Wellington R Maclnnis v. Minister of National Revenue, [1984] CTC 2403

Sarchuk, TCJ:—The appeal of Mr Wellington R Maclnnis is from a reassessment by virtue of which the Minister of National Revenue included the sum of $58,775 in the appellant’s taxable income for the taxation year 1975. The issue is whether the said sum which the appellant received in 1975 from Crown Cork & Seal Ltd (Crown Cork) was an item of taxable income to him as assessed by the respondent or a capital payment received by him as part of the consideration for the sale of his shares in International Laboratories Ltd.

The appellant was the only witness called so that the facts relating to the transaction from which the issue arises must be ascertained, in so far as it is possible to do so, solely from his evidence and from the documents produced on his behalf.

For a number of years prior to 1972 the appellant had been employed by Sherwyn-Williams as general manager in charge of both manufacturing and sales. International Laboratories Ltd, a Winnipeg paint manufacturer, was at that time owned and operated by Sherwyn-Williams. In the latter part of 1971, aware of the fact that Sherwyn-Williams was prepared to sell its subsidiary, the appellant had a number of discussions with two Winnipeg businessmen, John A Schimnowski and Ernst Buhle, as a result of which they purchased International Laboratories Ltd. It was intended that the business continue to be carried on in a company to be incorporated as International Laboratories (1972) Ltd, (International).

The respective interests acquired by the partners were, Schimnowski - 35 per cent, Buhle - 35 per cent and the appellant - 22/2 per cent. The balance of 7/2 per cent was held by RoyNat Ltd as part of the financing arrangement. Buhle and Schimnowski each advanced $125,000 to International and gave personal guarantees to the Royal Bank for the same amount. The appellant was not required to contribute any capital, but he did give a personal guarantee to the Royal Bank in the sum of $125,000, and provided the bank with a life insurance policy for $75,000.

The appellant’s 22/2 per cent interest was agreed upon at a meeting involving the appellant, Messrs Buhle and Schimnowski and their respective financial advisors. This percentage was based on the appellant’s knowledge and expertise in the business and as consideration for his future services as president and general manager of International.

Although sales were good in 1972 and 1973, in fact increasing in the latter year, financial problems were being encountered. The plant needed refurbishing and modernization and notwithstanding increasing sales an inflationary trend was driving costs upward and profitability was being reduced. In 1974, Interna- tional suffered substantial losses. A conflict appears to have developed between the appellant and the two principal shareholders. Funds were required to enlarge the facilities to increase productivity, but the appellant’s partners were unwilling to contribute any additional capital.

This discord led to a suggestion by Buhle and Schimnowski that International should be sold. In October of 1974 the appellant (who personally was reluctant to sell) was instructed and authorized to find a purchaser. The appellant testified that he hoped to find a national company carrying on a similar business to act as purchaser so that the operation of International (and his future employment) would be continued. Eventually, Crown Cork showed interest provided that it could acquire all of the shares. It examined International’s plant and operations, its books and financial statements, concluded that its products and processes were compatible, and assured itself that RoyNat’s 7/2 per cent interest would be available.

On the evidence before me it would appear that all negotiations on behalf of International’s shareholders (excepting RoyNat) were conducted by the appellant. Following meetings between the appellant and the president and vice- president of Crown Cork, the shareholders of International received a written offer to purchase, dated November 29, 1974 (Exhibit A-2). The offer was for the purchase of the entire outstanding share capital of International by Crown Cork at a price of $1.00 per share and the purchase by Crown Cork of the outstanding debt due to shareholders J A Schimnowski and E Buhle for $250,000.

Concurrently, Crown Cork sent a personal letter to the appellant dated November 29, 1974, (Exhibit A-3) confirming its intention to continue his employment in the event Crown Cork acquired International, on the following terms:

In connection with our offer to purchase the outstanding shares of International Laboratories (1972) Ltd, it is our intention, if our offer is successful, to enter into an employment contract with you. This contract will provide for:—

1. A five-year term.

2. A salary of $30,000 annually commencing in 1975, with increases of 5 per cent each year thereafter for the term of the contract.

3. Participation in the profits of International Laboratories (1972) Ltd, according to the formula outlined in Schedule “A” attached. This is to establish the principle only; the actual figures will change, depending upon the final settlement with the shareholders of International Laboratories (1972) Ltd.

