The Duke of Westminster Principle

Duke-ing it out with the CRA

The year was 1930. The big crash in America had just occurred, but it had a world-wide impact. Everyone was doing everything they could to stay afloat and reduce their expenses. 

The Duke of Westminster, tired of the exorbitant income taxes he had to pay every year, had his advisors review the income tax legislation at the time and decided to change how he paid his staff: his gardener, his laundryman, his architect, etc. It’s a bit technical, but basically instead of paying them as a regular employee, he drew up a covenant that would have him (the Duke) pay an equivalent amount to what they might have earned in his employ. This would be paid regardless of whether they worked or not, yet there was an expectation that they continue to work. In fact, there were provisions in the covenant that would discourage them not doing the work. Provisions that effectively allowed for the same result as firing.

And here’s where it gets fun. The British Inland Revenue Service wasn’t too happy about this arrangement. They challenged his deductions claiming that they amounted to tax evasion and then, in 1935, they took the Duke to court. The well-known case centres around the gardener, but the deductions for the other “employees” was effectively the same, just with varying amounts and dates and there were additional court cases for those covenants as well. All in all, it’s believed that he used this same arrangement for about 100 employees.

On May 7, 1935, Lord Tomlin (one of five judges in the case) famously stated “Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.”

And so it was that the British Inland Revenue Service lost their case.

This became (and remains) known as the Duke of Westminster Principle: that it is acceptable to conduct one’s affairs in a manner that will result in a reduction of taxes. And to the extent that it doesn’t conflict with other new rules, this principle is still considered a valid one today.

The Canada Revenue Agency (CRA) and the department of finance have gone to some lengths to circumvent the Duke of Westminster principle, namely the introduction in 1988 of GAAR: the General Anti-Avoidance Rule. Directly from the department of finance: 

“In general, the CRA can apply the GAAR to deny a “tax benefit” obtained by a taxpayer if the tax benefit results from an “avoidance transaction” and if it may reasonably be considered that the transaction results in a misuse of the provisions of the Act or in an abuse having regard to those provisions read as a whole.”

In short, they say that if going from A to C would result in a tax break being denied, then going from A to B and then B to C will also be denied. This was passed in order to prevent what they consider to be aggressive tax schemes. 

Here’s the thing to remember: CRA is not always in the right. Just because they say something is true, doesn’t mean it is. Just look at the Duke of Westminster case. Sometimes you need to be prepared to stand up for your own rights. The Duke did and not only was he found innocent, he was venerated, and still is today.

Let’s be clear: tax evasion is illegal. Don’t do it! Tax avoidance is a different animal though. Up until 1988, tax avoidance was 110% legitimate. Frankly, it still is today… just not if it’s too aggressive. But what’s too aggressive? Well, that’s a bit of a guessing game, and your guess is as good as CRAs.

Structure your affairs in accordance with the Duke of Westminster principle. You are entitled to. If what you’re attempting doesn’t pass the sniff test, then walk away. Of course, if something isn’t legitimate, you don’t want to go there. You don’t want to go there directly (A to C), but you also don’t want to go there circuitously (A to B to C). 

But even if it’s in a grey zone and you believe it’s legit, then go for it. Take all the legitimate steps that you can to reduce your tax bill. 

A quick word on grey areas. Life is most often lived in grey zones. Don’t let them automatically prevent you from trying a strategy. Grey zones are areas that just haven’t been tested either way. CRA may disagree with a taxpayer and a taxpayer may disagree with CRA. Either could be right. Grey zones are simply those where the courts need to decide. And that’s OK. 

I would recommend that if you are even a bit unsure, get a legal opinion. Relying on a legal opinion is a very good indicator to the courts and to CRA that you weren’t trying to cheat the system. That you took the laws seriously and were trying to abide by them. A legal opinion won’t ensure a win, but it will provide a healthy level of protection. It won’t necessarily protect you from CRA challenging something you do or even from it being disallowed, but almost certainly will protect you from ever being charged with tax evasion.

“Listen to counsel and receive instruction, that you may be wise in your latter days.”

• Proverbs 19:20 (New King James Version)