Peter Cundill & Associates Ltd. v. The Queen, 91 DTC 5085, [1991] 1 CTC 197 (FCTD), aff'd 91 DTC 5543 (FCA)

Cullen, J.:—

Background

This is an application by way of statement of claim filed on November 20, 1989, objecting to the Minister of National Revenue's tax reassessments for the plaintiff's 1985 and 1986 taxation years.

Facts

The plaintiff is a British Columbia corporation located in Vancouver. The plaintiff entered into portfolio management contracts with two funds, the Cundill Value Fund (hereinafter the “Value Fund”) and the Cundill Security Fund (hereinafter the "Security Fund”), pursuant to which the plaintiff agreed to provide the following services:

(a) to generally administer the assets and affairs of the Fund and provide all administrative services in respect thereof, including office facilities, equipment, stationery and office supplies, telephone service, light and electrical power, business taxes and licences, postage and delivery and all necessary personnel;

(b) to sell, purchase or otherwise manage the investment and reinvestment from time to time of the assets of the Fund to the extent required by and subject to the supervision of the Directors of the Fund; and

(c) to act as Agent for the Fund in the qualification, sale allotment, issuance and delivery of Mutual Fund Shares of the Fund.

In late 1983, Peter Cundill decided to move to London, England. In 1984, Peter Cundill and Associates (Bermuda) Ltd. (hereinafter PCAB) was incorporated, with Peter Cundill as the sole beneficial shareholder. In 1984 the plaintiff entered into an agreement with Peter Cundill & Associates (Bermuda) Ltd. (hereinafter “PCAB”) whereby the company provided the plaintiff with the investment counselling and transaction skills of F. Peter Cundill, in order to enable the plaintiff to fulfil its portfolio management contracts with the Value Fund and the Security Fund. In consideration for these services PCAB would receive a fee which ranged from 50 per cent to 100 per cent of the fees received by the plaintiff under its agreements with the Value Fund and the Security Fund. In essence, the plaintiff was subcontracting the services to PCAB which were originally provided by the plaintiff through F. Peter Cundill personally. The counselling and transaction skills were then provided and these services were paid for.

By notices of assessment dated May 24, 1988, Revenue Canada assessed the plaintiff for the 1985 and 1986 taxation years, imposing withholding tax as follows:

1985—25% tax of $341,587.75 on a fee paid to PCAB of $1,366,351

1986—25% tax of $614,299.75 on a fee paid to PCAB of $2,457,199.

The plaintiff then filed notices of objection to the assessments. The Minister of National Revenue confirmed the assessments on August 30, 1989.

Plaintiff's Position

The plaintiff submits that PCAB has only provided investment counselling and transaction advice to PCAB and the plaintiff maintains that PCAB has not provided any management or administration services to the plaintiff. The plaintiff states that all management and administration functions were performed by employees of the plaintiff, and that the role of F. Peter Cundill was limited to the selection of investments for the various funds. Further, with regard to the dealings with PCAB,the agreement specifically provided that neither party had the right to control or direct the business or professional activities of the other. Mr. Cundill is also not related to any of the other shareholders of the plaintiff. Therefore, the plaintiff submits that it has been dealing at arm's length with PCAB.

The plaintiff submits that the fee paid by the plaintiff to PCAB was not a management or administration fee, nor is there any other reason to subject it to tax under Part XIII of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Therefore, the Minister's assessments should be vacated.

The plaintiff therefore requests that the appeal be allowed, with costs.

Defendant's Position

The defendant submits that the terms of the agreement between the plaintiff and PCAB speak for themselves. It is the further submission of the defendant that not only are the fees identified as management fees in the agreement, the stated business of the plaintiff is that of investment counsel, which is the very service provided to the plaintiff by PCAB. In addition, the defendant states that the plaintiff and PCAB were not dealing at arm's length, and puts the plaintiff to strict proof thereof.

In assessing the plaintiff, the Minister of National Revenue considered the plaintiff's business during the years in question to be that of investment counsel. Prior to March 31, 1984, Mr. F. Peter Cundill had owned 75 per cent of the plaintiff, and Guest Holdings Ltd. held 25 per cent of the issued share capital of the plaintiff. After March 31, 1984, the shareholdings were changed to:

As of March 31, 1984, Mr. Cundill ceased to be a resident of Canada and became a resident of the United Kingdom. At this time, the plaintiff entered into portfolio management contracts with the Value Fund and Security Fund, for which the plaintiff received fees based on the net assets of the funds. The Minister assumed at all times F. Peter Cundill was the investment advisor who made the investment decisions for the funds administered by the plaintiff.

