Ingram v. MNR, 91 DTC 939, [1991] 2 CTC 2259 (TCC)

Teskey, T.CJ.:—The appellant appeals his reassessment for the year 1987 wherein the respondent determined that the appellant had received, by virtue of him being a director of Electromagnetic Inc. (O.E.X.), income from stock options of $335,925 in accordance with the provisions of subsection 7(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The amount is not in dispute.

Facts

From the evidence received, the court makes the following findings of facts.

The appellant, a businessman, joined Household Finance at the age of 19 and remained with them for 22 years, then in 1973 he changed jobs and joined First City Trust. He became a vice-president of First City Trust, as well as being in charge of the residential mortgage division. In 1986, First City Trust went out of the residential mortgage business in British Columbia and the appellant found himself unemployed. He was approached in October of 1986 by Elford Scott (Scott) commonly known as Ford, a social friend and neighbour for 20 years.

At the time he knew Scott was a stock promoter. Scott advised the appellant that he and his two partners Byron Williams (Williams) and Montague Simons (Simons) who were also stock promoters trading under the name of B.M.F. Trading (B.M.F.) were promoting the stock of O.E.X., a public company listed on the Vancouver stock exchange. O.E.X. had apparently purchased from a company in Arkansas the right to market a product for $3,000,000 (payable over an extended period of time). The American company had to nominate two Americans to the Board of Directors to represent their interests (presumably to make sure the $3,000,000 was paid). The Company Act of British Columbia required that a majority of the directors be Canadians. Williams was a director of O.E.X. as well as its president and already held all allowable stock options. Both Scott and Simons already had held all allowable stock options pursuant to the rules of the Securities - Commission. These rules also prohibited them from holding any further stock options either as employees or directors of O.E.X. Thus, B.M.F. had to find two Canadians to sit on the Board of Directors of O.E.X. so that the total number would be five (two Americans and three Canadians).

Scott asked the appellant, (a Canadian) if he would sit on the Board of Directors of O.E.X. as a nominee director of B.M.F. He explained that he would not have to attend any meetings and that if any resolutions were needed, all he would have to do is attend at B.M.F.'s office, on Burrard Street, Vancouver, and sign the same. It was also explained that he would be given stock options, but these were not his but were B.M.F's who would control them, exercise them and reap any benefit. The appellant never attended any directors' meeting nor received directly or indirectly any benefit whatsoever from O.E.X. (save the stock options in question) or B.M.F. The appellant was never involved with company policy or the direction it was proceeding. He simply was not involved.

B.M.F. opened a trading account with Canarim Investment Corporation Ltd. (Canarim) stock brokers under the appellant's name. The appellant gave written authorization to Canarim authorizing Simons and/or Scott to trade stock on their instructions in his name. Simons and/or Scott made hundreds of trades in the appellant's name. The partners of B.M.F. operated between 20 and 50 trading accounts. They determined, as well as bought and sold stock in each other's names and accounts as well as in the appellant's trading account. This buying and selling between these accounts was for the obvious purpose of creating the illusion that O.E.X. stock (and whatever other stock they were promoting) was being actively traded by third parties. This trading was kept a secret and never disclosed to anyone.

A written stock option agreement was entered into by the appellant with O.E.X. on October 21, 1986. Three (3) separate Treasury Orders to exercise the options were executed by the appellant in 1987.

Each Treasury Order contained the following paragraph:

And we also certify that the said allotment is not made consequent upon a direction given by an optionee or other party primarily entitled to ownership in said shares, but that it constitutes that first transaction having the effect of creating ownership, control or the right to receive such shares.

The shares were sold through Canarim on either Simons or Scott's instructions. On each occasion, the appellant was called by someone at B.M.F. and he would attend at their offices to endorse the Canarim cheque and, at the same time, he would execute the required Treasury Order.

As far as the appellant was concerned, the partners of B.M.F. ran and controlled O.E.X. He claims and pleads that he was their nominee. Eventually all trading of O.E.X. stock was suspended and the partners of B.M.F. were prohibited from trading directly or indirectly in any stock on the Vancouver Stock Exchange for 12 years and the appellant's trading privileges were suspended for two years.

The appellant did not file his 1987 T-1 tax return until February 24, 1989 and then only on the request of the Department of National Revenue. In his return he did not include the stock option benefit. He was assessed on July 6, 1989 and objected to the assessment on September 24, 1989.

