Thibault v. R., 99 DTC 489, [1999] 2 CTC 2645 (TCC)

Lamarre Proulx T.C.J.:

These are appeals in respect of the 1987 and 1989 taxation years.

What is in issue for 1987 is: (1) whether amounts paid for consulting services — which were the subject of an undertaking entered into when shares were disposed of in 1987 — to a corporation of which the appellant is the principal shareholder form part of the proceeds of disposition of the shares and thus give rise to a capital gain; (2) if so, whether those amounts, which were received during the years following the sale of the shares, must be included in computing the appellant’s income for 1987; and (3) whether the penalty imposed under subsection 163(2) of the Income Tax Act (“the Act’) was imposed in accordance with the Act.

What is in issue for 1989 is whether certain amounts may be deducted in computing the appellant’s income from a business or property. The amounts in question are fees allegedly paid to the appellant’s lawyers, but there are no records describing the services rendered.

The facts on which the Minister of National Revenue (“the Minister”) relied in making his reassessments are described as follows in paragraph 16 of the Reply to the Notice of Appeal:

[TRANSLATION]

1987 Taxation Year

(a) until January 1987, the appellant owned 75 percent of the shares of Relais Nordik Inc.;

(b) during the 1987 taxation year, the appellant was also the majority shareholder of Croisières Navimex Inc.;

(c) in January 1987, the appellant sold his shares in Relais Nordik Inc. to Vermonbec Inc.;

(d) in his income tax return for the 1987 taxation year, the appellant reported a taxable capital gain based on proceeds of disposition of $100,000 (for all of the shares):

(e) the actual sale price in the above transaction was $250,000:

(f) the Minister of National Revenue therefore added $56,250 as an additional taxable capital gain for the appellant’s 1987 taxation year;

(g) by failing to report the additional taxable capital gain, the appellant knowingly, or under circumstances amounting to gross negligence, made or participated in, assented to or acquiesced in the making of a false statement or omission in his return in respect of the 1987 taxation year and is therefore liable to a penalty under subsection 163(2).

1989 ‘Taxation Year

(h) in his income tax return for 1989, the appellant claimed fees of $6,635.94, $7,292.80 and $6,290.90 as business expenses;

(i) the appellant did not provide the Minister of National Revenue with proof that those fees were paid;

(j) the fees are not outlays or expenses made or incurred by the appellant for the purpose of gaining or producing income from a business or property of the appellant.

The appellant, Chantal Viel, a Revenue Canada auditor, and Danielle Cloutier, manager of the law firm, testified at the request of counsel for the appellant. Alain St-Arnaud, CA, the appellant’s accountant, testified at the request of counsel for the respondent.

The appellant is a director of shipping companies involved in passenger and cargo transportation. The appellant told the Court that he began his career in the shipping industry working for a shipping company, Groupe Desgagnés, from 1972 to 1982. He began his own shipping activities in 1984.

In 1986, the appellant and Guy Gagnon started a corporation called Relais Nordik Inc. to obtain the contract to service the Lower North Shore from the Quebec government. Relais Nordik Inc.’s shareholders were the appellant, Mr. Gagnon and Corporation Vermonbec Inc. (“Vermonbec”). Vermonbec, whose principal shareholder was a Mr. Lacaille, provided financial support.

The service contract was obtained at the end of 1986. However, it was obtained at a price $1,000,000 lower than that of the second lowest bidder, which caused Vermonbec a great deal of concern. It began to doubt the appellant’s administrative abilities, since it was the Navimex corporation, of which the appellant was the principal shareholder, that had prepared the bid.

Vermonbec was involved in road transport, not shipping. Mr. Lacaille, who was concerned about the price difference, apparently consulted Navimex’s competitors, Logitech Navigation and Transport Desgagnés. The appellant said he considered that a betrayal. This resulted in an intense conflict between the principal shareholders of Relais Nordik Inc. that became known to the main players in the area’s shipping industry and ended up jeopardizing the service contract itself.

According to the appellant, the memorandum of understanding he entered into with Vermonbec prior to the incorporation of Relais Nordik Inc.

— which was not filed but is referred to in the share sale agreement (Ex- hibit 1-1, Tab 9) — provided that decisions required the approval of the owners of more than 75 percent of the shares. The appellant owned 25 percent of the shares (he and Mr. Gagnon owned 25 percent of Relais Nordik Inc.’s shares in a proportion of 75 percent to 25 percent). Thus, no decisions could be made by Vermonbec without the appellant’s agreement.