Until March 31, 1984, Mr. Cundill was an employee of the plaintiff, and his salary was charged as a business expense of the plaintiff. PCAB is a Bermuda corporation incorporated on February 17, 1984 and F. Peter Cundill beneficially owns all of its outstanding shares. On February 17, 1984 the plaintiff entered into an agreement with PCAB whereby PCAB would provide to the plaintiff the investment and transaction skills or Mr. Cundill as required, to fulfil the plaintiff's portfolio management contracts with the Value and Security Funds. The Minister therefore submits that the income of the plaintiff, and of PCAB, were directly dependent on the investment decisions of Mr. Cundill. All investment decisions were made by Mr. Cundill, who directly contacted the various brokers involved in the transactions on behalf of the plaintiff. These actions suggest that PCAB provided management services.

The plaintiff states that Mr. Cundill held only 50 per cent of the issued shares of the plaintiff. However, the defendant submits that in essence Mr. Cundill exercised control over the management of the company by making the decisions and providing the services necessary for the plaintiff to fulfil its management contracts. The value of Mr. Cundill to the plaintiff was demonstrated by the fact that in 1984 the Value Fund insured Mr. Cundill's life for $5,000,000, and the plaintiff also carried life insurance on Mr. Cundill at some point. The defendant further states that the evidence reveals that a significant motivation in the reduction of Mr. Cundill’s shareholding was the disapproval by securities regulators of the control of the plaintiff by a non-resident, and that he continued to be in complete control of both corporations despite holding only 50 per cent of the shares. In short, the fees paid by the plaintiff to PCAB were management fees, and these two parties were not dealing at arm's length with each other, for Mr. Cundill was the controlling mind directing both corporations.

On that basis, Revenue Canada determined that PCAB was liable for 25 per cent tax on the fees received by the plaintiff for the services of Mr. Cundill. The plaintiff had failed to withhold the tax payable by PCAB, and therefore was liable to pay the amount that should have been withheld from the payments made to PCAB as tax.

In assessing and reassessing the plaintiff, the defendant relied upon paragraph 212(1)(a), subsections 212(4), 214(1), 215(1), (6), 227(10) and paragraph 251 (1)(b) of the Income Tax Act and submits the plaintiff was properly assessed for the management fees paid to PCAB. Further, the plaintiff failed to withhold tax in the amount of 25 per cent for payments made in 1985 and 1986 to PCAB, a non-resident corporation with which it did not deal at arm's length.

The defendant therefore requests the action be dismissed, with costs.

Issues

The issues in this case are: (1) whether PCAB, through the services of Mr. Cundill, provided any management administrative services to the plaintiff; and

(2) whether PCAB and Mr. Cundill and the plaintiff were all dealing at arm's length with one another.

(1) whether PCAB, through the services of Mr. Cundill, provided any management administrative services to the plaintiff

Part XIII of the Act imposes a 25 per cent withholding tax on the income from Canada of non-residents, unless modified by the terms of a tax treaty. Para-

graph 212(1)(a) of the Income Tax Act is reproduced below:

212. (1) Every non-resident person shall pay an income tax of 25 per cent on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(a) a management or administration fee or charge;

The purpose of this section of the Act is to make non-residents subject to tax on management or administration income received in Canada. The tax is to be withheld at the source, and therefore the employer is required to deduct the tax at the appropriate rate before the non-resident is paid. Failure to withhold the tax or remit it to Revenue Canada is subject to penalty.

