Petrucci v. M.N.R., docket 97-103-UI

Date: 19980609

Dockets: 97-17-UI; 97-103-UI

BETWEEN:

PETER PETRUCCI, NELLO BERTO,

Appellants,

and

THE MINISTER OF NATIONAL REVENUE,

Respondent,

Reasons for Judgment

Porter, D.J.T.C.C.

[1] These appeals were heard together on common evidence, by consent of the parties, at Toronto, Ontario, on February 24, 1998.

[2] The Appellant, Nello Berto ("Berto") appeals the decision of the Minister of National Revenue (the "Minister") dated November 7, 1996, that his employment with P.L.G. Construction Ltd. (the "Company"), from June 21 to December 17, 1993, from April 25 to November 25, 1994 and from March 20 to December 29, 1995, was not insurable employment under the Unemployment Insurance Act (hereinafter referred to as the "Act"). The reason given for the decision was that:

"...You were employed in excepted employment because, based on your circumstances of employment, you were not dealing at arm's length with the payor, P.L.G. Construction Ltd."

[3] The Appellant, Peter Petrucci ("Petrucci") appeals the decision of the Minister dated November 7, 1996, that his employment with P.L.G. Construction Ltd. (the "Company"), from February 14 to November 18, 1994 and from March 13 to December 8, 1995, was not insurable employment under the Act. The reason given for the decision was that:

"...You were employed in excepted employment for the period February 14, 1994 to March 8, 1994 because you controlled more than 40% of the voting shares of the payor, P.L.G. Construction Ltd. Furthermore, for the period March 9, 1994 to November 18, 1994 and March 13, 1995 to December 8, 1995, you were employed in excepted employment because you were not dealing at arm's length with the payor, P.L.G. Construction Ltd."

[4] The decisions were said to be issued pursuant to paragraphs 3(2)(c) and 3(2)(d) respectively, of the Act.

[5] The established facts reveal that the Company was incorporated in 1986. It carried on a bricklaying business. In May of 1993 Berto's wife, Vicki, purchased 50% of the outstanding shares in the Company from an unrelated person, one Gino Trevisan. At that time, Petrucci owned the remaining 50% of the shares in the Company. One month later Berto went to work for the Company (June 1993). He was laid off that winter and claimed unemployment insurance benefits. In March 1994 the shareholdings were changed again. Berto obtained 25% by way of a transfer of one-half of his wife's shares for which he did not appear to pay anything and Petrucci similarly transferred one-half of his own shares to his wife. Petrucci and Berto continued to work for the Company. They supervised a number of employees. The work was seasonal and they each claimed unemployment insurance benefits in the winters of 1994 and 1995. The issue is whether or not they were at arm's length to the Company during these respective periods of employment.

The Law

[6] In the scheme established under the Act, Parliament has made provision for certain employment to be insurable, leading to the payment of benefits upon termination, and other employment which is "excepted" and thus carrying no benefits upon termination. Employment arrangements made between persons, who are not dealing with each other at arm's length, are categorized as "excepted employment". Quite clearly the purpose of this legislation is to safeguard the system from having to pay out a multitude of benefits based on artificial or fictitious employment arrangements.

[7] Subsection 3(2) of the Unemployment Insurance Act reads in part as follows:

"3(2) Excepted employment is

...

c) subject to paragraph (d) [which refers to persons and related corporations has no applicability in this case] employment where the employer and employee are not dealing with each other at arm’s length and, for the purposes of this paragraph,

(i) the question of whether persons are not dealing with each other at arm’s length shall be determined in accordance with the provisions of the Income Tax Act;...”

[8] Paragraph 251(1)(b) of the Income Tax Act reads as follows:

"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." (emphasis added)

[9] Although the Income Tax Act specifies that it is a question of fact whether persons were at a particular time dealing with each other at arm’s length, that factual question must be decided within the cradle of the law and in reality it is a mixed question of fact and law; see Bowman, T.C.J. in R.M.M. Canadian Enterprises et al. v. The Queen, 97 DTC 302.