Mr. Lacaille and Mr. Gagnon therefore met in late December 1986 to resolve the dispute. Mr. Gagnon negotiated for the appellant at the appellant’s request. The parties ultimately agreed that the only way to put an end to the conflict would be for the shares owned by the appellant and Mr. Gagnon to be bought. The transaction occurred in 1987.

On January 29, 1987, an agreement was entered into by Relais Nordik Inc., party of the first part, Corporation Vermonbec Inc., party of the second part, Sylvio Thibault, party of the third part, Guy Gagnon, party of the fourth part, and Croisières Navimex Inc., party of the fifth part. The agreement can be found at Tab 9 of Exhibit I-1. Clauses I and 4 of the agreement read as follows:

[TRANSLATION]

I. That Corporation Vermonbec Inc. purchase, for one hundred thousand dollars ($100,000), all the shares and all the rights and interests that the party of the third part and the party of the fourth part have in Relais Nordik Inc., and more specifically 18 A class A shares held by the party of the third part and 6 /4 class A shares held by the party of the fourth part.

The said amount shall be paid to the party of the third part and the party of the fourth part as follows:

A cheque for $75,000 made out to Sylvio Thibault and cashable on January 30, 1987, and a cheque for $25,000 made out to Guy Gagnon, also cashable on January 30, 1987.

4. The party of the first part hires the party of the fifth part as a consultant for a period of five (5) years for $150,000, payable in sixty (60) consecutive equal instalments, the first of which shall be paid on April 30, 1987. In this regard, the party of the fifth part shall, but only when requested, provide the party of the first part with shipping expertise for the contract that the party of the first part is to perform for the Quebec government. At the beginning of the party of the first part’s fiscal year, it shall send a series of post-dated cheques for the coming year to the party of the fifth part in accordance with the amounts set out above.

The party of the first part and the party of the fifth part shall put in writing the nature and conditions of the services to be provided, which must be satisfactory to the party of the fifth part.

The appellant explained this payment partly as a purchase price and partly as a price for services by saying that he himself would have preferred to be paid in cash but that this agreement was the best he could negotiate. He did not think that there were any tax benefits to proceeding in this way. He admitted that he would certainly not have agreed to the sale of the shares if there had been no consulting contract.

The explanations given for the payment for services were unclear. The appellant said that he thought Mr. Lacaille wanted to retain his expertise, since everything had been prepared by Navimex and Navimex knew both the physical and administrative aspects of the operational side of shipping. He noted that Mr. Lacaille, Vermonbec’s president, did not know the shipping industry. Navimex was the one with the expertise.

He also said that, immediately after his shares were purchased by Vermonbec, Relais Nordik Inc. hired Navimex’s two main employees, which then made it difficult for Navimex to provide consulting services. The appellant added that Groupe Desgagnés and not Navimex was Relais Nordik Inc.’s consultant during the first year of the contract.

The appellant confirmed that Guy Gagnon received 25 percent of the amount paid under the consulting contract because he owned 25 percent of the shares purchased. This made it difficult to see the contract for services as valid. The appellant then explained that Mr. Gagnon provided Navimex with his expertise even though he was not an employee of that company.

Navimex was initially paid for the consulting contract without providing any services. However, Groupe Desgagnés purchased Relais Nordik Inc. during the year that followed the sale of the appellant’s shares. Relais Nordik Inc. stopped making payments under the contract for services and brought an action to have the consulting contract cancelled on the ground that the consultant was disloyal.

Mr. Thibault had testified in proceedings between Groupe Desgagnés and Secunda Marine, a company connected to the shipping service contract. Groupe Desgagnés believed that the appellant had deliberately testified against its own position. The appellant said that all he had wanted to do was to objectively explain the background to the contract between Relais Nordik Inc. and Secunda Marine.

In opposing Groupe Desgagnés’s action to cancel the contract for services, counsel for the appellant’s primary strategy was to argue that the contract was valid. He also brought an action to recover the shares on the basis that the purchase price had not been paid, arguing that the contract for services was a simulation and that the payment for the services constituted the price of the shares.

The judgment by the Superior Court of Quebec dated September 30, 1991, did not accept the position that there was a simulation but found that the contract for services was valid. The judgment was filed at Tab 10 of Exhibit I-1. It states the following at pages 6-10 and 13:

[TRANSLATION]

Relais Nordik also argued that, by doing this and supporting Secunda’s position on the cargo capacity of the ship, as well as in the arrangements for the delivery of the ship if it was not ready on time, he breached his duty of loyalty as a former shareholder of Relais Nordik and the principal shareholder of Navimex, with which Relais Nordik still had a consulting services contract for a period of five years.

