533702 Ontario Ltd. v. MNR, 91 DTC 982, [1991] 2 CTC 2102 (TCC)

Mogan, T.C.J.:—For the 1986 and 1987 taxation years, the appellant reported income from an active business carried on in Canada and claimed the small business deduction under subsection 125(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The respondent did not adjust the appellant’s reported income in any material way but assumed that any amount reported by the appellant as income from an active business carried on in Canada was income from a “personal services business" within the meaning of paragraph 125(7)(d) of the Act. The only issue in this appeal was whether the appellant carried on an active business or a personal services business. The two relevant definitions appear in paragraphs (a) and (d) subsection 125(7) of the Act:

125. (7)(a) “active business carried on by a corporation” means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade;

125. (7)(d) "personal services business” carried on by a corporation in a taxation year means a business of providing services where

(i) an individual who performs services on behalf of the corporation (in this paragraph and paragraphs 8(3)(a.1) and 18(1)(p) referred to as an "incorporated employee"), or

(ii) any person related to the incorporated employee

is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless

(iii) the corporation employs in the business throughout the year more than five full-time employees, or

(iv) the amount paid or payable to the corporation in the year for the services is received or receivable by it from a corporation with which it was associated in the year;

It is apparent from the above definitions that they are mutually exclusive. If a corporation carries on only one business, it cannot be both an active business and a personal services business. Because the assessments under appeal were issued on the basis that the appellant carried on a personal services business, it is necessary to determine whether the conditions in paragraph 125(7)(d) are satisfied.

Throughout 1986 and 1987, the issued shares of the appellant were held as follows:

Dick Brouwer came to Canada from the Netherlands in 1984 and joined his older brother Harry in the plumbing business in London, Ontario. They would contract with a house builder to supply and install all of the plumbing fixtures in new houses. They did the same for renovations but they were not engaged in the service business of fixing taps and leaking pipes. In January 1985, Harry retired; Dick bought out his interest in the business and became the controlling shareholder of Brouwer Plumbing and Heating Ltd. (BPH). From and after January 1985, Dick Brouwer managed and was responsible for all the operations of BPH.

During the 1980s, the design and fixtures of bathrooms changed with the introduction of new products like whirlpool baths, brass and gold faucets. BPH continued to quote on standard products to the builders but the house buyers would frequently want to upgrade the bathroom fixtures. At first, the house buyers had to be sent to Toronto where the new products were on display by the major suppliers like American Standard and Crane. If the house buyer provided his own upgraded fixtures, there would frequently be problems for BPH if any parts were missing. In order to be competitive and provide a complete service, BPH decided to build a showroom on its own premises where all of the new products could be displayed.

In 1983, BPH had moved to 833 Central Avenue in London, Ontario where it had a storage warehouse and office but no showroom. In 1985, BPH designated an area approximately 20 feet by 40 feet as a showroom within their premises at 833 Central Avenue. It was decorated like a number of bathrooms in a model house with the most modern upgraded fixtures. Dick Brouwer had no experience in marketing bathroom fixtures at the retail level through a showroom and so he started by arranging appointments with customers when he or a secretary would come down from the office to meet the customer in the showroom on the lower level of the BPH premises. By the latter part of 1985, Dick Brouwer did not have time to spend in the showroom because of the building boom in the construction of new houses in southern Ontario which lasted from 1985 through to 1988. He therefore asked his wife Joyce if she would work in the showroom. Apparently she had a flair for decorating and had chosen some of the tiles, towels, carpets, wallpaper and colour combinations for the showroom displays.

Joyce Brouwer said that she would be interested in operating the showroom as her own business but did not want to be an employee of her husband taking orders from him on a daily basis. It was therefore decided that the showroom would be designated as a venture of the appellant's corporation. Prior to 1985, the two issued shares of the appellant were held one by Dick and one by Joyce. When she stated that she would operate the showroom as her own business, additional shares of the appellant were issued on December 16, 1985 so that Joyce held 71, Dick held nine, Carla held ten and Richard held ten. On or about December 16, 1985, the appellant commenced managing the showroom. Showroom hours were 9:00 a.m. to 5:00 p.m. Monday to Friday and 9:00 a.m. to 1:00 p.m. Saturday although the hours of BPH were 7:30 a.m. to 5:00 p.m. Monday to Friday.

Stephen Barta was employed to work in the showroom from April 7, 1986 but he resigned on September 11, 1986. Tim Hoover replaced Stephen Barta on October 14, 1986 and worked in the showroom beyond the end of 1987. Prior to the arrival of Stephen Barta, Joyce Brouwer had worked in the showroom and, from September 11 to October 14, 1986, Joyce and her daughter Carla did the selling in the showroom. When Stephen Barta was hired, he was interviewed first by Joyce because she had known him many years previously. He was then interviewed by Joyce and Dick. Tim Hoover was interviewed only by Dick when he was hired. Joyce stated in evidence that she regarded both Barta and Hoover as her employees; she was their boss. She also stated that she did not go to the showroom on any regular basis but occasionally to consult with Dick. Barta, Hoover and other employees of the appellant corporation were paid with cheques issued by BPH.