[10] What is meant by the term "arm's length" has been the subject of much judicial discussion both here in Canada, in the United States, the United Kingdom and in other Commonwealth countries such as Australia where similar wording appears in their taxing statutes. To the extent that the term has been used in trust and estate matters, that jurisprudence has been discounted in Canada when it comes to the interpretation of taxation statutes; see Locke, J. in M.N.R. v. Sheldon’s Engineering Ltd., 55 DTC 1110.

[11] In considering the meaning of the term "arm's length" sight must not be lost of the words in the statute to which I gave emphasis above, "were at a particular time dealing with each other at arm's length". The case law in Canada as Bowman, T.C.J. points out in the R.M.M. case (above) has tended to dwell upon the nature of the relationship rather than upon the nature of the transactions. I am not sure that having regard to the inclusion of these words in the statute, that this approach is necessarily the only one to be taken, for to do so is to ignore these somewhat pertinent words, to which surely some meaning must be given. Perhaps this development has come about as a result of the factual situations in a number of the leading cases in Canada. These have tended to involve one person (either legal or natural) controlling the minds of both parties to the particular transaction. Thus even though the transaction might be similar to an ordinary commercial transaction made at arm's length that itself has not been enough to take the matter out of the "non arm's length" category; see for example Swiss Bank Corporation et al. v M.N.R., 72 D.T.C. 6470 (S.C.C.).

[12] In effect what these cases say is that if a person moves money from one of his pockets to the other, even if he does so consistently with a regular commercial transaction, he is still dealing with himself, and the nature of the transaction remains "non arm's length".

[13] However, simply because these leading cases involved such factual situations, does not mean that people who might ordinarily be in a non arm's length relationship cannot in fact "deal with each other at a particular time in an 'arm's length' manner", any more than it means that people who are ordinarily at arm's length might not from time to time deal with each other in a non arm's length manner. These cases are quite simply examples of what is not an arm's length relationship rather than amounting to a definition in positive terms as to what is an arm's length transaction. Thus at the end of the day all of the facts must be considered and all of the relevant criteria or tests enunciated in the case law must be applied.

[14] The expression "at arm's length" was considered by Bonner, T.C.J. in William J. McNichol et al. v. The Queen, 97 D.T.C. 111, where at pages 117 and 118 he discussed the concept as follows:

"Three criteria or tests are commonly used to determine whether the parties to a transaction are dealing at arm's length. They are:

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

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

(c) "de facto" control.

The decision of Cattanach, J. in M.N.R. v. T R Merritt Estate is also helpful. At pages 5165-66 he said:

"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 were 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.

...

Finally, it may be noted that the existence of an arm's length relationship is excluded when one of the parties to the transaction under review has de facto control of the other. In this regard reference may be made to the decision of the Federal Court of appeal in Robson Leather Company v M.N.R., 77 DTC 5106."

[15] This approach was also adopted by Cullen, J. in the case of Peter Cundill & Associates Ltd. v. The Queen, [1991] 1 C.T.C. 197, where at page 203 he says this:

"Whether the parties in this case were dealing at arm's length is a question to be examined on its own particular facts."

[16] Many of these cases, as I say, are premised on the relationship existing between the parties which was determined to be all conclusive. There is little direct guidance there, when consideration is being given to the nature of the transaction or dealing itself. This question has, however, been quite succinctly dealt with by the Federal Court of Australia in the case of The Trustee for the Estate of the late AW Furse No 5 Will Trust v. FC of T, 91 ATC 4007/21 ATR 1123. Hill, J. said when dealing with similar legislation in that country :

"There are two issues, relevant to the present problem, to be determined under s.102AG(3). The first is whether the parties to the relevant agreement were dealing with each other at arm's length in relation to that agreement. The second is whether the amount of the relevant assessable income is greater than the amount referred to in the subsection as the "arm's length amount".

