Agreements. [ 134 ] Unsurprisingly, the Respondent alleges the contrary. According to the Respondent, the films were never truly transferred to the Partnerships, whose sole purpose was to enable the Appellants to benefit from tax savings, and Fox to benefit from the 3% fee.

The Appellants’ tax savings would arise from the fact that the P&A expenses would be deductible while only one-half of the capital gains realized on the sale of the partnership units would be included in income. [ 135 ] The Respondent says the conduct of the parties when structuring, reviewing and implementing the arrangements is not at all consistent with their stated intent of making a long-term investment in the films.

According to the Respondent, the arrangements were structured to allow Fox to reacquire full ownership of the films prior to their commercial release and to receive a fee equal to 3% of the P&A expenses deducted by the Partnerships. The Appellants’ intention in entering into the transactions was to benefit from the substantial tax savings associated with the deduction of these expenses. [ 136 ] I will now examine the evidence to see which of these two contrary assessments of the evidence is accurate. C.

Background of the Investment Structure [ 137 ] The Appellants called the promoters who devised the structure, Messrs. Warren Nimchuk and Warren Fergus, as witnesses. Both are chartered accountants with years of experience at accounting firms. At the time of the transactions, Mr. Nimchuk was either a senior tax manager or a partner at PwC with extensive experience in the Canadian film financing industry. [64] Mr. Fergus had left public practice some years before to market tax and insurance products with a former client, who introduced him to Mr. Nimchuk. Mr.

Fergus left that business to join Grosvenor Park, a production services tax shelter company, and eventually became their national sales manager. When Parliament enacted the matchable expenditure rules (discussed below), Grosvenor Park folded. At that time, Mr. Fergus refocused his attention on the tax investment products he had been selling prior to joining Grosvenor Park. It was at this point that Messrs. Nimchuk and Fergus began the discussions that led to the creation of the structure that is before the Court today. [ 138 ] It became clear at trial that Mr. Nimchuk was the technical expert while Mr.

Fergus took the lead in marketing and client service. In examination-in-chief, Mr. Nimchuk acknowledged his extensive familiarity with the " “matchable expenditure” " rules found in

section 18.1 of the Act and their impact on film production in Canada. [ 139 ] Prior to the matchable expenditure rules, major US studios would receive tax-assisted financing by entering into production services arrangements with Canadian partnerships organized to finance production services in exchange for a future right to income. The partnership would realize a loss in the early years because it would deduct current expenses against a possible future right to income. The partners in these arrangements would claim losses in the early years and benefit from a significant tax deferral. [ 140 ] Mr. Nimchuk acknowledged that the enactment of

section 18.1 put an end to the above arrangements. The new regime offered refundable tax credits to foreign producers for eligible film production activities carried on in Canada. Mr. Nimchuk quickly became a recognized expert, who was frequently called upon to demystify the workings of this new regime. He testified that he had developed a broad range of contacts with the major film studios, including Fox. [ 141 ] Following the enactment of the matchable expenditure rules, Mr. Nimchuk had a preliminary conversation with two of Fox’s business affairs executives, whom he knew through his prior dealings with Fox.

He testified that he proposed a new arrangement whereby Fox would transfer a newly produced film to a Canadian partnership. The partnership would grant distribution rights to Fox and, to maximize revenues for the partnership, would undertake to incur a significant part of the P&A expenses leading up to the film’s commercial release. Mr. Nimchuk explained that Fox was interested in the proposal on the condition that it be granted an option that, if exercised, would allow it to reacquire the film. [ 142 ] According to the promoters, this arrangement offered two significant potential benefits for investors.

If Fox did not exercise its option, the investors stood to earn an attractive return from the commercial exhibition of the film. On the other hand, if Fox exercised its option and reacquired the film, the investors would benefit from significant tax savings.

The tax savings arise from the fact that the P&A expenses would be fully deductible, whereas only one-half of the capital gains realized by the investors on the disposition of partnership units (which would occur automatically when Fox exercised the option) would be included in income. [ 143 ] This new arrangement offered tax benefits similar to the " “production services” " arrangements described above, but was not affected by the matchable expenditure rules because the partnerships owned the films. [ 144 ] According to Mr. Nimchuk, Fox enjoyed the best of both worlds under these arrangements.

