Marcel Laperriére v. Minister of National Revenue, [1984] CTC 2829

Tremblay, TCJ [TRANSLATION]:—This case was heard in Montréal, Quebec on November 16 and 17, 1983.

l. Issue

According to the appeal submissions, the issue is whether in computing his income for 1980 the appellant, an engineer employed at the time at Laboratoire Ferex Inc, was correct in including only $60,000 in income instead of $120,000 which, according to the appellant, was received as damages. This amount was received from a former co-contractor of X-Per-X Ltée as a result of a lawsuit filed in Superior Court for breach of contract. The appellant further claimed that he was entitled to use the said $60,000 to purchase an income-averaging annuity contract to partially defer the payment of tax on this amount, which is taxable.

The respondent argued that the $120,000 was part of a total of $337,951 paid by the co-contractor. No part of this latter sum was on account of damages since, according to the respondent, the contracts entered into between the parties had been scrupulously observed. The $120,000 was thus a salary, wages or other remuneration from an office of employment paid to the appellant.

2. Burden of Proof

2.01 The appellant has the burden of showing that the respondent’s assessment is incorrect. This burden of proof results not from a particular section of the Income Tax Act, but from several judicial decisions, including a judgment of the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1181.

2.02 The facts presumed by the respondent are set out in subparagraphs (a) through (m) of paragraph 8 of the respondent’s reply to the notice of appeal. This paragraph reads as follows:

8. In assessing the appellant for the 1980 taxation year, the Minister of National Revenue relied, inter alia, on the following facts:

(a) the appellant was an engineer and during the taxation year in question was employed by Laboratoire Ferex Inc; (admitted)

(b) on October 3, 1969, the appellant signed a ten-year contract of employment with X-Per-X Ltée, beginning on October 20, 1969; (admitted)

(c) X-Per-X Ltée was represented in the contract by its president and chief shareholder, Mr Jean-Paul Valade; (admitted)

(d) the said contract provided, inter alia, that the appellant would receive an annual salary of $16,000 and that either party could unilaterally terminate the contract by giving six months’ notice in writing;

(e) on October 9, 1969 the appellant entered into a second agreement with Mr Jean-Paul Valade and the Société d’administration et de fiducie, whereby he purchased from Mr Jean-Paul Valade fourteen common shares of X-Per-X Ltée capital stock at $4,500 per share; the agreement also gave the appellant an option on three other X-Per-X Ltée shares, which he exercised, with the result that during the relevant period he held seventeen shares of X-Per-X Ltée out of a total issue of forty shares; (admitted)

(f) the agreement also provided that if the appellant quit or was dismissed the vendor, Mr Valade, had the option of repurchasing his shares within thirty days at 80 per cent of their purchase price;

(g) at the annual board of directors’ meeting, the appellant and Mr Valade were accustomed to vote themselves a bonus and dividends on the basis of their respective holdings, which they would receive in two equal payments during the following year;

(h) on March 19, 1979, the appellant was notified by X-Per-X Ltée that his contract,

which expired on October 20, 1979, would not be renewed; (admitted)

(i) the appellant then received salary cheques for the next seven months and a vacation cheque equalling 6 per cent of his annual salary, all in accordance with his contract of employment;

(j) the appellant then filed suit against X-Per-X Ltée and its principal shareholder, Mr Jean-Paul Valade; the parties settled their differences out of court on or about November 16, 1979 for a total of $337,951; (admitted)

(k) The said $337,951 was divided as follows:

* $77,701	— Purchase by Mr Valade of the appellant’s X-Per-X Ltée
	shares
*$106,250	— Bonus voted in December 1978 and receivable in 1979
* $34,000	— Dividends voted in 1978 and receivable in 1979
*$120,000	— Amount payable in two $60,000 instalments on March 15
	and June 15, 1980
(admitted)

(1) no part of the $337,951 paid to the appellant was on account of damages since the contracts between the parties had been scrupulously respected;

(m) $120,000 was paid to the appellant during the 1980 taxation year and was on account of a salary, wage or other remuneration from his employment by X-Per-X Ltée;

At the beginning of the hearing, the appellant admitted certain presumed facts; such admissions are noted alongside each paragraph admitted.

