Highland Roofing Ltd. v. M.N.R., docket 97-1987-UI

Date: 19981016

Docket: 97-1987-UI

BETWEEN:

HIGHLAND ROOFING LTD.,

Appellant,

and

THE MINISTER OF NATIONAL REVENUE,

Respondent.

Reasons for Judgment

Brulé, J.T.C.C.

[1] This appeal arises from a decision by the Minister of National Revenue (the "Minister") dated August 25, 1997, that Steven Wentland was engaged in insurable employment with the Appellant during the period from October 7, 1995 to October 7, 1996, for the purposes of the Unemployment Insurance Act (the "UI Act") and the Employment Insurance Act (the "EI Act").

Facts

[2] The Appellant is a corporation incorporated under the laws of British Columbia on August 9, 1989 under the name 370676 B.C. Ltd. The Appellant's name was later changed to Highland Roofing Ltd. on October 17, 1989. The Appellant's authorized share capital consists of 10,000 common voting shares, 100 of which were issued during the period in question. Fifty of these issued shares were transferred to Lorna Holdings Limited ("Lorna") on October 15, 1992. Subsequently, on January 12, 1994, Larry Beber acquired five common voting shares of the Appellant. Hence, the share structure at that time was as follows:

Lorna Holdings Ltd. 50 shares 50%

Larry Beber ("Beber") 30 shares 30%

Steven Wentland ("Wentland") 20 shares 20%

Total 100 shares 100%

[3] According to the annual report on August 9, 1994, the directors of the Appellant were Beber and Wentland.

[4] Lorna was incorporated on September 21, 1992. The Register of shareholders indicates that Beber and Wentland each owned 50% of the shares of Lorna. The document is undated and it is impossible to determine the year to which it is applicable. However, a Share Purchase Agreement dated October 3, 1996 indicates that Wentland sold 10 shares in Lorna to Beber. This is the same number of shares referred to in the Register of Members so presumably, the share distribution was not altered prior to this date. In the September 21, 1996 Annual Report, it is stated that Beber and Wentland were directors of Lorna, with Beber acting as President and Wentland as Secretary.

[5] This remained the situation until October of 1996, at which time the Share Purchase Agreement, previously mentioned, was entered by the parties. The Share Purchase Agreement effectively transferred all of Wentland's shares in both the Appellant and Lorna to Beber. Further, Wentland agreed to resign his directorship and office in both companies. This was effected in letters of resignation dated October 3, 1996.

[6] It was submitted by the Respondent that Wentland was employed in insurable employment with the Appellant during the period from October 7, 1995 to October 7, 1996. The Appellant is in the business of residential roofing. Wentland was a foreman of the roofing crew employed by the Appellant. It is submitted that he worked under a contract of service in which he worked approximately 40 hours per week at an hourly rate of $17.00 paid weekly.

[7] The Appellant submits that Wentland was a shareholder in control of the corporation and he therefore was non-arm's length with the Appellant. Evidence was raised at trial indicating that Wentland had a drinking problem and that his employment would have been terminated, had he not been in control of the Appellant. Larry Beber Jr. testified that he had been employed by the Appellant for 12 years and that he considered Wentland to be the owner and boss of the Appellant during the period in question.

Issues

[8] The following are the issues to be determined by the Court.

1. Was Wentland engaged in insurable employment with the Appellant pursuant to paragraph 3(1)(a) of the UI Act and paragraph 5(1)(a) of the EI Act?

2. Did Wentland control more than 40% of the shares of the Appellant and is therefore exempt from insurable employment pursuant to paragraph 5(2)(b) of the EI Act?

3. In the alternative, did Wentland deal with the Appellant at non-arm's length, such that he would be exempt from insurable employment pursuant to paragraph 5(2)(i) of the EI Act?

Analysis

[9] This appeal has arisen under the following provisions of the EI Act. (It should be noted that the UI Act was repealed and replaced with the EI Act on June 30, 1996. Hence, both Acts are applicable to the present appeal. However, the provisions of both Acts are identical in substance, so for ease of reference I have limited my analysis to the provisions in the EI Act.)

"5.(1) Subject to subsection (2), insurable employment is

(a) employment in Canada by one or more employers, under any express or implied contract of service or apprenticeship, written or oral, whether the earnings of the employed person are received from the employer or some other person and whether the earnings are calculated by time or by the piece, or partly by time and partly by the piece, or otherwise;

...

5.(2) Insurable employment does not include

...

(b) the employment of a person by a corporation if the person controls more than 40% of the voting shares of the corporation;

(i) employment if the employer and employee are not dealing with each other at arm's length.

5.(3) For the purposes of paragraph (2)(i)

(a) the question of whether persons are not dealing with each other at arm's length shall be determined in accordance with the Income Tax Act; and

(b) if the employer is, within the meaning of that Act, related to the employee, they are deemed to deal with each other at arm's length if the Minister of National Revenue is satisfied that, having regard to all the circumstances of the employment, including the remuneration paid, the terms and conditions, the duration and the nature and importance of the work performed, it is reasonable to conclude that they would have entered into a substantially similar contract of employment if they had been dealing with each other at arm's length."