The following example illustrates the commercial arrangements among the various parties:

1. BPH would enter into a contract with a house builder (X) to supply and install all the plumbing fixtures required for the new houses in a particular housing project.

2. X would enter into an agreement of purchase and sale with a customer (C) who wanted to purchase a new house in the project.

3. If C wanted to upgrade some or all of the plumbing fixtures from the standard ones provided in the agreement of purchase and sale, X would refer C to BPH.

4. C would come to the showroom at the premises of BPH on Central Avenue to see the fixtures on display and catalogues of other products not on display. If C decided to purchase some upgrades, he would go back to X and sign an amendment to the agreement of purchase and sale providing for the upgraded plumbing fixtures and an upward adjustment in the purchase price of the house.

5. C would have no way of knowing that he was dealing with the appellant corporation in the showroom because all visible signs at the Central Avenue premises bore the name BPH.

6. BPH would purchase the upgraded fixtures from arm's length suppliers and install them in C's new house.

7. C would pay X for the house. X would pay BPH for the supply and installation of all plumbing fixtures. BPH and the appellant would allocate between them the profit realized on the purchase and sale of the upgraded fixtures.

The appellant's showroom business commenced in the latter part of its taxation year ending March 31, 1986. At the end of that taxation year, BPH and the appellant had not established a formula for the allocation of profit and so, on a somewhat arbitrary basis, BPH paid to the appellant a management fee of $125,000. For the year ending March 31, 1987, Dick and Joyce met with the accountant who prepared the financial statements for both BPH and the appellant, and they decided that the profit on upgraded fixtures sold through the showroom would be allocated 80 per cent to the appellant and 20 per cent to BPH. The sources of revenue for the appellant's 1986 and 1987 taxation years were as follows:

It is necessary to apply the provision of paragraph 125(7)(d) of the Income Tax Act to the facts in this appeal. At the commencement of argument, counsel for the appellant conceded that the conditions in subparagraphs (iii) and (iv) of paragraph 125(7)(d) applied to this case. In other words, the appellant corporation never had more than five full-time employees at any relevant time; and the appellant corporation filed income tax returns on the basis that it was not associated with BPH, and the respondent has never suggested or concluded that the appellant and BPH were associated. The appellant also concedes that Joyce Brouwer who performs services on behalf of the appellant corporation is a specified shareholder of the appellant. The appellant put forward the following three arguments:

1. The services provided by the appellant corporation were not provided to BPH but were provided to independent third parties like a house builder (X in the above example) or a customer who purchased a new house (C in the above example).

2. Although Joyce Brouwer as the "incorporated employee" provided services during the appellant's 1986 taxation year, she did not provide services during the appellant's 1987 taxation year because those services were provided by other employees of the appellant like Stephen Barta, Tim Hoover and daughter Carla Brouwer. The appellant cannot succeed on this argument for 1986 but can succeed for 1987.

3. Joyce Brouwer was an independent contractor and, therefore, would not reasonably be regarded as an officer or employee of BPH but for the existence of the appellant corporation.

The appellant and respondent are in agreement that the appellant corporation provided services of some kind. The appellant must take this position in order to prove (if possible) that it carried on an active business because it was not engaged in the purchase and sale of any product or property. The respondent must take this position in order to prove (if possible) that the appellant carried on a personal services business. If the parties were not in agreement on this fundamental fact, I should have thought that the appellant corporation was not engaged in any commercial activity with respect to the showroom and that its purported services with respect to the showroom were nil. I am left, however, with the agreement of the parties that the appellant corporation provided services of some kind. In connection with the appellant's first argument, I must determine to whom the services were provided.

The appellant's first argument is not supported by the evidence. In my view, the appellant corporation provided no services whatsoever to the house builder or the customer who purchased a new house. From a legal point of view, there was no privity of contract between the appellant and the builder or the customer. The customer who visited the showroom and decided to order an upgraded plumbing fixture went back to the builder to amend his agreement of purchase and sale. In order to comply with the amended house purchase agreement, BPH would then purchase and install the upgraded fixture. The allocation of profit on the upgraded fixture was a purely internal matter between the appellant and EPH settled long after the fixture was installed. From a factual point of view, the customer would not even know that the appellant existed. The only business name displayed on the premises at 833 Central Avenue was the name "Brouwer Plumbing & Heating". Indeed, there was no evidence that the appellant, as a "numbered company”, had a business name at all.

The showroom had no commercial purpose apart from the plumbing business of BPH. The purported employees of the appellant were paid with cheques issued by BPH. I infer from the relatively naked balance sheet of the appellant (as at March 31, 1986 and 1987) that BPH owned all physical assets connected with the showroom (display fixtures like tubs, sinks, showers and toilets; decorative accessories like towels, rugs, tiles, wallpaper and lighting). There is no evidence that the appellant owned fixed assets or inventory of any kind. The first arm's length salesman (Barta) was found by Joyce but interviewed by Dick and Joyce. The second (Hoover) was found and interviewed by Dick alone. Although Joyce stated that she regarded herself as "the boss" of Barta and Hoover, she also said that she did not go to the showroom on any regular basis but occasionally to consult with Dick. The appellant is caught in a real dilemma. On the one hand, to prove that the services were provided by Barta and Hoover and not by Joyce as the "incorporated employee” and specified shareholder, she stated that she was seldom at the showroom. On the other hand to prove that the appellant carried on an active business with employees like Barta and Hoover (supposedly not employed by but paid by BPH) she stated that she was their "boss"; albeit in absentia.

