MeGILL
LAW JOURNAL
VOLUME 8
MONTREAL, 1962
NUMBER 3
LIFTING THE CORPORATE VEIL IN
CANADIAN INCOME TAX LAW
G. T. Tamaki*
The theory that a corporation is a distinct legal personality separate from
its shareholders and from other corporations, is firmly imbedded in the pattern
of Canadian fiscal legislation. The purpose of this article is to consider some
of the circumstances and the manner in which Parliament has wholly or
partially disregarded the effect, for income tax purposes, of what has often
been described as the “corporate veil” and to examine the judicial approach
to this question.’
From the purely conceptual viewpoint, if each corporation is a legal person
separate from its shareholder members and from other corporations, there is
no reason why it should not be treated as an independent taxpayer without
regard to its relationship to the shareholders or other persons, including
corporations. Moreover, it would pay tax on exactly the same basis as natural
persons. However, it is obvious that this legalistic comparison cannot be
carried too far. A corporation cannot have medical expenses to pay, dependants
to support, alimony payments to make, or incur many other obligations of
natural persons; if corporate persons had to pay income taxes at the graduated
rates considered appropriate for individuals, most corporations would soon be
driven out of business; and if corporate distributions of earnings to share-
holders, which in the strict theory of the law are always income to the recipient,
were taxed at all times as ordinary income to both natural and corporate
shareholders there would be little incentive to incorporate or for corporations
to distribute their “tax-paid” earnings when made. On the other hand, to
ignore the corporate entity entirely in order to tax the shareholders on the
basis of distributed (or undistributed) earnings of the corporation would be
*B.A., LL.B., LL.M., Montreal. Of the Bars of Quebec, Saskatchewan and Nova Scotia. Lecturer
in Taxation, Faculty of Law, McGill University.
‘On the general subject of “Lifting the corporate veil”, see L.C.B. Gower, The Principles of Modern
Compan.) Law, (2nd Ed.) London, 1957, Chapter 10, and the references cited therein.
McGILL LAW JOURNAL
[Vol. 8
equally cumbersome and unrealistic, except possibly for closely-held “one-
man” or “family” corporations. 2
The Legislative Pattern
The Canadian income tax system, in common with that of many other
countries, everywhere recognizes the legal existence of a corporate taxpayer
distinct from its shareholders and from other persons. Thus, under the Income
Tax Act, each corporation is a separate taxpayer and is subject to tax upon its
earnings at special corporate rates.’ No consolidation of profits and losses of
groups of corporations, even as between parent and subsidiary corporations, is
permitted.4 Moreover, the distribution of its earnings by a corporation by
way of a dividend is normally regarded as resulting in income to the recipient,
although special concessions are found as to the extent of the taxability thereof
in the hands of corporate and individual shareholders. The principle of cor-
porate personality is thus carefully preserved although the tax effect of the
principle may be modified in special instances.
The two most widely-known exceptions to the strict application of the
rule of the separate corporate personality in fixing the incidence of tax under
the Income Tax Act, are found in the provisions relating to the income of
certain investment corporations. First, there is the concept of a “personal
corporation” which is in essence a closely-held family investment corporation
controlled by a Canadian resident individual.5 Such a corporation, which
normally serves as a corporate pocket for personal or family investments, is
recognized as a separate legal entity but is exempted from corporate tax and
instead its annual income is taxed in the hands of the shareholders whether
or not it is distributed to them. Actual distributions subsequently made are
not taxed a second time. The result is that shareholders whose rates of tax
are in excess of the corporate rates cannot reduce their burden of tax simply
by “incorporating” their holdings. At the same time, shareholders of personal
corporations are not penalized if their tax rates are less than the corporate
ruhe idea of a “family” corporation having the right to elect to be treated’as an ordinary corpo-
ration or as a partnership of shareholders was found in Section 22 of the Income Tax Act, R.S.C.
1927, C.97, until repealed in 1932 by S.C. 1932, C.43. For a comprehensive analysis of the problems
of corporate taxation in general, see Final Report of the Royal Commission (U.K.) on the Taxation
of Profits and Income, 1955, Cmd. 9474.