4. Payment by Crown to you of the difference between $310,000 and the final purchase price of both the share capital and loans due shareholders of International Laboratories (1972) Ltd, such payment to be not less than $25,000.

5. Participation in Crown’s group life, medical and pension plans.

Neither Buhle nor Schimnowski were aware of the existence of this letter or of the proposed arrangement between Crown Cork and the appellant.

The offer to purchase was discussed by the shareholders and was formally accepted on December 3, 1974 (Exhibit A-5).

On December 24, 1974, a contract was entered into between the shareholders (excluding RoyNat) and Crown Cork (Exhibit A-4). While some terms were amended prior to closing which took place in April 1975 in Toronto, Ontario, in all material respects the financial arrangements did not change. The purchase price for 92/2% of the shares of International (held by the appellant, Buhle and Schimnowski) remained at $251,000.

Upon closing Schimnowski and Buhle each received a cheque for $125,000 which amount was, as agreed, allocated as payment of the debt due to them under their shareholders’ loans. The remaining $1,000 (allocated to share purchase price) was distributed equally to Schimnowski, Buhle and the appellant.

The evidence is clear and unambiguous that the subject of the additional payment of $59,000 by Crown Cork to the appellant did not form part of the closing, was not discussed at any time during the closing and was not within the knowledge of Schimnowski or Buhle.

Mr Maclnnis received the $59,000 from Crown Cork some time after the closing in four instalments. The first payment of $10,000 was made on April 30, 1975, and was forwarded to the appellant’s home address together with a letter from Crown Cork marked “personal and confidential” (Exhibit R-l). The letter was clearly in response to a request for payment made by the appellant and stated that the payment was:

. . . an advance on account of the amount due you from Crown in connection with the purchase of International Laboratories (1972) Ltd. This is covered in paragraph 4 of our letter to you dated November 29, 1974.

It is not disputed that the appellant was never employed directly by Crown Cork or that he was not at any of the relevant times an officer or director of Crown Cork. It is also a fact that upon acquisition of International by Crown Cork the appellant contiuned to be employed by International as the president and general manager on essentially the terms outlined in the letter of November 29, 1974 (Exhibit A-3), including the salary, the pension and health benefits and the profit sharing arrangement. In 1977 when International was amalgamated with and became a division of Crown Cork, (subsequently to be dissolved in 1981) the appellant retained this position and as he stated, other than changing from a wholly owned subsidiary to a division of its parent, International continued to conduct its business in all respects in the same manner as before. His personal responsibility as a general manager was not altered or affected by the change.

The Appellant's Submissions

The appellant says that since he was never employed by Crown Cork, the payment received can not be considered to be income in any sense of the word and accordingly the respondent was wrong in including it in his taxable income. His position is that the $59,000 payment represented an inducement from Crown Cork to persuade him to sell his equity interest in International, a step that he, unlike the other shareholders, was reluctant to take. It was argued that in these circumstances the payment was a non-taxable receipt akin to a windfall or a voluntary payment. Counsel for the appellant cited The Queen v J E Cranswick, [1982] CTC 69; 82 DTC 6073, as authority.

In the alternative the appellant submitted that the payment represented consideration for the disposition of his capital property, ie a capital gain on the disposition of his shares, and that if taxable at all should be taxed on that basis. This position was supported, the appellant claimed, firstly by the fact that Crown Cork was prepared to pay a maximum $310,000 for International (as disclosed by Exhibit A-3) and the $59,000 paid to Mr Maclnnis represented nothing more than a portion of that capital payment, and secondly by the fact that Crown Cork purportedly treated the payment as a cost of capital acquisition and not as an employment expense.

It was argued that the respondent’s assumptions could not be supported by reference to paragraphs 6(3)(a) and 6(3)(b) of the Act. Counsel submitted that Exhibit A-3, the letter of November 29, 1974, did not of itself create any binding legal obligation and could only be read as an expression of the intention of the parties. The appellant did not accept an offer of a position of employment with Crown Cork but simply continued in his existing position with International.