The crucial question in this case is whether the plaintiff paid a non-resident for management or administrative services. Unfortunately a " management or administration fee or charge" is not defined by the Act. Generally speaking, a management or administration fee is an amount paid in respect of managerial services in connection with the direction or supervision of business activities. In Harel v. D/M.R. (Québec), [1977] C.T.C. 441; 77 D.T.C. 5438, De Grandpré, J. stated that in cases where there is doubt about the meaning of legislation, administrative interpretation, while not conclusive, can be accorded real weight and become an important factor in interpretation. In Interpretation Bulletin IT-468 (the bulletin in effect for the 1985 and 1986 taxation years) it was suggested that the terms included "the functions of planning, direction, control, coordination, systems or other functions at a managerial level”. This definition suggests that the management or administration extends beyond the provision of those functions necessary for day-to-day operations and would encompass the decision-making process as it relates to the present and future direction and operation of the business. In this case, it is undisputed that Peter Cundill made all the investment decisions. In the context of the stated business of the plaintiff of investment counselling, investment decisions are obviously relevant to the future direction and operation of the plaintiff. The profitability of the plaintiff depends directly upon the investment planning decisions of Peter Cundill. I would conclude that the investment decisions made by Peter Cundill are management tasks and that they fall within the purview of the statute.

It is also worthy of note that in the only reported case dealing with these provisions of which I am aware, Windsor Plastic Products Ltd. v. The Queen, [1986] 1 C.T.C. 331; 86 D.T.C. 6171 (F.C.T.D.) the management services provided to the plaintiff were as follows (at 334 (D.T.C. 6174)):

(a) Market research and product direction;

(b) Know-how and expertise in the automobile industry;

(c) Operations planning;

(d) Financial planning;

(e) Annual audit assessment.

Although there was no express determination on the point, Muldoon, J. clearly intended that they be considered as management or administrative functions, as he found in favour of the Minister. It is clear that the functions provided in the Windsor Plastics case, especially market research and know-how and expertise, are similar to those provided by PCAB in the context of the investment counselling business.

It was submitted by counsel for the plaintiff that the words management" and "administration" are virtually synonymous, and that the interpretation of the term "management" should be coloured by the word "administration", with all its connotations of the more mundane aspects of the business of investing which were carried out by the other employees of the plaintiff. The plaintiff stated that the term "administration" implied the more “nuts and bolts" aspects of the business, and that therefore the investment planning activities of Peter Cundill would be excluded if the proposed definition were applied.

In stating that the term "administration" should be the dominating consideration as opposed to management”, counsel for the plaintiff relied on the rule of construction noscitur a sociis, or"a word is known by its companions". In Customs and Excise Commissioner v. Viva Gas Appliances Ltd., [1984] 1 All E.R. 112 (H.L.), Lord Diplock described the rule as follows at 116:

The maxim noscitura sociis may be a useful aid to statutory interpretation, but the contexts in which it is applicable are limited. In the case of a word which is capable of bearing various shades of meaning, the fact that it is included in a list of words of greater precision in which some common characteristic can be discerned may enable one to say that the chameleon word takes its colour from those other words and of its possible meanings bears that which shares the characteristic that is common to others.

Rules of construction, of course, are only tools to assist the Court in its task of interpreting legislation, and no one rule is conclusive of the issue. In any event, resort to the rule is not appropriate in the case at hand. Such an approach fails to give sufficient weight to the fact that the words "management" and "administration" are divided by the disjunctive "or", which tends to suggest that the words were intended to bear separate meanings. If Parliament intended that the words be synonymous, it is difficult to see why both words would be included in the section. The plaintiff submits that the word" management", according to the rule, should take its meaning from the more general word "administration". With respect, it is not self-evident to me that the word "administration" is more "general" than "management". It does appear that the word "administration" is more readily adaptable to the purposes of the plaintiff's argument than is "management", but this does not mean that the plaintiff's approach should govern. While it is true that it is conceivable that the functions envisioned by management" and "administration" may overlap, to restrict the meaning of the two words in the way proposed by the plaintiff would mean that the use of one of the words would serve no useful purpose, especially given the presence of the disjunctive "or": Superior Pre-Kast Septic Tanks v. The Queen, [1978] 2 S.C.R. 712; [1978] C.T.C. 431; 78 D.T.C. 6263 (S.C.C.), at 434 (D.T.C. 6266).

Therefore, I find that the PCAB was performing management services for the plaintiff for which it was paid a fee. However, subsection 212(4) of the Act does exclude for the purposes of paragraph 212(1)(a), the following amounts, so long as they are reasonable in the circumstances:

(a) an amount paid or credited to a non-resident for a service performed provided that the service was performed in the ordinary course of a business carried on by the non-resident and the non-resident and the payer were dealing with each other at arm's length at the time of the performance of such service, or

(b) an amount paid or credited to a non-resident provided that the amount was a reimbursement of a specific expense incurred for the performance of a service and the service performed by the non-resident was for the benefit of the payer.