Sylvio Thibault argued that the real price of the shares was not just $100,000, as stated in the contract, but also another $150,000, the amount of the consulting services contract awarded to Navimex. The value negotiated and agreed on for the shares was actually $10,000 per share, which results in a total of $250,000. That figure is arrived at by adding up the consideration for the purchase and for the consulting contract.

In short, Mr. Thibault argued that there was the contract involved a simulation that had tax benefits for both parties: the seller, because it was not he but one of his companies that received the greatest portion of the sale price, and the purchaser, Vermonbec, which became the owner of 25 shares with $150,000 out of the total price of $250,000 being paid by the company in which the shares were held, as if it were an expense incurred to earn income. Relais Nordik’s income was thus reduced and Vermonbec laid out only /s of the value agreed on for the shares at the time of the transaction.

...I conclude that there was no simulation.

...Most of the evidence shows that what was written was the parties’ real intention.

There are so many different things incorporated into this contract that it must be concluded that, in spite of this, the intention was for everything to be done in relation to the contract’s main purpose, namely disposing of shares on the one hand and purchasing them on the other.

There is nothing unusual about one or more sellers accepting a lower price because someone close or related to the seller or sellers benefits from the contract, especially when this suits all of the parties to the contract.

That judgment was appealed, and the appellant made the same two arguments in an affidavit. The affidavit was filed at Tab 26 of Exhibit I-1. It states the following at page 2:

[TRANSLATION]

10. On January 29, 1987, Guy Gagnon and I sold our shares to Corporation Vermonbec Inc. for $250,000, as can be seen from Exhibit P-1 filed with this Court:

11. However, the terms of the contract indicate that $100,000 was to be paid when the contract was signed and that a $2,500 payment was to be made on the 30th of each month for 60 months, starting on April 30, 1987;

12. Under the contract, the defendant appeared to promise to perform a contract to provide the plaintiff with shipping expertise on request, as can be seen from clause 4 of the contract;

13. That clause was merely a simulation in relation to the payment of the balance of the sale price....

The case was subsequently settled out of court, as was another case between the appellant and Groupe Desgagnés.

What is in issue for 1989 is the deduction of $24,000 that was supposedly paid to the appellant’s lawyers. The Minister’s officer asked for proof of the payments made by the appellant in 1989. A cheque for $10,000 made out to his lawyers was filed at Tab 24 of Exhibit I-1. It is dated January 31, 1989. The account statements and invoices filed at Tabs 18 to 22 of the same exhibit are all dated quite a bit later than the cheque and do not refer to the $10,000 payment.

The appellant explained that he has about 15 personal and corporate files at his lawyer’s office. The name of the corporation as it appears on the invoices is often incorrect. He pays and distributes the payments fairly between the corporations, and his lawyer does the same. If the payment is for a personal matter, he said, he uses personal cheques, and if the amounts in question involve a corporation, it is the corporation that pays. The appellant described the businesses he was operating in 1989.

Chantal Viel, a Revenue Canada auditor, explained that the appellant was assessed as he was for 1987 based on his statements and the facts. With regard to 1989, she said that the appellant had been told several times that his accounting had to be satisfactory so that the Department’s auditors could determine the nature of the expenses for which he was claiming deductions. The conforming expenses were allowed.

Counsel for the appellant argued that the consulting contract was valid and that there was no simulation. It was a valid ordering of the appellant’s affairs so as to pay the least possible tax within the meaning of the Supreme Court of Canada’s decision in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536. He referred in particular to the following passage at page 552:

In the field of taxation itself the traditional position was re-echoed in Inland Revenue Commissioners v. Duke of Westminster, [1936] A.C. 1, at pp. 19-20, where it was stated:

Every man is entitled if he can to order his affairs so as that [sic] 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.

Counsel for the appellant also referred to the decision of the Superior Court of Quebec in the case between the appellant and Groupe Desgagnés, in which the judge found that there was no simulation (see paragraph 20 of these reasons). Counsel for the appellant noted that the trial lasted four days and involved a number of preliminary proceedings.

Counsel for the appellant argued in the alternative that, if the Court finds that the contract for services was a sham transaction, the proceeds of disposition were not received in full in 1987 and the appellant is entitled to a reserve under subparagraph 40(l)(«)(iii) of the Act because the additional amount was paid not in 1987 but in later years; he also noted that the appellant incurred substantial legal expenses to have that money paid to him. Although this argument was not raised in the Notice of Appeal, it was made at the hearing. I asked counsel for the respondent to give me his opinion on the subject, which he was good enough to do during a subsequent hearing held by means of a conference telephone call.