Under cross-examination, Joyce admitted that she did not go into the showroom business for the money, and that the 80/20 split between the appellant and BPH on the profit from upgraded fixtures was decided "strictly with the accountant and I had very little to do with the accountant". In connection with the 80/20 split, Dick was asked in cross-examination if the profit allocated to the appellant would be substantially less if the appellant were owned by persons outside his family; and he answered "it probably would be”. He was also asked why the high portion (80 per cent) of the profits was allocated to the appellant. His answers were (a) because Joyce wanted it;

(b) the 80/20 split was determined in consultation with the accountant; and (c) "why not?” The only conclusion I can draw concerning the earnings of the appellant (the $125,000 management fee paid in its 1986 taxation year and the 80/20 split allocated in its 1987 taxation year) is that such earnings were totally within the discretion of Dick Brouwer as the controlling shareholder of BPH and the earnings were determined on an arbitrary basis favourable to the appellant.

In the respondent's reply to the notice of appeal the respondent alleged that, when making the assessments under appeal, the respondent relied upon certain assumptions or findings of fact including:

8 (k) the Appellant reported an inter-company transaction with Brouwer Plumbing and Heating Limited in the amount of $199,187.50 as gross profit on showroom sales;

(l) the amount of $199,187.50, referred to in subparagraph 8(k) was recorded in an artificial journal entry which resulted in the recording of sales at $612,735.50 and cost of sales of $413,548.00 in the Appellant’s financial statement for the period;

(m) the Appellant did not in fact engage in the sales described in subparagraph 8(1), above.

The respondent also alleged that the said amount of $199,187.50 reported by the appellant as gross profit for 1987 was in fact a further management fee. These are serious allegations concerning a journal entry said to be artificial and a certain amount reported as profit on sales said to be a management fee. The appellant made no significant attempt to rebut these allegations. Evidence put forward on behalf of the appellant comprised only the oral testimony of Dick Brouwer (more than one hour) and Joyce Brouwer (perhaps 20 minutes). There was not one page of documentary evidence entered on behalf of the appel-

lant: no agreement between the appellant and BPH defining duties, rights or obligations; no agreement concerning the showroom; who owned it; who could use it; who would be compensated for its use; or how such compensation could be measured; no financial records or financial statements. The absence of appellant’s documents is surprising given the serious allegations in the respondent's pleading. The only documents in evidence are the appellant's income tax returns for the years under appeal introduced by respondent's counsel in cross-examination.

The whole story of the appellant's purported showroom business did not have a true ring. It sounded more like the dream of a tax advisor planted in the minds of productive, responsible and hard-working citizens like Dick and Joyce Brouwer. I was favourably impressed with their character as witnesses and with their good relationship with each other but I could not accept their bland, undocumented description of a purported business which did not have any commercial independence but appeared to be an integral part of the BPH business. If the appellant corporation provided services of some kind (as the parties have agreed), those services were provided to BPH and to no other person.

The appellant's second argument is based on the premise that Joyce Brouwer did not provide any services to BPH during the appellant's 1987 taxation year because the showroom was serviced in that year by Stephen Barta and Tim Hoover. This argument has no merit. To be technical, Joyce worked in the showroom for the first seven days of the 1987 taxation year until Stephen Barta started to work on April 7, 1986; and she worked from September 11 to October 11, 1986 after Stephen Barta left and before Tim Hoover arrived. Also, if she was their "boss" as she stated, then she must have supervised their work which was a direct service to BPH because the appellant had no other client or customer.

As stated above, the parties agree that the appellant provided services of some kind. I have already decided that the appellant provided services to BPH and to no other person. Therefore, Joyce Brouwer's efforts with respect to the showroom (i.e., supervising employees like Barta, Hoover and daughter Carla, or advising on decor) at any time in a taxation year were services provided to BPH.

The appellant put forward an imaginative third argument to the effect that Joyce Brouwer was an independent contractor and therefore would not reasonably be regarded as an officer or employee of BPH but for the existence of the appellant corporation. Counsel cited a number of cases with distinguishing tests for employee and independent contractor. After some reflection, I have concluded that this argument is not well-founded because the business of providing showroom services carried on by the appellant had no commercial independence from the business of BPH. But for the existence of the appellant corporation, any individual who was an officer or employee of the appellant providing services with respect to the showroom would reasonably be regarded as an officer or employee of BPH. If Joyce Brouwer was brought into the showroom enterprise because of her flair for decorating, and if the showroom provides services only to BPH, Joyce Brouwer would be an officer or employee of BPH but for the existence of the appellant even if third parties were hired to work the showroom. The appeal will be dismissed.

Appeal dismissed.