As such, the plaintiff must try to fit itself within the confines of this exception to avoid liability for the tax.

(2) whether PCAB and Mr. Cundill and the plaintiff were all dealing at arm's length with one another

The next step is [to] determine if the parties involved in this case were acting at arm's length. Section 251 of the Act covers this situation and is reproduced below:

251. (1) For the purposes of this Act

(a) related persons shall be deemed not to deal with each other at arm's length; and

(b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length.

Again, the Act does not contain an all-inclusive definition of the terms. Generally, the expression "arm's length” is used when relationships between corporations and individuals are called into question. In order to understand what is meant by the term "arm's length” an examination of the jurisprudence is helpful. The Supreme Court of Canada in M.N.R. v. Sheldon's Engineering Ltd., [1955] S.C.R. 637; [1955] C.T.C. 174; 55 D.T.C. 1110, stated at 180 (D.T.C. 1113; S.C.R. 644): "Where corporations are controlled directly or indirectly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm's length.”

Whether the parties in this case were dealing at arm's length is a question to be examined on its own particular facts. Many factors are relevant in the determination of the issue, such as ownership and control of a corporation. However, share control (or absence of it) is not necessarily conclusive; it is only a factor to be considered in determining the question of arm's length (Robson Leather Co. v. M.N.R., [1974] C.T.C. 872; 74 D.T.C. 6666, Collier, J. affd [1977] C.T.C. 132; 77 D.T.C. 5106 (F.C.A.)).

In Interpretation Bulletin IT-419 Revenue Canada suggested the following factors will determine whether or not dealings are at arm's length:

(a) the existence of a common mind which directs the bargaining for both parties to a transaction,

(b) parties to a transaction acting in concert without separate interests, and

(c) de facto control.

The criteria enunciated in IT-419 have also been the criteria consistently considered by the courts. In this case, it appears the factor that will illuminate the situation is determining the controlling mind of these two corporations. If the mind” acting for one party is the same mind" directing the second party, then they cannot really be said to be dealing at arm's length (Oryx Realty Corp. and Shofar Investment Corp. v. M.N.R., [1972] F.C. 33; [1972] C.T.C. 35; 72 D.T.C. 6018; affd [1974] 2 F.C. 44; [1974] C.T.C. 430; 74 D.T.C. 6352 (F.C.A). Further, as Cattanach, J. noted in M.N.R. v. Merritt, [1969] 2 Ex. C.R. 51; [1969] C.T.C. 207; 69 D.T.C. 5159 at 217 (D.T.C. 5165):

In my view, the basic premise on which this analysis is based is that, where the "mind" by which the bargaining is directed on behalf of one party to a contract is the same" mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties are dealing at arm's length. In other words where the evidence reveals that the same person was "dictating" the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at "arm's length".

It is apparent from the evidence presented at trial that while Peter Cundill only owns 50 per cent of the shares of the plaintiff, he exercises an influence and control over the affairs and future of the plaintiff that is disproportionate to his shareholding. The financial well-being of the company is directly dependent upon the investment decisions which he makes. While the plaintiff stated that it did have replacements in mind should the plaintiff ever lose the services of Peter Cundill, it is clear that they considered him to be among the best, if not the best, investment counsellor in the field and that replacing him would have been a source of great disruption to the plaintiff's affairs. In many ways Peter Cundill was the "product" of the company and the source of most of its goodwill. It is clear that in negotiating the terms of compensation between PCAB and the plaintiff, Peter Cundill was in a bargaining position of great strength because of the plaintiff's reliance upon him. It is also worthy of note that a significant, if not the overriding, reason that Peter Cundill reduced his shareholding in the plaintiff to a 50 per cent holding was to comply with the wishes of securities regulators. Based on the foregoing, I find that the plaintiff and PCAB were not dealing at arm's length and therefore the plaintiff does not come within the statutory exception.

Accordingly, I would conclude that the amounts in question ought to have been withheld from PCAB's fee and remitted by the plaintiff. The appeal is dismissed with costs.

Appeal dismissed.