[10] Subsection 5(2) of the EI Act exempts individuals from insurable employment in various circumstances. In particular, an individual who controls more than 40% of the shares of the employer will not be considered to be engaged in insurable employment. Likewise, an individual who does not deal with his employer at arm's length wil fall within the exception of 5(2) and there will be no insurable employment.

[11] According to the evidence adduced at trial, Wentland directly controlled 20% of the voting shares of the Appellant during the period in question. It was submitted by counsel for the Appellant that Wentland also indirectly controlled another 25% of the shares. This indirect control, it was argued, resulted from Wentland's shareholding in Lorna. According to the Share Purchase Agreement, Lorna owned 50% of the Appellant's issued shares and Wentland owned 50% of Lorna. Consequently, it was argued by counsel for the Appellant that Wentland's ownership of 50% of Lorna gave him indirect control of 25% of the Appellant. If this argument is accepted then one must conclude that Wentland was not employed in insurable employment pursuant to paragraph 5(2)(b), as he controlled more than 40% of the Appellant.

[12] However, the Court is reluctant to accept this argument. Wentland only owned 50% of the shares in Lorna. Hence, he was not in a majority position and therefore, could not single-handedly determine how the company would vote the shares it held in the Appellant. In other words, Wentland lacked de jure control. Consequently, it would be erroneous to conclude that Wentland indirectly controlled 25% of the Appellant by virtue of his shareholdings in Lorna. Given this fact, the Court must conclude that the Appellant only controlled 20% of the shares of the Appellant and therefore does not fall within paragraph 5(2)(b) of the EI Act.

[13] Paragraph 5(2)(i) of the EI Act states that insurable employment does not include employment between an employer and an employee not dealing with each other at arm's length. According to paragraph 5(3)(a) of the EI Act, arm's length relationships should be examined in accordance with the provisions of the Income Tax Act (the "Act"). The sections relevant to an arm's length analysis read as follows:

"251. Arm's length

(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.

(2) Definition of "related persons" For the purpose of this Act, "related persons", or persons related to each other, are

(a) individuals connected by blood relationship, marriage or adoption;

(b) a corporation and

(i) a person who controls the corporation, if it is controlled by one person,

(ii) a person who is a member of a related group that controls the corporation, or

(iii) any person related to a person described in subparagraph (i) or (ii); and

(4) Definitions concerning groups. In this Act,

"related group" means a group of persons each member of which is related to every other member of the group;

"unrelated group" means a group of persons that is not a related group."

[14] The definition of arm's length in subsection 251(1) of the Act states that related parties shall be deemed not to be at arm's length and that it is a question of fact whether non—related individuals deal with each other at arm's length.

[15] "Related persons" is defined in subsection 251(2). More specifically, paragraph 251(2)(b) defines related persons in reference to corporations. It basically provides that a corporation is related to an individual if that individual controls the corporation, is a person who is a member of a related group that controls the corporation or is an individual who is related to such a person.

[16] According to subparagraph 251(2)(b)((i), in order for the Court to conclude that Wentland dealt at arm's length with the Appellant, it must have been shown that only one person controlled the company and that Wentland was that individual. This seems unlikely on the facts.

[17] According to Duha Printers (Western) Ltd. v. The Queen, 98 DTC 6334 (S.C.C.), it is a well-recognized principle that references to "control" under the Act mean de jure control. The test of de jure control was established in Buckerfield's Ltd. v. Minister of National Revenue [1964] C.T.C. 504 (Ex. Ct.) and has since been accepted as the correct definition (M.N.R. v. Dworkin Furs (Pembroke) Ltd. et al., [1967] S.C.R. 223). De jure control exists when a shareholder, by virtue of his or her shareholdings, has the ability to elect a majority of the board of directors of a corporation. As was previously stated, Wentland only had control of 20% of the voting shares of the Appellant. His holdings in Lorna were insufficient for him to elect a majority to the Board of Directors of Lorna and therefore, he would not have been able to control how the shares in the Appellant were voted by Lorna. Hence, he did not have sufficient shares in the Appellant to elect a majority of the board of directors of the company. Consequently, the Court concludes that Wentland did not have de jure control of the Appellant and therefore was at arm's length with it.

[18] Nor can it be said that Wentland and the Appellant are related and therefore non-arm's length by virtue of subparagraph 251(2)(b)(ii). That provision states that an individual who is a member of a related group that controls the corporation is related to said corporation. Subsection 251(4) defines a related group as two or more individuals who are related to each other. There is no evidence to indicate that Wentland and Beber are related and therefore they do not constitute a related group who controls the Appellant.

[19] Paragraph 251(1)(b) states that it is a question of fact whether non-related individuals deal with each other at arm's length. When examining this issue the Court has in mind three tests cited with approval by the Federal Court of Appeal in Peter Cundill & Associates Ltd. v. Canada [1991] 2 C.T.C. 221 (F.C.A.). At page 223, Mahoney, J.A. States:

"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 the transaction,

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

(c) "de facto" control.