It was emphasized that the appellant was not an employee of Crown Cork; there was no employment contract; the appellant was under no legal obligation to remain with International and there was no obligation or enforceable claim against Crown Cork to engage him or to pay any amount to him. Accordingly, the payment of the $59,000 could not be deemed to be remuneration for services rendered as contemplated by subsection 6(3) of the Act.

In further response to the respondent’s assumptions the appellant submitted that there was no evidence that the payment was a negotiation fee.

The Respondent’s Position

Counsel submitted that a major factor in the acquisition of International by Crown Cork was the continuation of the provision of services by the appellant. The $59,000 paid by Crown Cork to the appellant was remuneration for services to be performed by him for Crown Cork by remaining in the position of president and manager of their newly acquired subsidiary, International.

In the alternative counsel argued that the payment was remuneration for services performed by the appellant for Crown Cork in successfully negotiating the purchase and sale of International.

In either event the respondent submitted that the amount was properly included in computing the appellant’s income in accordance with sections 3 and 5(1) of the Income Tax Act.

Findings

On the evidence before me it is difficult to determine the nature of the payment made by Crown Cork to the appellant. It would have been of assistance to the Court if some evidence had been adduced, perhaps from the officers of Crown Cork who could have been subpoenaed, as to the object and purpose of the arrangements between it and the appellant. Crown Cork’s accounting records might have cast some light on whether the payment was made on account of shares or not. Unfortunately, although apparently available, such evidence was not presented to the Court.

Notwithstanding that, on the evidence before me I can readily find that the payment to the appellant was not a grant or voluntary payment or a payment in the nature of a windfall such as the payment considered by the court in The Queen v Cranswick, (supra). I also find that there is little evidence to support the respondent’s assumption that the $59,000 payment was a negotiating fee. How appellant’s efforts to bring the parties together were considered by Crown Cork and whether they were a factor in their ultimate arrangements with him is not known to the Court. There is no evidence upon which I could find that the appellant received all or part of the $59,000 as remuneration for negotiating the sale of International.

What remains for consideration is the appellant’s position that the payment was part of the sale price of his shares and was a capital receipt. The evidence on this issue is less than persuasive. The onus of proof is on the appellant to establish that the respondent’s assumption was wrong. This onus has not been met. The evidence does not satisfy me on a balance of probabilities that the payment was made for the reason suggested by the appellant. In fact it is far more proba- ble that the payment was made to retain the appellant’s services, albeit with International and not with Crown Cork. Several of the documents tendered by the appellant support this conclusion. Exhibit A-4, the purchase agreement dated December 24, 1974, provides that the purchase price payable was $251,000. It was the appellant’s evidence that $1,000 of that amount was allocated to the cost of the shares. Neither this document nor the offer to purchase (Exhibit A-3) which proposed specific terms and conditions of employment for the appellant following Crown Cork’s acquisition of International, when read in its entirety, satisfies me that the payment described in paragraph 4 thereof could only be intended to be remuneration for services. The appellant argued that the letter was merely an expression of intention and not a binding contract. This does not square with the fact that the letter from Crown Cork accompanying the first instalment specifically states that payment is being made pursuant to the terms contained in the November 29, 1974 letter. It is significant that following closing the appellant demanded payment as provided for in Exhibit A-3 and was paid. In my view the respondent’s position that the letter (Exhibit A-3) can only be construed as evidence of a firm and binding agreement between Crown Cork and the appellant is well founded.

At trial counsel for the appellant attempted to introduce two letters recently written by officers of Crown Cork as evidence of the treatment accorded the payment by Crown Cork. The letters were intended to establish, in part at least, Crown Cork’s purpose in making the payment. This evidence was clearly hearsay, its introduction was objected to by counsel for the respondent and the objection was sustained.

While a lingering suspicion may exist that perhaps not all of the $59,000 was paid to the appellant as consideration to him for remaining as the general manager of Crown Cork’s subsidiary the evidence before me does not permit me to find, on a balance of probabilities that the payment was made by Crown Cork as part of the price paid for the appellant’s shares. I find that the payment was made by Crown Cork to retain the services of the appellant for International and this in my view, constitutes payment for services to be rendered by the appellant and was income within the meaning of section 3 of the Income Tax Act.

The appeal is dismissed.

Appeal dismissed.