The three partners, Williams, Scott and Simons, had each filed their 1987 T-1 tax returns in April of 1987 showing a total estimated income for B.M.F. of $75,000 with each one showing income of $25,000 from B.M.F. Each filed amended T-1 tax returns in November of 1989 for 1987 with a statement of income and expenses for B.M.F. showing revenue of $2,773,162.22 and expenses of $518,420.21 with a net income of $2,254,742.01 proportioned equally between the three partners at $751,580.67. The B.M.F. Financial Statement showed the total gain on the stock options in the appellant's name and others, was brought into income. The handwritten notes of Graham John Morin, an accountant hired by B.M.F., dated May 16,1989 were produced which indicate how the stock option benefits were calculated and confirm that the figures are correct. The estimated T-1 tax returns filed in April of 1987 were grossly wrong.

Appellant's Position

The appellant argues that he was the nominee, or in the alternative a trustee, or in the alternative an agent for B.M.F., and that he did not have the beneficial ownership of the stock options and therefore all gains were gains of B.M.F. who (albeit late) have declared the profit as income. (The partners of B.M.F. all had large losses in 1986 which eliminated all taxes on the 1987 income.)

As a preliminary point, the appellant argues that the partners of B.M.F. are taxable on the gain from the stock option and sale of the shares notwithstanding that they were in breach of the Securities Commission's Rules. In the case M.N.R. v. Eldridge, [1964] C.T.C. 545; 64 D.T.C. 5338 (Ex. Ct.) Mr. Justice Cattanach in the course of deciding the income tax appeal of the operator of a call-girl organization stated at page 551 (D.T.C. 5342) that: "it is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses are subject to tax".

The appellant further argues that the partners of B.M.F. as principal and not the appellant as agent, is the entity taxable on the gains. He refers the Court to the Exchequer Court decision of Richardson Terminals Ltd. v. M.N.R., [1971] C.T.C. 42; 71 D.T.C. 5028, affd [1972] C.T.C. 528; 72 D.T.C. 6431 (S.C.C.) wherein the Exchequer Court said: “profits from a business are income of the person who carries on the business and are not, as such, income of a third person into whose hands they may come" and by way of argument, the appellant submits that the business of trading in shares was B.M.F.'s business. The partners thereof conducted the stock transactions albeit in an account in the name of the appellant.

The appellant further argues that the partnership had capacity to deal with the shares therefore it could (and did) deal with the shares through an agent even though it was contrary to certain Securities Commission's Rules for the partnership to do this. He argues that the principle cited in Denison Mines Ltd. v. M.N.R., [1971] C.T.C. 640; 71 D.T.C. 5375 was obiter dicta and not necessary for the Court's decision and that the agency principle when it was dealt with in Alberta Gas Ethylene Co. v. Canada, [1989] 1 C.T.C. 135; 89 D.T.C. 5058 (F.C.T.D.); [1990] 2 C.T.C. 171; 90 D.T.C. 6419 (F.C.A.) was cited without analysis and that the same principle, when dealt with by Mr. Justice Pigeon, of the Supreme Court of Canada in Victuni Aktiengesellschaft v. Minister of Revenue (Que.), [1980] 1 S.C.R. 580; 112 D.L.R. (3d) 83 uses the word "capacity" and therefore, since the partners of B.M.F. had capacity to deal with the shares (even though such activity resulted in a breach of the security rules) the gain falls in the hands of the partners of B.M.F., the principals and not the appellant, the agent.

Respondent's Position

The respondent argues when being advised by the Court that it was satisfied that the appellant was the nominee of B.M.F., that the appellant attempted to be an agent of B.M.F., and therefore on the authority of Denison, supra, and Alberta Gas, supra, a person cannot do by an agent what he cannot do himself. Therefore since the principals of B.M.F. all had used up all stock options allowable by the Securities Commission's Rules, the appellant's claim of nominee fails in law and he has to be treated as acting on his own behalf.

Analysis

The Court is satisfied that the legal principles laid down in Eldridge, supra, and Richardson Terminals, supra, are irrelevant to the facts in this appeal. The issue herein is whether the appellant acting as nominee is taxable.

The appellant pleads that he was the nominee of the partners of B.M.F. and argues that the income made on the stock options is income of the partners of B.M.F. The Court has to decide if it makes any difference whether a "nominee" is a trustee or agent or a combination of both or something entirely different.

District Judge Lindley of the U.S. Circut Court of Appeals in Schuh Trading Co. v. C.I.R. (1938), 95 F.R. (2d) 404 defined the word "nominee" at page 411 wherein he said:

. . . The word nominee ordinarily indicates one designated to act for another as his representative in a rather limited sense. It is used sometimes to signify an agent or trustee. It has no connotation, however, other than that of acting for another, in representation of another, or as the grantee of another.

The Court is satisfied that in these circumstances the use of the word "nominee" connotes either a trustee or an agency. The appellant describes himself as a nominee director. This, he cannot be. Even though he abrogated all his duties and obligations, he was a director of O.E.X.

On the facts of this case, the appellant was either a trustee or an agent in fact if not in law.

