An undisclosed agency exists if an agent enters into a contract with a third party on behalf of a principal, but does not reveal to the third party either the identity of the principal or the fact that the agent is acting on behalf of any principal.

The TCC decision in 2253787 Ontario Inc. (2014 TCC 121) was very suspicious of undisclosed agency, nearly analogizing it to a sham transaction.

Two private corporations (the taxpayers) were incorporated for the sole purpose of purchasing Apple iPhones in Canada and reselling them to gray market wholesalers in other regions such as Hong Kong, where the products were not yet officially available. The taxpayers used friends, relatives, and contractors to buy one or two iPhones a day and reimbursed each buyer for the purchase of the iPhone, including HST, and paid a fee in return for proof of payment and the iPhone. The taxpayers couriered the iPhone overseas and resold it in a foreign market. The taxpayers, which were GST/HST registrants, claimed ITCs on the iPhones purchased in Canada. 

The CRA disallowed ITCs on the iPhone purchases, arguing that the taxpayers were not the recipients of the supply of the iPhones and that there was no agency relationship between the taxpayers and the buyers. The taxpayers appealed to the TCC on the basis that an agency relationship had existed. 

The TCC seemed to rely on Royal Securities Corporation Ltd. v. Montreal Trust (1967 OR 137), which established a three–part test to determine whether an agency relationship exists: (1) consent from both parties, (2) authority from the principal to allow the agent to affect the principal’s rights and obligations as if it had entered the contract itself, and (3) its control over the agent’s actions.  The TCC found that the first and third requirements were met, but not the second requirement. 

The TCC observed that it was a term of a contract with Apple (the Retail Store Purchase Policies and Sale and Refund Policy) that only an end user may purchase a product and that resale and export were prohibited. From this the TCC concluded that the taxpayers could not have created or maintained a legal relationship with Apple directly because they intended to export and resell the product.  An agent cannot have a legal capacity that exceeds that of the principal, and thus the TCC found that the buyers could not have been the taxpayers’ agents. 

We question the TCC’s analysis of the purported agent-principal relationship, which improperly affiliated the capacity to enter into a contract with the intention to breach a contract. The TCC correctly cited the FCA decision in 1524944 Ontario Ltd. (2007 FCA 74 at para 18) for the legal concept that a principal cannot appoint an agent to enter into a contract for which the principal lacks the legal capacity to enter.

However, the TCC in 2253787 Ontario implied that the taxpayers lacked capacity to contract directly with Apple to purchase the iPhones because they intended to breach terms of the contract by exporting and reselling the iPhones: if this proposition were true it would undermine the concept of efficient breach.

A corporation’s capacity to enter into legal relationships is found in its constating document and is not affected or limited by any contractual terms to which it may agree. The contractual terms of Apple’s sales, including prohibitions on export, did not affect the taxpayers’ capacity to contract, even if from the outset they intended to breach those contractual terms by exporting and reselling the iPhones. Apple may have a claim for breach of contract, but in our view, the taxpayers had the capacity to contract with - purchase from - Apple directly.     

It is also a matter of concern that the TCC was so critical of the fact that the agency relationship was undisclosed to Apple at the time of sale. The court’s conclusion seems to ignore the widely accepted legal concept of an undisclosed agent and implies that the non-disclosure of an agency relationship to a third party is inappropriate even though the common law recognizes the legitimacy of an undisclosed agent. The SCC has said that generally in contracts with third parties the undisclosed principal “has the same rights and liabilities under the contract whether he or she was disclosed to the third party and despite the fact that his or her name did not appear on the face of the contract” (Friedmann Equity Developments Inc. v. Final Note Ltd., 2000 SCC 34: at para 15)

John G. Bassindale and Robert G. Kreklewetz

A version of this article was published in the July 2014 issue of Canadian Tax Highlights.