Bates v. M.N.R., docket 97-485-UI

Date: 19980609

Docket: 97-485-UI

BETWEEN:

BETTY BATES,

Appellant,

and

THE MINISTER OF NATIONAL REVENUE,

Respondent,

and

C.S.I. CAULKING SERVICES INC.,

Intervener.

Reasons for Judgment

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

[1]This appeal was heard at Winnipeg, Manitoba, on March 17, 1998.

[2]The Appellant, supported by the Intervenor (the Company) appeals the determination of the Minister of National Revenue (the "Minister") dated November 5, 1996 that her employment with the Company from January 6, to May 25, 1994 and from July 28, to December 13, 1995 was not insurable employment under the Unemployment Insurance Act (hereinafter referred to as the "Act”). The reason given for the determination was that:

“...You were not employed under a contract of sevice, and therefore, you were not an employee.

Notwithstanding the fact that you were not engaged under a contract of service, it has been found that you and CSI Caulking Sevices Inc. were not dealing with each other at arm`s length. The Minister is not satisfied that a substantially similar contract of employment would have been entered into if you and CSI Caulking Services Inc. had been dealing with each other at arm’s length.”

[3]The established facts reveal that at the material times the outstanding issued shares of the Company were owned 50% by Steve Bates, the husband of the Appellant, and 50% by one Albert Hrushka, an unrelated person. These two persons were the sole directors and President and Secretary of the Company respectively.

[4]Whilst the Appellant and her husband are related persons within the meaning of the Act, counsel for the Minister conceded that she is not a related person to the Company.

[5]The issues are clouded somewhat by the existence of a letter sent to the Company by Employment and Immigration Canada on October 31, 1990, informing the Company that the employment of Betty Bates from September 19, 1988 to September 19, 1990 was insurable because she was employed under a contract of service.

[6]At the conclusion of the evidence, counsel for the Minister conceded that Betty Bates was indeed employed under a contract of service during the periods in question. The sole issue thus remaining is whether or not the parties, that is the Company and the Appellant, were dealing with each other at arm's length. This issue however is further clouded by the unfortunate wording of the determination expressed by the Minister that he was not satisfied that they would have entered into a substantially similar contract of employment if they had in fact been dealing with each other at arm's length. This being the same wording as is found in subparagraph 3(2)(c)(ii) of the Act relating to the exemption applicable in certain circumstances to related persons, presupposes that the Minister thought the Company and the Appellant were related persons when in fact they were not as has been conceded by counsel.

[7]The issue to be decided by this Court is whether or not the Company and the Appellant were in fact dealing with each other at arm's length at the material times. If they were the employment is insurable and subject to meeting the other criteria the Appellant would be entitled to claim unemployment insurance benefits. If they were not, the employment is excepted employment under paragraph 3(2)(c) of the Act, that is to say it is not employment that carries the right to unemployment insurance benefits upon termination.

The Law

[8] 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.

[9] 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;...”

[10] 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)

[11] 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.

[12] 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.

[13] 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.).

[14] 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".

[15] 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.

[16] 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."

[17] 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."

[18] 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]

[19] 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."

[20] 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".

[21] 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."

[22] 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.

[23] 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.

[24] 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.

[25] 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."

[26] 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.

The Facts

[27]Steve Bates and Albert Hrushka each owned one half of the issued shares in the Company at the material times. The Company carried on a caulking business, that is to say they applied various compounds to buildings basements and roofs to prevent leaks. The Company was incorporated in 1984. Steve Bates basically looked after sales, going out to promote the business on a daily basis and to secure contracts. He also tended to the general administration of the Company. The office of the Company was in a separate room in his residence. Albert Hrushka took little part in the administration but rather attended to the actual work of the company overseeing the workers and the like.

[28]In both years in question the sales of the Company varied from month to month but overall annually produced gross revenues of approximately $150,000.00. The business was a seasonal one, the busy time being from approximately May to September.

[29]The Appellant, generally over the years, ran the office of the Company, taking phone calls, doing accounts and payroll, preparing reports and proposals and paying the bills. It was apparent from the evidence that she was often engaged by the Company throughout the busy season.

[30]In 1994, because there had been a downturn in business (although I note no figures were produced to confirm this) the Company decided to move into a new area of business, namely metal buildings. These had not formed part of their enterprise before. The Appellant was engaged, she said, to drive around Winnipeg and find metal buildings and ascertain their ownership or management. It is not at all clear to the Court why she was engaged to do this work when Steve Bates himself was available, it not being the busy season. In any event that is what they say happened. At the end of 20 weeks, for which she was paid bi-weekly, her work was terminated. This was at the commencement of the busy period, when her work in the office was said previously to be just about indispensable. She was laid off, Steve Bates said, because they had a big overdraft with no revenue coming in and thus the Company could not afford to keep her on. It was the Appellant or some other workers who had to be laid off and the Company needed to do the work to survive. They said her work was generally allowed to pile up, although she continued to do the payroll on a voluntary basis. She said this involved fifteen minutes per month. It is noteworthy that her period of employment was exactly 20 weeks, the minimum required to be eligible for unemployment insurance benefits. It is also of note that the termination slip showed a lack of work as the reason for the layoff whereas in fact the evidence showed it was a lack of funds.

In 1995, the Appellant did not start work until July 28 and finished on December 13. Again it is noteworthy that this was exactly 20 weeks. She says she resumed her normal duties during this time and caught up on the previous year`s accounting work.

[31]It is further noteworthy that Pauline Hrushka, the wife of Albert Hrushka, was hired by the Company for the exact same 20-week period. Her duties were said to working out in the field. She herself did not testify.

Conclusion

[32]Counsel for the Minister says the fact that two years in a row the Appellant worked for exactly 20 weeks and further in the second year (1995) both wives were engaged for exactly the same 20-week period, shows that there was not an arm's length dealing between the Appellant and the Company. Counsel for the Appellant submits that this does not necessarily follow. He submits that the Appellant is entitled to arrange her affairs as she wishes and if these happen to coincide with the unemployment insurance requirement provisions that does not necessarily mean at all that the dealings are not made at arm's length. The Company contracted for her services for the period of time that it needed them and could afford them. She contracted for a certain period of employment. Different minds, he says, are being applied to each side of the equation.

[33]I am of the view that it is beyond the bounds of coincidence that the periods of employment in question were 20 weeks, the minimum required to obtain benefits. It is also beyond the bounds of coincidence that the two wives were hired in 1995 for the same minimum 20-week period. The whole arrangement smacks of a certain element of collusion between the players, that is the directors of the Company and their wives to arrange their affairs so that unemployment insurance benefits could be claimed.

[34]I have the gravest doubts that the employment from January to May 1994 was really arranged for the benefit of the Company. Steve Bates himself could have done this work. It was not the busy season. His work normally entailed going out and finding the business. The Company, it seems, was in a financial fix, although accounts and figures have not been produced. The arrangement it seems to me was not a genuine one, in the sense that it was an arrangement concocted to obtain unemployment insurance benefits rather than to attend to the needs of the Company. Successful as it was, it was followed again the next year with respect to both wives.

[35]The perception of collusion is such that I cannot say that the Minister was wrong to conclude that this was not an arm's length dealing. On balance I agree with his conclusion. Undoubtedly over the previous years Betty Bates genuinely worked for the Company. The facts in previous years may well have been quite different to those presented to me with respect to 1994 and 1995. I cast no aspersions upon her good character in this respect. However her dealings for these two years with the Company were not in my opinion at arm's length.

[36]The appeal is accordingly dismissed and the decision of the Minister confirmed.

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

"Michael H. Porter"

D.J.T.C.C.