The Queen v. Laidlaw Transport Ltd., 77 DTC 5091, [1977] CTC 151 (FCTD)

Collier, J:—The plaintiff appeals a decision of the Tax Review Board. The defendant in its computation of its income tax for its 1969 taxation year deducted from income an amount of $61,317. The defendant described it as a “management fee’’. It contended it was an expense incurred by it for the purpose of earning income.* [1] The Minister disallowed the deduction and assessed accordingly. The defendant appealed successfully to the Tax Review Board.

In answer to a question put by me I was told the evidence at this hearing was, for practical purposes and with one minor exception which I do not think material, substantially the the same as that before the Board. There were only two witnesses: Mr M G DeGroote and Mr Harold D Pringle.

I am in agreement with the conclusion reached by the then Chairman of the Tax Review Board. At the completion of the argument on this hearing I directed the appeal of the Crown be dismissed. I said written reasons would be given.

It is necessary to recount some of the business history of the defendant and of DeGroote.

The defendant was incorporated as an Ontario private company on July 8, 1958. It acquired the transportation business of a proprietorship which went back to 1924. The defendant then took over or obtained licences to operate public commercial vehicles in certain areas. By 1968 it held numerous such licences permitting it to operate commercial vehicles in Ontario and Quebec as well as some of the United States. Licences, territories and extensions of those territories are granted upon approval of the Ontario Highway Transport Board. DeGroote, effective January 1, 1959, acquired all the shares of the defendant.

He acquired at the same time control of two other companies: Laidlaw Motor Sales Limited and Hepburn Transport Limited. These two companies amalgamated on April 27, 1966 and continued, first under the name Laidlaw Motor Leasing Limited and, in 1969, Laidlaw Motorways Limited. At some stage DeGroote’s shares in the defendant were transferred to Motorways. DeGroote was the sole share holder in the latter. It held no public commercial vehicle licences. It engaged in the selling and leasing of truck parts and auto equipment. I shall refer to that company as the “parent” or “parent company”. DeGroote was, at all relevant times, the president and chief executive officer of the parent and the defendant.

Prior to the fall of 1968 the whole of his time, for practical purposes, was directed to the affairs of the defendant. He drew a salary only from the defendant. In 1968 it was $35,000. The defendant was the company which held the licences, had the routes, had the customers, and was effectively earning the income for itself and the parent.

DeGroote was expansion-minded. He wanted to acquire control of other transport companies. By that means additional licences and additional routes would be obtained. Coopers & Lybrand (then McDonald, Currie & Co) were the companies’ auditors. DeGroote enlisted the aid of Pringle of that firm to assist in devising methods of and financing for expansion. For a time DeGroote tried, through banks and other standard financing institutions, to raise the needed funds. The results were discouraging. Approval of loans sometimes came too late for opportune acquisitions. It was indicated to him his business, really meaning the defendant, was too small an operation for adequate assistance to come from the larger financial institutions.

Finally, on advice from consultants, the decision was made to try and obtain financing by the sale of shares, through an underwriter, to the public. This, of course, required the creation of a public company. The defendant was the logical choice. But its conversion to a public company, with changes in share structure, would have required, because it held the licences, approval of the Ontario Highway Transport Board. There were many technical obstacles in that route. The procedures would have been cumbersome. There would have been delay.

It was decided to convert the parent company to a public company and so obtain financing for the defendant’s operations and expansion plans through it. On April 25, 1969 the parent was turned into a public company and its share capital altered. Through a prospectus in June 1969, sinking fund debentures to a total of $1 million and 200,000 shares were offered. Of the shares, 200,000 were being sold by the parent and 75,000 by DeGroote.

The financing by the sale of shares and debentures was very successful. It had required a great deal of work and time. From the inception of the expansion plans in the fall of 1968 until the successful completion of the underwriting, DeGroote spent substantially all his time on those matters. He was forced to delegate the running of the defendant to others. Pringle, himself, spent 300 hours on the project. He testified that an accountant at that time calculated he had 1,500-1,600 chargeable hours a year. From the fall of 1968 until the termination of the financing project, the only time DeGroote spent on the affairs of the defendant was at night and on weekends. Nevertheless, the substantial benefit of a successful underwriting was obviously to be channelled to the defendant. That this was, in fact, the result is shown by immediate dramatic increase in growth, revenues and profits for 1969 and subsequent years.

DeGroote is obviously a capable and successful businessman. In that statement I am echoing the views of the Tax Review Board where this was said [p 2247]:

It is obvious from observing him in the witness-box, and from the manner in which he gave his evidence and the results that have been achieved, that he is very forceful and an enterprising businessman.

Pringle testified that long before the financing was completed the question of a charge to the defendant for DeGroote’s services in bringing it about had been discussed with DeGroote. He said an agreement had been made. The precise amount of the charge or expense was left to be settled later, on Pringle’s advice.