3R.S.C. 1952, C.148. The corporate rates for 1961, including Old Age Security Tax of 3%, are 21%
on first $35,000 taxable income and 50% thereafter. These rates are subject to special rules applying
to “associated corporations” discussed below.
‘See, however, Section 75 of The Income Tax Act, S.C. 19,18, C.52, which was repealed for the
1952 R.S.C. and subsequent years by Section 26 of S.C. 1951, C.51.
‘Sections 67 and 68 of the Income Tax Act. Even in the case of personal corporations, the separate
legal existence of the corporation is carefully preserved. See Maclean J. in Richardon v. M.N.R.
[1940-41] C.T.C. 258, at p. 263. See also G. McGregor, “Personal Corporations – A study of their
background and treatment under the Canadian income tax”, Canadian Tax Papers, No. 18. Canadian
Tax Foundation.
No. 3]
LIFTING-THE CORPORATE VEIL
rates. A somewhat similar modification in the rigid application of the corporate
personality rule is available to investors who are non-residents of Canada.
Non-residents who incorporate a Canadian investment corporation which
qualifies as a “non-resident-owned investment corporation” can be placed in
substantially the same Canadian tax position as if they owned Canadian in-
vestments directly and paid the normal 15/o withholding tax on income from
such investments. In this case, the corporation pays a 15% corporate tax and
no further tax is levied upon the distribution of the balance of its earnings to
the non-resident shareholder.6
Disregard of the corporate veil in a somewhat different manner is also
evident in the rules relating to so-called “associated corporations” for determin-
ing the effective rates of corporate tax, which under the Act depend upon the
size of each corporation’s taxable income. Because the general corporate tax
rate is considerably higher than the special rate applicable to a stated maximum
amount of taxable income, the lower rate is made available only once for a
group of so-called “associated corporations”.’ In this case, the identity of the
controlling shareholders rather than the mere legal existence of separate cor-
porate entities is made the test of entitlement to the lower rate of corporate
tax designed to assist the genuinely smaller businesses. 8
The facade of incorporation is also partially disregarded in the provisions
affecting certain transactions between closely-related corporations and between
a corporation and its shareholders. The technique employed in the Income
Tax Act to discourage any tendency for such corporations to enter into artificial
arrangements for tax avoidance purposes is to write into the statute the detailed
tax consequences, often penal in nature, of transactions or relationships
between persons (including, but not limited to, corporations) not dealing with
each other at arm’s length. 9 Thus, the concept of the separate corporate per-
sonality will not protect the taxpayer from tax in cases of “rigged” prices for
sales or purchases, artificial transactions with non-residents, unreasonable
deductions or expenses or other methods of artificially reducing income. 10
The legislative attempts to deal with the problem of the tax treatment of
distributions to shareholders of earnings already taxed in the hands of the
corporate entity show that this aspect of the theory of corporate personality
has been the most troublesome to administrator and taxpayer alike. As has
6Section 70 of the Income Tax Act. See also Section 69 for special treatment accorded to “invest-
ment companies”.
7Section 39 of the Income Tax Act. See Note 4 for rates applicable.
sHowever, the detailed definition is such that it has led to more rather than less corporations,
often without any business justification whatsoever.
‘Sections 139(5), 12(3), 17, 137 of the Income Tax Act.
“This also applies to capital cost allowances for depreciable property acquired in a non-arm’s
length transaction. Section 20(4) of the Income Tax Act. For other examples of the statutory
disregard of the veil of incorporation, see Sections 27(5) and 28(2). For offences by a corporation
and its officers, see Section 134.
McGILL LAW JOURNAL
[Vol. 8
already been indicated, the logical conclusion flowing from the strict theory
of a separate corporate personality is that every distribution by way of dividends
to another person is income to the recipient. In order to ease the burden of
multiple taxation on the same initial corporate profit, the Income Tax Act
modifies the rule by providing that normally inter-corporate dividends are
(except when paid to a non-resident corporation) tax-free to the recipient.