Counsel for the appellant did not argue strongly about the imposition of penalties under subsection 163(2) of the Act, since he was arguing that the contract for services was not a sham transaction. However, he did argue that, if the Court were to conclude that the contract for services was a sham and that the payments for services were payments made to purchase the shares, the penalties should be reduced on the basis that, given the reserve to which the appellant may be entitled, there was only one capital gain that should be included in computing his income.

Counsel for the appellant argued that the lawyers’ fees the appellant sought to deduct in 1989 were clearly amounts incurred for the purposes of the appellant’s businesses and were certainly not gifts to the law firm.

Counsel for the respondent argued that the important point to be determined is whether the contract for services between Vermonbec and Navimex that was part of the agreement dated January 29, 1987 (see paragraph 12 of these reasons) reflected the economic reality of the transaction. Counsel for the respondent argued that the contract was a sham transaction, as that term is used in tax law, because it did not create between the parties the legal relationship that they intended to create. He referred to Stubart, supra, at page 572:

The element of sham was long ago defined by the courts and was restated in Snook v. London & West Riding Investments, Ltd., [1967] 1 All E.R. 518. Lord Diplock, at p. 528, found that no sham was there present because no acts had been taken:

...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.

This definition was adopted by this Court in Minister of National Revenue v. Cameron, [1974] S.C.R. 1062, al p. 1068 per Martland J.

As regards the right to a reserve, counsel for the respondent explained to the Court that the appellant was entitled to a reserve under subparagraph 40( 1 )(a)(iii) of the Act as it read in 1987. The provision was amended for the 1988 and subsequent taxation years, which could have led to a different result.

With regard to the deductions for fee payments claimed for 1989, counsel for the respondent argued that the appellant gave no proof of the legal services for which the deductions were claimed and that it was therefore impossible to determine whether the expenses were incurred for the purpose of gaining or producing income from a business or property or whether they were current or capital expenses.

Analysis and conclusion

I will begin by referring to the decision of the Exchequer Court of Canada in Front & Simcoe Limited v. M.N.R., 60 D.T.C. 1081, at page 1085:

In Simon's Income Tax, Second Ed., Vol. I, p. 50, the author, after referring to a number of decisions, states:

The true principle, then, is that the taxing Acts are to be applied in accordance with the legal rights of the parties to a transaction. It is those rights which determine what is the “substance” of the transaction in the correct usage of that term. Reading “substance” in that way, it is still true to say that the substance of a transaction prevails over mere nomenclature.

Earlier, the author had referred to the statement of Viscount Simon in ZR.C. v. Wesleyan and General Assurance Society, 30 T.C. 11, 24, 25 H.L., in which he expressed the principle in these words:

It may be well to repeat two propositions which are well established in the application of the law relating to income tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it. Secondly, a transaction which, on its true construction, is of a kind that would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax.

The question for determination, therefore, is “What is the real character of the receipt?” and in answering that question I am entitled to regard the surrounding circumstances. In that connection, reference may be made to the speech of Lord Tomlin in I.R.C. v. Westminster (Duke), [1936] A.C. 1, 20, where he referred to “the indisputable rule that the surrounding circumstances must be regarded in construing a document”.

I will also refer in particular to the principles set out in Stubart, supra, namely that every taxpayer is entitled to order his or her affairs so that the tax attaching is as low as possible and that a transaction may be valid even if it has no purpose other than a tax purpose, provided that it reflects the taxpayer’s actual rights and obligations.

In my opinion, the evidence clearly showed that the contract for services included in the agreement referred to in paragraph 12 of these reasons was intended to cause third parties to think that the rights or obligations created were different from those that the parties intended to create. The parties never intended to enter into a genuine contract for services. The purpose of the contract for services was to disguise as payments for services what were actually payments for the purchase of shares. The contract may be valid and binding on the parties under the civil law. That is what the Superior Court of Quebec decided. However, that decision was not rendered under the provisions of the Act. As far as tax law is concerned, the agreement is a sham, and that is the effect that must be given to it.

Since the respondent’s argument was based on the fact that the contract for services did not reflect the parties’ intention, I conclude that her argument is valid in fact and in law. The amounts payable under the alleged contract for services are part of the proceeds of disposition of the shares. Since counsel for the respondent has agreed that the appellant is entitled to a reserve under subparagraph 40( 1 )(«)(iii) of the Act, the appeal is accordingly allowed in this respect for 1987. The amount of the penalties and interest will have to be adjusted accordingly.

As for 1989, since the appellant did not identify the legal services for which the money was paid to his lawyers, if it was in fact paid, it is impossible to determine the nature of the expenses. The appeal is therefore dismissed for that year.

The whole with costs to the respondent.

Appeal from 1987 assessment allowed; appeal from 1989 assessment

dismissed.