If Fox believed a film would be

successful, it would exercise the option and retain 100% of the distribution revenue. If Fox believed the film would perform poorly, it would allow the option to lapse. In that case, Fox would earn the revenues provided for under the Distribution Agreements while the Appellants bore the risk of their share of the distribution revenues not being sufficient to enable them to recoup their investments in the film. [ 145 ] Mr. Nimchuk had done most of the technical work in preparing the structure. Once the structure was in place, it came time to market it. This was Mr. Fergus’ area of expertise, and he was successful.

Various investors used this structure to generate tax losses in connection with eight Fox films. The Palettas, personally or through their corporate holdings, used it three times. Two of those investments are before the Court. [ 146 ] The promoters testified that in their negotiations and discussions with Fox, Fox never gave any indication as to whether or not it would exercise the options. The promoters also acknowledged that Fox exercised the options every time.

The Appellants and the promoters would have the Court believe that it was a mere coincidence that Fox caused the options to be exercised in all eight separate transactions implemented with the assistance of the promoters. For the reasons that follow, this is beyond reasonable belief. D. Credibility of the Promoters [ 147 ] I do not find either of the promoters to be a credible or trustworthy witness. [ 148 ] Mr. Nimchuk was the first to testify. In the Appellants’ Opening Statement, Mr. Nimchuk is described as a partner at PwC who assisted Mr.

Fergus in negotiating with Fox, establishing the Partnerships and setting up the structure. [65] His examination-in-chief was conducted in a manner largely consistent with how he was presented at the start of the trial. [ 149 ] The Respondent quickly established that this presentation was misleading. Early in cross-examination, the Respondent asked Mr. Nimchuk a series of questions designed to elicit whether he had a personal interest in the outcome of the structures. The record illustrates the extent to which Mr. Nimchuk tried to disguise the secret side deal that he struck with Mr.

Fergus at the outset of their relationship: Q. In respect of this transaction you were involved as an employee of Price Waterhouse Cooper only? Or were you involved in any other capacity in these transactions? A. No, just through Price Waterhouse. Q. Okay. If we look at the documents that are part of the closing binders, there are numerous transactions. We have referred to them extensively. Are there side deals, to your knowledge, that are not in the closing binders? A. With the studio? Between the partnership? Q. In respect of this transaction? A. Not that I'm aware of. Q. Okay. Are there any secret deals? A.

What's a secret deal? Q. A deal that was not supposed to be disclosed as part of the closing binders. That you know of? A. To the best of my knowledge there was no other agreements relating to the transaction between any of the parties. Q. There were no written agreements that are not in the closing binders? A. There were no agreements that I'm aware of, either written or otherwise. Q. Otherwise being oral agreements or any sort of agreement that are not in the closing binders? A. Yeah, no agreements. Q. Can we say the same for the other Transaction, the Swilken [sic] Transaction?

You were involved as an employee of Price Waterhouse Cooper? A. Yes. Q. Only in that capacity? A. Yes. Q. And there are no side deals in respect of the Swilken [ sic ] transaction either? A. No. Q. No oral arrangement? A. No.

Q. No written arrangement? A. No. [66] [Emphasis added.] [ 150 ] In fact, this was untrue. Counsel for the Respondent confronted Mr. Nimchuk with documentary evidence of his financial stake in the transactions beyond his involvement as an employee and/or partner of PwC. As the evidence mounted, Mr. Nimchuk attempted at every step to mislead the Court, admitting only what was immediately before him and denying the rest until eventually it all came out. [ 151 ] The promoters received their fees in two stages: firstly out of the cash put up by the Appellants and secondly from Fintrust at the defeasance stage.

Both payments went to corporations controlled by Mr. Fergus or his wife ( " “Fergus Corporations” " ), including one called Puppy Productions Inc. and another called Savage Beagle Productions Inc. When directed to the evidence of the first payment stage, Mr. Nimchuk testified that he did not know why the money went to the Fergus Corporations and denied that it was his share of the profits: Q. --And the amount that was paid to that corporation was a division of this profit…of this amount, $2,243,457 between--it was split between Savage Beagle and Puppy Production. Do you know why is that? A. No. Q.

It was split 50-50. There was $75,000 that was already in Warren Fergus's possession. And the balance is 50-50? A. Magnolia Lane? Q. Yes. A. Yes. Q. So that was not your share of the p

[…]