3. Facts

3.01 On examination-in-chief, the appellant stated the following.

(a) He graduated from McGill University in 1956 with a degree in engineering. He was twenty-four years old. In 1969, he was earning between $22,000 and $24,000 per year.

(b) In September 1969, he made the acquaintance of Mr Jean-Paul Valade, a professional engineer with shares in various companies, including Laboratoire Ferex Inc, X-Per-X Ltée and Bori & Landry Inc. They were compatible and complemented each other, and entered into an oral agreement to go into business together. The appellant’s chief duty was to monitor the quality of the metals used in engineering projects (bridges, dams, pipelines and so forth) to ascertain whether the said materials conformed to the contract specifications. This metal inspection was performed by x-ray or by other methods.

(c) In furtherance of this agreement the first contract, dated October 3, 1969, was entered into between X-Per-X Ltée and the appellant. The latter became the exclusive employee of X-Per-X Ltée (Exhibit A-l) at a salary of $16,000 per year (clause 3) for a ten-year period, renewable for an additional ten years unless one of the parties wished to terminate the contract (clause 9). In this contract, it is also stated that Mr Jean-Paul Valade, president and general manager, would receive a salary of $30,000 (clause 3).

Otherwise either party could terminate the contract at his sole discretion at any time on six months’ notice (clause 10).

(d) The preamble to contract A-l reads as follows:

Whereas the employer is a corporation specialized in managing, undertaking, inspecting and completing major engineering projects, its services are in international demand and it seeks to employ competent and qualified engineers;

Whereas the employee is an engineer and wishes to offer his professional services exclusively to the party of the first part;

(e) On October 9, 1969, an agreement was entered into (Exhibit A-2) between Jean- Paul Valade and Marcel Laperrière whereby the latter purchased fourteen X-Per-X Ltée common shares from Mr Valade for $63,000, payable without interest at $6,300 per year. Paragraph 5 of Exhibit A-2 reads as follows:

should the purchaser leave his employment or be dismissed by X-Per-X Ltée, the seller at his sole option will have the right to repurchase from the purchaser within thirty days all the shares acquired and held by the purchaser at the same price that the latter originally paid for them, except that the shares acquired as dividends or bonuses from the company may be repurchased by the vendor within the same period of time for 80 per cent of the purchase price paid by the purchaser;

Clause 6 also provides for the sale of three other shares to the appellant. The latter purchased them for $14,700.

Paragraphs 10 to 13 of Exhibit A-2 include a sale-purchase clause in the event one shareholder should die before the other and also make provision for insurance premiums and a call price of $5,000 per share.

(g) Before entering into contract A-2, Mr Valade held thirty-eight shares of X-Per-X Ltée, his wife Réjeanne Martineau-Valade had one share and his brother Jacques Valade had one.

After contract A-2 was signed, the breakdown of shares was as follows:

Mr Valade	18
his wife	l
his brother	1
the appellant	17
Jacques Trouvé	3

The plan was to reach a fifty-fifty split between the two groups. As it happened, however, Mr Valade purchased Mr Trouvé’s three shares.

(h) In 1973 the appellant formed a company, Les Placements Cardino Ltée, to hold the X-Per-X Ltée shares.

(i) Relations between Mr Valade and the appellant were good until fall 1978. At work the appellant was treated as a partner and the two men behaved as equals: all administrative decisions were discussed in common; since the cheques required only one signa- paid to the appellant ($16,000) and Mr Valade ($30,000) did not affect the making of decisions. For tax reasons, the company always paid more bonus than dividend. As long as the partners were getting along, decisions were always made jointly.

(c) At the end of 1978 the net profit was more than $550,000 before the bonus was paid. There was almost no need to keep any cash in the company since there were hardly any tangible assets, which explains why such a large amount was distributed to the shareholders.