The first of the two issues is not to be decided solely by asking whether the parties to the relevant agreement were at arm's length to each other. The emphasis in the subsection is rather upon whether those parties, in relation to the agreement, dealt with each other at arm's length. The fact that the parties are themselves not at arm's length does not mean that they may not, in respect of a particular dealing, deal with each other at arm's length. This is not to say that the relationship between the parties is irrelevant to the issue to be determined under the subsection..." [emphasis added]

[17] Bowman, T.C.J. alluded to this type of situation in the R.M.M. case (above) when he said at page 311 :

"I do not think that in every case the mere fact that a relationship of principal and agent exists between persons means that they are not dealing at arm's length within the meaning of the Income Tax Act. Nor do I think that if one retains the services of someone to perform a particular task, and pays that person a fee for performing the service, it necessarily follows that in every case a non-arm's-length relationship is created. For example, a solicitor who represents a client in a transaction may well be that person's agent yet I should not have thought that it automatically followed that there was a non-arm's-length relationship between them.

The concept of non-arm's length has been evolving."

[18] In Scotland, in the case of Inland Revenue Commissioners v. Spencer-Nairn 1991 SLT 594 (ct. of Sessions) the Scottish Law Lords reviewed a case where the parties were in a non arm's length situation. They commented favourably on the approach taken by Whiteman on Capital Gains Tax (4th ed.), where it was suggested by the author that two matters that should be taken into account when considering the words 'arm's length'. These were whether or not there was separate or other professional representation open to each of the parties and secondly, perhaps with more relevance to the situation on hand, whether there was "a presence or absence of bona fide negotiation".

[19] In the United States the term "arm's length" was defined in the case of Campana Corporation v. Harrison (7 Circ; 1940) 114 F2d 400, 25 AFTR 648, as follows:

"A sale at arm's length connotes a sale between parties with adverse economic interests."

[20] I dealt with these cases in Campbell and M.N.R. (96-2467(UI) and (96-2468(UI)) and the principles for which they stand. I adopt all that I said in that case.

[21] At the end of the day it would seem to me that what is intended by the words "dealing at arm’s length" can best be described by way of an example. If one were to imagine two traders, strangers, in the market place negotiating with each other, the one for the best price he could get for his goods or services and the other for the most or best quality goods or service he could obtain, these persons one would say would be dealing with each other at arm's length. If however these same two persons, strangers, acted with an underlying interest to help one another, or in any manner in which he or she would not deal with a stranger, or if their interest were to put a transaction together which had form but not substance in order to jointly achieve a result, or obtain something from a third party, which could not otherwise be had in the open marketplace, then one would say that they were not dealing with each other at arm's length.

[22] If the relationship itself (and here it must again be remembered that the Act does not say "where they are in a non arm's length relationship" it says "where they are notdealing with each other at arm's length") is such that one party is in a substantial position of control, influence or power with respect to the other or they are in a relationship whereby they live or they conduct their business very closely, for instance if they were friends, relatives or business associates, without clear evidence to the contrary, the Court might well draw the inference that they were not dealing with each other at arm's length. That is not to say, however, that the parties may not rebut that inference. One must however, in my view, distinguish between the relationship and the dealing. Those who are in what might be termed a "non arm's length relationship" can surely deal with each other at arm's length in the appropriate circumstances just as those who are strangers, may in certain circumstances, collude the one with the other and thus not deal with each other at arm's length.

[23] Ultimately if there is any doubt as to the interpretation to be given to these words I can only rely on the words of Madam Justice Wilson who in the case of Abrahams v. A/G Canada [1983] 1 S.C.R. 2, at p. 10 said this:

"Since the overall purpose of the Act is to make benefits available to the unemployed, I would favour a liberal interpretation of the re-entitlement provisions. I think any doubt arising from the difficulties of the language should be resolved in favour of the claimant."