However, this partial disregard of the corporate entity does not extend to
dividends received by natural persons, for when dividends are ultimately received
by a resident shareholder who is a natural person, he is taxed at graduated
rates, depending upon his total taxable income but with a special tax reduction,
often referred to as a “dividend tax credit”, equal to a flat percentage (now
20%/) of the dividend.” At the same time the Canadian tax system has always
adhered to the principle that the sale of shares in the capital stock of a corpo-
ration, being the sale of a source of income, does not give rise to income (unless,
of course, it is the taxpayer’s business to deal in such sources of income) even
if such shares represent an interest in the accumulated income of the corporation.
*The idea that shareholders who are natural persons should not be permitted
to extract the undistributed income of their corporate entity tax-free if their
effective personal rates of tax are over the dividend tax credit, referred to
above, is reflected in the most complex and detailed system of safeguards and
special taxes which exists anywhere in the Income Tax Act. These provisions
have grown in ad hoc fashion over the years and it is generally claimed by
Canadian business and conceded by the fiscal authorities, that their cumulative
effect is to place undesirable restrictions upon corporate organization and
enterprise. 12
Judicial Approach
While the legislative attempts to modify the tax effects of the strict rule of
corporate personality have become increasingly numerous and complex, the
existence of the rule has been carefully recognized in the taxing statutes and
the courts have also jealously preserved the legal theory of a separate corporate
personality, the logical result of which was so strikingly illustrated in Salomon
v. Salomon & Company.1 3
In the most celebrated case arising under the Income War Tax Act, the
predecessor to the present Income Tax Act, the Judicial Committee of the
Privy Council ruled that it was “manifestly against sound and fundamental
principles” for the Minister of National Revenue to ignore the taxpayer’s
legal existence separate from its shareholders and its predecessors in exercising
a statutory discretion on the amount of depreciation allowance to be granted
‘1 See Sections 6(lXaXi), 28(1) and 38 of the Income Tax Act.
“See in this connection Reports of the Proceedings of the Canadian Tax Foundation Conference
for 1959, 1960 and 1961. See also the Budget Speeches of the Minister of Finance of March 31, 1960
and of June 20, 1961.
13[1897] A.C. 22.
No. 3]
LIFTING THE CORPORATE VEIL
to the taxpayer. In this case, Pioneer Laundry and Dry Cleaners, Ltd. r. A.N.R.,14
the Minister of National Revenue, who was empowered by statute to fix, in
his discretion, a reasonable amount as a depreciation allowance for property
owned by a corporation, denied the taxpayer corporation the normal allowance
based on its cost of the assets on the ground that it had acquired, through its
parent corporation, fully depreciated property from a predecessor corporation
with the same name and shareholders but at an enhanced price.
The Exchequer Court of Canada upheld the Minister’s decision on the
ground that although the appellant corporation was a different legal entity
from the former corporation, it was in reality the successor and pointed out
that the purchase was made through the intervention of the taxpayer’s parent
corporation which came into existence on the same date as the taxpayer. In
the Supreme Court of Canada, the majority upheld the Exchequer Court and
agreed that the Minister had properly decided not to grant an allowance.
However, the Judicial Committee upheld the minority view in the Supreme
Court that in the absence of fraud or improper conduct, which was not alleged
by the Crown, the legal status of the taxpayer cannot be disregarded and that
it was improper for the Minister to ignore the legal position in order to regard
‘the substance of the matter”. Lord Thankerton, speaking for the Com-
mittee said:
Their Lordships agree with the Chief Justice and Davis J. that the reason given for the
decision was not a proper ground for the exercise of the Minister’s discretion, an& that he was
not entitled, in the absence of fraud or improper conduct, to disregard the separate legal
existence of the appellant company and to enquire as to who its shareholders were and its
relation to its predecessors. The taxpayer is the company, and not its shareholders. Their
Lordships agree with the reasons given by these learned Judges, and their application of the
authorities cited by them, and it is unnecessary to repeat them.
One of the authorities cited by the Chief Justice and Davis J. in the Supreme
Court, was that of The Duke of Westminster’s Case,”, the leading authority for
the rule that in taxation matters the legal position cannot be disregarded in
favour of what was sometimes referred to as the doctrine of “‘the substance”
in order to tax a person who has legally ordered his affairs in such a manner
as to lessen the burden of tax.16
The so-called doctrine of “the substance” became an issue again in the
Supreme Court of Canada in 1953 in Army & Navy Department Stores, Ltd. v.