Counsel for the plaintiff argued there was no written agreement between the parent and defendant that a charge was to be made or its amount. Nor were there any directors’ or corporate minutes corroborating this testimony. I accept the evidence of DeGroote and Pringle: that a decision was made before the funds were raised, that the defendant would be charged a “fee” for DeGroote and the parent’s services in respect of the successful raising of those funds. DeGroote was (until his 75,000 shares were sold) the sole shareholder of the parent. It was the sole shareholder of the defendant. DeGroote was the president and executive officer of both. DeGroote obviously was in a position to, and did, bind both companies in respect of the amount he charged the defendant for the services of himself and the parent in respect of the raising of funds. The absence of any written agreement or formal minutes is, in my view, of no consequence.

As I have recounted, the underwriting was successful. $1,550,000 was subscribed. DeGroote’s 75,000 shares were sold. He retained a 72.4% interest in the parent. After underwriting discount, he received $211,150. The balance of $1,269,250 went to the parent company.

Approximately half a million dollars was used to retire long-standing debts. A large part of the balance was then injected into the defendant to acquire other corporations and to expand. Results were, as I have said, immediate and spectacular. They have continued to date. The defendant’s revenue in 1968 was approximately $3,475,000.* [2] Its net earnings for the year were approximately $180,000. The net earnings of the parent and its subsidiaries (including the defendant) increased in 1969 to $5,660,000. By 1973 they reached approximately $36,000,000; by 1976 they were $60,000,000. The net income in 1969 was approximately $400,000; in 1973 approximately $2,500,000; in 1976 approximately $3,500,000.

Counsel for the defendant [s/c] argued that all of this was of no avail in respect of the legal position. It was said there was no formal agreement or arrangement (written or oral) between parent and subsidiary that the proceeds of the underwriting would primarily be for the benefit of and put into the defendant; the defendant could not legally have compelled the parent to so act. I do not accept the contention. The argument ignores the earlier history of the Laidlaw group, the intent of DeGroote and the prospectus, and the practical business control by DeGroote of what the parent and the defendant did vis-a-vis each other.

During the period in 1968 through 1969, when DeGroote directed all his activities to the raising of funds, he did not draw any salary from the parent. In 1969 he elected to take only $9,700, and that from the defendant. He said he did this for two reasons. He had received in that year $211,250 for some of his shares. He did not need whatever salary he would have been entitled to. The parent and the defendant were expanding. He preferred to leave as much cash in the Laidlaw group as he could. In my opinion, there is nothing that requires an employee to be paid or to accept a salary or remuneration. DeGroote was an employee of both the defendant and the parent in the period in question. His services as an employee were primarily to the parent. The defendant reaped the benefit.

The fixing of the actual amount of the charge or expense to be borne by the defendant was, as noted, left to Pringle. He had previous experience in matters of this kind. Pringle and DeGroote were satisfied an amount of $75,000 to $125,000 was reasonable and justified. I accept that evidence. The parent’s charge to the defendant for its services (through the efforts of its employee DeGroote) in obtaining the cash te allow the subsidiary to develop was, in my view, warranted and fair.

Pringle set a final figure of $61,317. The net loss for the parent company for the fiscal years in question was that amount. If the full value of the services ($75,000 to $125,000) had been charged as an expense to the defendant and paid by it to the parent, tax would have been payable by the parent on any sum greater than the net loss. This would have further reduced the cash available.

The defendant contends the sum paid by it for the services rendered to it by the parent (through DeGroote) was an expense incurred for the purpose of gaining or producing income for the defendant. The Chairman of the Tax Review Board so found. I agree.

Both before this Court and the Board, the amount in controversy was frequently described as, or termed, a “management fee”. Some legal authorities which considered management fees, and their deduct- ibility aS an expense in particular circumstances, were cited. I do not think it of any real assistance to characterize the sum by the term “management fee’’ or by any other appellation. The question here is, was it an expense, was it actually incurred, was it justified and reasonable; does the statute permit its deductibility?

Counsel for the Crown contended that any services rendered by the parent, through DeGroote, to the defendant were paid for by DeGroote’s drawing $9,700 from the defendant. I disagree. The evidence (which I accept) is that the services rendered had a value of over $75,000 to $100,000. The plaintiff then said that, if any expense was incurred, it was an expense of the parent and not the defendant; only the defendant could claim it as a deduction; reference was made to subparagraphs 11(1)(c)(i) and (ii) and paragraph 11(1)(cb). As I see it, this sum was, from a practical business point of view, properly chargeable to the defendant. The provisions of section 11 of the old Act relied upon, do not, in my opinion, have application.

The plaintiff submitted, lastly, that if the defendant were to be allowed an expense in this respect, the Court should fix it at an amount lower than that claimed.* [3] There is nothing in the evidence which indicates $61,317 is unreasonable. Nor is there any evidence to indicate any lesser amount would, in the circumstances, be proper.

The appeal is dismissed. The defendant is entitled to costs.