(d) The witness attempted to bring about a reconciliation after he saw how Mr Va- lade’s desire to retire from business in 1978 was followed by what Mr Valade considered an unattractive offer by the appellant to purchase the business and their subsequent falling out followed by Mr Valade’s notices (A-4 to A-5) to the appellant. He regarded this separation as a “terrible disaster’’. The two men had made net profits of over $550,000 in 1978. Their disagreement was killing the goose that laid the golden eggs.

(e) After the lawsuit had been filed, he did not take part in the negotiations which resulted in agreements A-6 and A-7.

(f) According to a statement prepared and filed as Exhibit A-8, in fall 1978 he evaluated the standard net profit of X-Per-X Ltée at $276,700. On the basis of the preceding three years (1975, 1976 and 1977), he had arrived at a standard net profit of $276,700 (ie, after deducting $75,000 for each man’s salary and the 50 per cent corporate income tax). The average net profit (ie on-third for each of the three years) was $92,000.

He set the value of the shares at that time at $375,000, or the book value ($144,800) plus goodwill (ie, an average of two and three times the average standard net profit ($184,400 and $276,700). The average value per share was $9,375.

They would have used these figures rather than those of the 1978 financial statements, and the fact that the appellant held approximately 40 per cent of the shares (17 out of 40), to establish the amount of $120,000.

(g) The company could have paid $400,000 in bonuses for the 1978 taxation year, but actually paid only $250,000.

4. Act — Case Law — Analysis

4.01 Act

The provisions of the Income Tax Act on which the parties in this case chiefly relied are 5(1), 6(3), 38, 39, 54(c)(ii)(A) and (B) and 61. These provisions will be cited as needed in the analysis.

4.02 Case law

Counsel for the parties referred to the following precedents:

1. The Queen v Robert B Atkins, [1975] CTC 377; 75 DTC 5263;

2. Rendell W Beck v MNR, [1980] CTC 2851; 80 DTC 1747;

3. Jack Cewe Ltd v G W Jorgenson, [1980] CTC 314; 80 DTC 6233;

4. Raymond Brackstone v The Queen, [1980] CTC 89; 80 DTC 6060;

5. Paul Girouard v The Queen, [1980] CTC 284; 80 DTC 6151;

6. RCA Limited v Abbey Cohen, [1978] CA (RJQ) 212;

7. Georges Marcotte v Assomption compagnie Mutuelle d’Assurance-Vie, [1981] CS (RJQ) 1102;

8. Jean Lecompte v Steinberg’s Limited, [1981] CS (RJQ) 211.

4.03 Analysis

4.03.1 The respondent based his reassessment on subsections 5(1) and 6(3) and argued that the $120,000 was a salary or other remuneration. These provisions read as follows:

Section 5. Income from office or employment:

(1) Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by him in the year.

6. (3) Payments by employer to employee:

An amount received by one person from another

(a) during a period while the payee was an officer of, or in the employment of, the payer, or

(b) on account of or in lieu of payment of, or in satisfaction of, an obligation arising out of an agreement made by the payer with the payee immediately prior to, during or immediately after a period that the payee was an officer of, or in the employment of, the payer,

shall be deemed, for the purposes of section 5, to be remuneration for the payee’s services rendered as an officer or during the period of employment, unless it is established that, irrespective of when the agreement, if any, under which the amount was received was made or the form or legal effect thereof, it cannot reasonably be regarded as having been received

(c) as consideration or partial consideration for accepting the office or entering into the contract of employment,

(d) as remuneration or partial remuneration for services as an officer or under the contract of employment, or

(e) in consideration or partial consideration for a covenant with reference to what the officer or employee is, or is not, to do before or after the termination of the employment.