11[1938-39] C.T.C. 411.
15[1936] A.C. 1.
“tThe reservation in the Pioneer Laundy and Dry Cleaners Ltd. Case of fraud or improper conduct as
a ground for ignoring the corporate veil is one which the courts have always recognized as an
exception to the Salomon rule. For examples, see Gower, op. cit. However, as was indicated in the
Pioneer Laundry and Doy Cleaners, Ltd. Case, avoidance of tax by legal means is not considered by the
courts to be fraud or improper conduct. See also, the Supreme Court of Canada decision in M.N.R.
v. Sheldon’s Engineering Co. Ltd. [1955] C.T.C. 174, for a more recent application of the rule of strict
construction of taxing statutes to transactions of successor and predecessor corporations and their
shareholders.
McGILL LAW JOURNAL
[Vol. 8
M.N.R., 17 in which the Court (Estey, J. diss.) held that shares owned by a
corporation in which an individual had a stock interest were not owned
“directly or indirectly” by the individual. The Supreme Court reaffirmed the
rule that a shareholder does not own, even indirectly, assets of the corporation.
The principle of the separate personality of a corporation does not always
work to the advantage of the taxpayer. In a recent Exchequer Court decision,
for example, the taxpayer’s claim that the business it carried on in Canada
was in reality that of its non-resident parent corporation was rejected on the
ground that unless the corporation which carried on the business was nothing
but a “sham”, the mere fact of ownership by a person of all the shares of the
corporation will not make its business that of the owner of the shares.18 This
view is one which is amply supported by the decided cases.19
The consequences of the courts’ refusal to look through the veil of incorpo-
ration to treat the shareholders as the real taxpayer are many and varied. For
example, the expenses incurred by a parent corporation to assist its subsidiary
to meet its promotional costs, are not deductible to the parent. 20 Reasonable
interest and other payments by a corporation to its shareholders cannot be
disallowed solely on the ground that such payments are being made to a
shareholder whether corporate or individual. 21 Pre-incorporation expenses
paid by a predecessor are not deductible to the corporate taxpayer. 22 On the
other hand, where a statutory provision makes it necessary for a corporation
to meet certain conditions to qualify for beneficial tax treatment, such as the
right to deduct prospecting and drilling and exploration expenses by corpora-
tions whose “principal business” is mining or producing oil or natural gas, a
corporation whose principal business so qualifies can be formed or acquired to
take advantage of the special concessions granted to such corporations.”3
17[1953] C.T.C. 293.
1 United Geophysical Co. of Canada Ltd. v. M.N.R. [1961] C.T.C. 134.
1″See in this connection, Stanley v. The Gramaphone and Typetritr, Ltd., 5 T.C. 358; Rogers fajstic
Corporation, Ltd. v. City of Toronto [1943] C.T.C. 215; Aluminum Company of Canada, Ltd. v. City of
Toronto [1944] C.T.C. 1.
A corporation can of course, act as an agent to perform services for any other person, including a
shareholder. For example, a non-resident corporation can be held to be carrying on business within
the taxing jurisdiction if it employs a subsidiary corporation as agent to carry out work for the parent.
See Firestone Tyre & Rulber Co. Ltd. v. Lewellin, 37 T.C. 111. However, such an agency relationship
will not be implied solely because of the parent and subsidiary relationship. See Firestone Tyre &
Rulher Co. of Canada, Ltd. v. C. of LT. [1942 C.T.C. 254. See also, Cohen L. J. in Ebbw Vale U.D.C
v. S. Wales Traffic Area Licensing Authority [1951] 2 K.B. 366 at p. 370, where he said “under the
ordinary rules of law, a parent company and a subsidiary company ….
are distinct legal entities,
and in the absence of an agency contract between the two companies one cannot be said to be the
agent of the other.”
“t Canadian Ice Machine Ltd. v. M.N.R. 17 Tax A.B.C. 214.
2tWright’s Ropes (Canadian) Ltd. v. M.N.R. [1947] C.T.C. 1; Falaise Steamship Co. Ltd. v. M.N.R.
[1959] C.T.C. 67.
2Boah Construction Co. Ltd. v. M.N.R., 14 Tax A.B.C. 243.