[24] In the end it comes down to those traders, strangers, in the marketplace. The question that should be asked is whether the same kind of independence of thought and purpose, the same kind of adverse economic interest and same kind of bona fide negotiating has permeated the dealings in question, as might be expected to be found in that marketplace situation. If on the whole of the evidence that is the type of dealing or transaction that has taken place then the Court can conclude that the dealing was at arm's length. If any of that was missing then the converse would apply.

Review of the evidence

[25] Clearly Petrucci controlled more than 40% of the voting shares of the Company up to March 8, 1994. Thus his employment up to that time was excepted employment and not insurable.

[26] When Berto went to work for the Company in June 1993, he was not a shareholder. His wife owned 50%. She had purchased her shares partly with money she had saved in a nest egg for herself and partly with money belonging to her and Berto jointly. Most of it she said was her own. She held a full-time job at a local biscuit factory and had her own money.

[27] As a general matter Berto agreed that his marriage was a traditional one but he said that on the whole he did what his wife told him to. He is not able to read and write English particularly well and relies upon his wife in this respect. Prior to may 1993 he had worked as a bricklayer for the Board of Education but that spring (1995) he was not called back. It was fortuitous perhaps that his wife had bought into the Company. He started work for the Company in June. He says he was paid an hourly wage of $18.00, just the same as the other employees. He went wherever Petrucci or Vicki directed him and he reported back in the evening as to what he had done during the day. He worked generally eight hours per day and was paid weekly by cheque. He was not a signatory on the bank account. The cheques were signed jointly by Petrucci and Vicki. The whole arrangement seemed perfectly normal in 1993 and the fact of Vicki owning 50% of the shares does not seem to have detracted from Berto being treated just like any other employee over this period of employment.

[28] In 1994 things changed with the modification in the share structure. Neither Berto nor Petrucci worked for an hourly wage. Instead each was given a set weekly salary, the exact amount of which the Court has been unable to establish as a number of inconsistent figures have been mentioned; nevertheless, it was in the region of $800.00. Their responsibilities included everything from actual bricklaying to supervising their crews. However, from time to time the Company was short of funds and they did not receive their weekly salaries.

[29] On another note, whilst they say that vacation pay was factored into their salaries, that is not apparent to the Court.

[30] It was noteworthy that although the Company was in a loss situation in 1994, they each received a bonus of $6,500.00.

[31] The two wives, who were said to be involved in the business decisions of the Company, i.e. all four of them making decisions together, have demonstrated little or no real involvement. The Court noted that Vicki had a full-time job elsewhere.

[32] The Court has no doubt that both Appellants were extremely hardworking individuals. However, they were quite clearly in control of themselves. There was no independent control function being exercised by the Company with respect to where they worked, how they worked or their terms of remuneration. They were not treated as other outside workers would have been. Indeed, Berto stressed that once he bacame a part owner his pay went down.

Conclusion

[33] With respect to the appeal of Nello Berto, I am well satisfied on the balance of probabilities, after considering all of the evidence, that his employment during 1993 was genuine employment and that he was dealing at arm's length with the Company throughout this period. There were diverse economic interests and the employment arrangement was the same as would have occurred in the open market. His appeal is allowed to this extent and the decision of the Minister varied accordingly.

[34] With respect to the appeals of both Appellants in relation to the years 1994 and 1995, I am not satisfied that they were dealing with the Company at arm's length. Whilst I would not go so far as counsel for the Minister who categorized the arrangement as a sham, I am not at all satisfied that the wives played any kind of role in the management of this Company. The two Appellants exercised unlimited control over their own employment arrangements. They acted in concert and clearly together they had no separate economic interests from the Company. They were in effect working for themselves.

[35] Both appeals in respect of the years 1994 and 1995 are dismissed and the decisions of the Minister confirmed.

Signed at Calgary, Alberta, this 9th day of June 1998

"Michael H. Porter"

D.J.T.C.C.