The appellant claimed that the $120,000 is compensation received for a breach of contract, or alternatively, as the result of a disposition of property within the meaning of 38(a) and 54(c)(ii)(A) and (B). These provisions read as follows:

38 For the purposes of this Act,

(a) a taxpayer’s capital gain for a taxation year from the disposition of any property

is /i of his capital gain for the year from the disposition of that property;

54. In this subdivision,

(c) “disposition” of any property, except as expressly otherwise provided, includes

(ii) any transaction or event by which

(A) any property of a taxpayer that is a share, bond, debenture, note, certificate, mortgage, hypothec, agreement of sale or similar property, or an interest therein, is redeemed in whole or in part or is cancelled,

(B) any debt owing to a taxpayer or any other right of a taxpayer to receive an amount is settled or cancelled,

4.03.2 What does the evidence reveal about the nature of the $120,000 which the appellant received? The source of this sum may perhaps help in determining its nature. On the basis of the evidence, namely the appellant’s uncontradicted testimony, which was borne out not only by the various contracts but also by the testimony of the accountant, Mr Marcel Camirand, and the financial statement in Exhibit A-8, the Court finds that:

(a) first, the said amount comes from surplus assets of X-Per-X Ltée;

(b) this surplus resulted from appellant’s work, among other things;

(c) this surplus increased the value of the company’s shares.

According to the explanations provided by Mr Camirand concerning Exhibit A-8 (para 3.03(f)) and those provided by the appellant in paragraph 3.20(f), there is no doubt that this surplus increased the value of the shares.

According to agreement A-6, however, the price of the shares was their book value, that is, the original amount paid by the appellant himself beginning in 1969, or $77,000 (para 3.01(e)). This amount was paid to the holder of the shares, namely Les Placements Cardino Ltée.

4.03.3 The $120,000 was paid to the appellant and not to Les Placements Cardino Ltée. If the appellant had owned the shares, the Court would not have hesitated to add this amount to the amount paid for the shares and to view them as a capital gain. There was no reason for X-Per-X Ltée not to pay the fair market value since paragraph 5 of Exhibit A-2 referred to above (para 3.01(e)) does not apply. The appellant had not been dismissed nor had he left his employment. Letter A-4 was nothing more than the notice required by clause 9 of Exhibit A-l (para. 3.01(c)) to terminate the ten-year period. Letter A-6 claiming 80 per cent of the original price of the shares was thus without foundation.

The Court is bound by the fact that the $120,000 was received by the appellant. According to the accountant, the bonus for 1978, which was part of the settlement, could have been $400,000 instead of $250,000 (para 3.03(g)): this means that of the $120,000 received, the sum of $60,000 (40 per cent of $150,000: $400,000-$250,000) could have been a bonus if the settlement had been different, and so clearly the $60,000 would be taxable in its entirety.

However, the Court is also bound by the fact that the settlement was arrived at by free and independent parties who were duly represented by counsel. Accordingly, the decision to award a bonus of $250,000 rather than $400,000 is not reviewable. Moreover, the said settlement occurred as the result of a lawsuit. It is therefore a transaction having the authority of a final judgment according to Art 1920 of the Civil Code of the province of Quebec.

One fact seems clear: the appellant had rights in the assets of the company at the end of 1978. He had worked there for ten years and was not a mere employee. He was at a decision-making level. The clause for the purchase and sale of the shares in the event of death confirms their association (para 3.01(f)(1) and (g)).

However, if the appellant had not filed suit, he would only have recovered the amounts mentioned in letters A-4 and A-5. “You have the two letters, and that’s that’’, Mr Valade had told him (para 3.01(n)).

The Court does not see how the $120,000 could be attributed to employment contract A-l, which set his salary at $16,000. The amounts due from this contract are not in dispute.

The appellant’s rights derive from the fundamental nature of their association and their joint efforts. The $120,000 cannot be viewed as having been received within the terms set out in subparagraphs (c), (d) and (e) of paragraph 3 of section 6 of the Act, cited above.

Moreover, in terminating their association, Mr Valade deprived the appellant of a major source of income: he “killed the goose that laid the golden eggs’’.

At the very least, the appellant was entitled to recover the capital that had accumulated in the business.

5. Conclusion

The appeal is allowed and the whole is referred back to the respondent for reconsideration and reassessment in accordance with the reasons for judgment set out above.

Appeal allowed.