2See Section 83A of the Income Tax Act for the concessions to oil and mining corporations.
No. 3]
LIFTING THE CORPORATE VEIL
Furthermore, certain advantages open to corporate taxpayers and not to
individual taxpayers can be obtained through incorporation, such as the
installation of a registered employees’ pension plan to include the controlling
shareholders, or to make salary payments to the spouse of a principal share-
holder which if paid directly by him would not be a deductible expense.24
While the courts have traditionally followed the rule in Salomon v. Salomon
& Company2 5 in the interpretation of the provisions of taxing statutes, they
have sometimes refused to allow the veil of incorporation to prevent an exami-
nation of the acts of the natural persons who control the actions of the corporate
taxpayer. Thus, the “residence” of a corporation for Canadian income tax
purposes is determined in accordance with the long established English rule
that it is the place where its “central management and control” abides, re-
gardless of the place of incorporation or of the statutory head office or indeed
the residence of the sbareholders.21 Central management and control is con-
sidered to be found where the controlling natural persons, not necessarily the
nominal directors, in fact make their decisions, as was forcefully illustrated
in the recent House of Lords decision in Unit Construction Co. Ltd. v. Bullock.2 7
The courts have also re-iterated that it is not what is statcd in the corporate
objects which govern the nature of the corporation’s business, but the business
in which it was in fact engaged.2
It is obvious that only the natural persons
who operate and manage the business can in fact carry on such business for the
corporate taxpayer. In a recent case it was even held that the intentions of
the promoters of a company were identical with the intentions of the corpora-
tion itself. 9 The Canadian courts have not yet dealt with the tax consequences
of the use of a corporate vehicle to trade in real estate, but if a real estate trader
sought to “incorporate” his landholdings for the sole purpose of later selling
his shares in the landholding corporation, he would probably be taxed on the
sale of the shares on the ground that he embarked on an adventure in the nature
of trade in respect of the shares. “0
2*Sections 11(l)g); 21(2).
251t is interesting to note that if Mr. Salomon had been subject to the provisions of the Canadian
Income Tax Act, he would have been taxable on the difference between the inflated price he received
for the sale of his business to his corporation and the real value thereof. See Losey v. M.N.R. (1957]
C.T.C. 146.
2 1Subject to Section 139(4a) of the Income Tax Act. See B.C. Electric Co. Ltd. V. The King [1946]
C.T.C. 224; Yamaska Shipping Co. Ltd. v. M.N.R., 28 Tax A.B.C. 187.
2711959) 3 A.E.R. 831.
28Sutton Lumber & Trading Co. Ltd. v. M.N.R. [1953) C.T.C. 237; Irrigation Iulastries Ltd. v. M.N.R.
(1960) C.T.C. 329.
2 0Regal Heights Lt.l. v. M.N.R. [1960) C.T.C. 384.
1cf. Deceased Estate v. Commissioner of Taxes, XVI South African Tax Cases 305; Associated London
Properties, Ld. v. Henricksen, 26 Tax Cases 46; but see Becker v. F.C. of Taxation, 10 A.T.D. 77, and
M.N.R. v. Strauss (19601, C.T.C. 86.
166
McGILL LAW JCURNAL
[Vol. 8
Conclusion
The legislative efforts to modify the strict application of the rule in Salomon’s
Case have been affected by the concern on the one hand that the rule itself
should be retained to preserve the corporate taxpayer as a source of revenue,
and on the other that tax avoidance by natural and corporate taxpayers through
the use of corporations and through artificial transactions must be discouraged.
Such efforts have also been influenced by the realization that the strict theory
of corporate personality must be modified in dealing with the taxation of
corporate distributions but no generally acceptable principle has as yet emerged
to cope with this difficult problem.” The courts have, however, consistently
refused to depart from the Salomon rule for tax purposes unless they were
clearly required by statute to do so. They have not hesitated on occasion to
look through the veil of incorporation to examine the actions of the real
persons behind it but only to determine the taxability of corporate profits
and not to disregard the existence of the corporate taxpayer.
3IFor a review of some suggested solutions to the problem, see G. T. Tamaki, “Tax Free Corporate
Distributions in Canada”, The Canadian Chartered Accountant, February, 1962.