The Court was referred to and considered the decision of Reed, J. of the Federal Court-Trial Division in Fraser v. M.N.R., [1991] 1 C.T.C. 314; 91 D.T.C. 5123, wherein she reviews the law of agency and trust. The Court also considered the following principles:

1. Principal and agent are linked by contractual agreement; settlor and trustee are linked by Equity as a mode or property conveyance (Waters). [1] That is, an agent acts for another; but a trustee holds property for another. (Bowstead) [2] .

2. The agent acts according to the instruction of the principal and is a "conduit pipe" for the principal; the trustee has no master but the law - he or she acts for neither the settlor nor the beneficiaries. (Waters)

3. While an agent may administer property for the benefit of the principal and a trustee administers property for the benefit of the beneficiaries, the trustee is always vested with (i.e., has legal title in) a property; the agent may never deal with property. (Bowstead).

4. The death of a principal or agent ends the agency; the death of a settlor, a beneficiary (to the extent of his or her position) or even the trustees do not end the trust, the latter being because no trust fails for lack of a trustee. (Waters).

5. A trust once created cannot be modified except to the extent a power reserved by the trustee allows; an agency can be modified at any time to any extent by agreement. (Waters).

6. The trustee's fiduciary nature vis-a-vis the trust property is always substantial and his or her duties strict; the agent's level of and duties under his or her fiduciary obligations will vary greatly depending on the nature of the agency.

The Court accepts that the appellant set up a relationship with the partners of B.M.F. This relationship was one of principal and agent.

Pigeon, J. dealt with the word "nominee" in Victuni, supra, a decision written in French. He quotes from the French text by the eminent authors Planiol and Ripert, entitled Traité de droit civil at page 584 in the right column the following paragraph:

Mais la convention est nulle si elle cherche à faire, par prête-nom, un acte qui aurait été interdit au mandat ostensible (Baudry-Lacantinerie et Wahl, nos 883 et seq.; Josserand, II, no 1436). Elle vise alors à tourner la loi et constitue une fraude.

In the reported decision on the same page is the English translation which says:

However, the agreement is void if it seeks through the nominee to make a contract which would have been beyond the capacity of the mandator by an ostensible mandate (Baudry-Lacantinerie and Wahl, Nos. 883 et seq. ; Josserand, II, No. 1436). Its purpose then is to circumvent the law and it constitutes a fraud.

The French word "interdit" has been translated to the word "capacity". However, the Robert & Collins French-English Dictionary, 2d edition, 1988 interprets "interdit" as "forbidden" or "prohibited" and does not interpret that word to mean "capacity".

A casual reader of this decision might come to the conclusion that there is a conflict between the French decision and the English version. The Court is convinced that Pigeon, J. used the word "capacity" in its broadest sense and not in the narrow technical sense such as: infancy, mental incompetency. Thus, the word "capacity" as used by Pigeon, J. in Victuni includes forbidden and prohibited; therefore, since the security rules forbid the principals from taking the stock options in question, they did not have the capacity in the sense that it was used by Pigeon, J. in the English translation. The original French text is abundantly clear.

On the authority of Victuni, Denison and Alberta Gas, supra, I am satisfied the agency agreement herein was void and therefore not enforceable between the appellant and B.M.F. Having determined that the agency was void, is that the end of the matter? I think not. Even though the agency agreement was void and therefore unenforceable between the appellant and B.M.F., the terms of the agency agreement were completed and all the money was passed by the agent appellant to his principal B.M.F. The ultimate economic benefit of the completed albeit void agency was with B.M.F.

Evans, J., as he then was, of the Ontario Court of Appeal in The Queen v. Poynton, [1972] C.T.C. 411; 72 D.T.C. 6329 dealt with economic benefit. He referred to Thorson, J.’s decision of Robertson v. M.N.R., [1944] C.T.C. 75; 2 D.T.C. 655, and the majority judgment in James v. United States (1961), 366 U.S. 213. He directs that some of the circumstances to be weighed in determining income, are:

(i) the manner of receipt,

(ii) the control over it,

(iii) the liabilities,

(iv) the restrictions attaching to it, and

(v) the person to whom the benefits accrue.

In this instance, no benefits accrued to the appellant. He had no control over the money.

Considering the above criteria, they all point to the income being that of the partners of B.M.F. The economic benefit was theirs.

It is interesting to notice that the position of the Minister in this case is exactly opposite to the position argued and adopted in Poynton.

Judgment

For the above reasons, the appeal is allowed, with costs, and the assessment is referred back to the Minister for reconsideration and reassessment on the basis that the appellant did not receive any income whatsoever as a result of the stock options exercised in 1987 of O.E.X. stock.

Appeal allowed.