...

It was accepted on appeal that IT-419 correctly and fully defined the factors determinative of whether or not dealings are at arm's length."

[20] According to McNichol et al. v. The Queen, 97 DTC 111 (T.C.C.), the common mind test referred to above was derived from two cases: M.N.R. v. Sheldon's Engineering Ltd., 55 DTC 1110 (S.C.C.) and M.N.R. v. Merritt Estate, 69 DTC 5159 (Ex. Ct.). These cases basically stated that where the same mind that directs the negotiations or bargaining for one party is the same mind that controls negotiations for the other party, then the Court must conclude that there is a common mind and that the parties do not deal with each other at arm's length.

[21] The bargaining which the Court must examine in the present case is the employment contract between Wentland and the Appellant. On the facts it seems unlikely that there was a common mind. Wentland was not the sole or majority shareholder of the Appellant. Beber owned 10% more of the stock and therefore was in a greater position to influence the direction of the Appellant. Although Wentland may have had some influence over corporate decisions, the Court thinks it unlikely that one can go so far as to state that he was the sole individual making such decisions and therefore a common mind existed when his employment contract was negotiated, if in fact a formal contract existed or an oral contract negotiated.

[22] The "acting in concert" test enunciated in Swiss Bank Corporation et al. v. M.N.R., 71 DTC 5235, affirmed 72 DTC 6470 (F.C.A.) states that when two or more parties act with a common interest to dictate the actions of another, then it cannot be said that the parties deal at arm's length. It is unlikely that the Appellant has common interests with Wentland. As previously stated, Beber would influence the interests of the Appellant as majority shareholder. On the evidence, Wentland was an ineffective employee who had a drinking problem. The Appellant, as a corporation, was probably concerned with maximizing profitability and share prices. Wentland's actions indicate that he did not share this interest with the company. Hence, the Court believes that one can fairly conclude that the Parties, the Appellant and Wentland, did not act in concert and therefore were at arm's length.

[23] The final indicator of a non-arm's length relationship was de facto control of the Appellant. De facto control is premised on the notion that control can exist beyond mere legal control as reflected in the corporation's share register. Hence, it is incumbent upon the Court to examine the relationship between Wentland and the Appellant to determine if he had influence over the affairs of the Appellant.

[24] Factors indicating de facto control were discussed in Multiview Inc. v. The Queen, 97 DTC 1489, in which the Court stated that the guidelines outlined in IT Bulletin 64R3 were useful to the analysis. Hence, the Court considered the percentage ownership of voting shares in relation to other shareholders, the ownership of corporate debts, shareholders' agreements, commercial contracts, the possession of unique expertise required by the corporation, and potential influence of family members on the operation of the business.

[25] The existence of de facto control on the part of Wentland is a question of fact based on the evidence adduced at trial. Evidence indicated that the employees of the Appellant viewed Wentland as the owner and boss of the Appellant. Further, his experience in the roofing business would have made him extremely valuable to the business. However, these facts do not decisively indicate de facto control of the Appellant. Wentland's skills were not unique and could have been replaced. Further, being viewed as the boss merely indicates a supervisory role, as foreman, not the directing mind of a corporation. Consequently, the Court does not believe that this evidence is sufficient to find that Wentland had de facto control of the Appellant.

[26] Finally, the Court should ask whether Wentland would have entered into a substantially similar employment contract with a third party. In Bellehumeur v. M.N.R. [1994] T.C.J. No. 700 (T.C.C.), Watson, J. stated that an individual can be an employee of a corporation to which he or she is also a shareholder or director. He then stated that it must be established on a balance of probabilities that a subordinate relationship existed between the employee and the employer. He indicated that such subordination may be indicated where one can affirmatively state that both parties would have entered into a similar contract with other individuals.

[27] Wentland was engaged as a foreman of a roofing crew. As such, he normally worked 40 hours per week and was paid an hourly rate of $17 which was paid on a weekly basis. None of the evidence indicated that his functions for the Appellant extended beyond this supervisory position. The belief that he was the "boss" by other employees was natural given Wentland's position as a supervising foreman. Further, the work was not unreasonable for the position and undoubtedly would have been offered to third parties. The Appellant submitted that Wentland suffered from a drinking problem and that he would have been fired due to poor work had he not been an owner of the company. This evidence is difficult to reconcile with the foregoing, but the Court is inclined to believe that Beber would not have allowed him to continue in this position if it negatively effected the company. Consequently, the Court must conclude that Wentland dealt with the Appellant on an arm's length basis and therefore does not fall within the exception outlined in paragraph 5(2)(i) of the EI Act.

[28] Wentland did not have sufficient control of the Appellant nor dealt with the Appellant in a non-arm's length manner such that he would be excluded from insurable employment under subsection 5(2) of the EI Act. Hence, Wentland was not engaged in insurable employment for the purposes of the EI Act and the UI Act.

[29] Accordingly, the appeal is allowed and the decision of the Minister is vacated.

Signed at Ottawa, Canada, this 16th day of October 1998.

"J.A. Brulé"

J.T.C.C.