Raoul Engel v. Minister of National Revenue, [1982] CTC 2422, 82 DTC 1403

M J Bonner:—The appellant appeals from assessments of income tax for the 1975, 1976 and 1977 taxation years. The appellant was, before 1975 during most of that year, a television journalist employed by Global Communications Limited (hereinafter “Global”). Changes were then made. Late in 1975 the appellant incorporated a company, Reasoned Communications Limited (hereinafter “Reasoned”), he entered into an employment agreement with Reasoned and resigned from Global. Reasoned entered into a contract with Global whereby Reasoned undertook to “lend” the appellant’s services to Global for a period of nine months, commencing December 1, 1975.

The Minister assessed tax on the basis that the appellant’s income included the amounts paid to Reasoned by Global under the last-mentioned contract (and renewals thereof) and not just the amounts received by the appellant as salary from Reasoned under the contract between him and Reasoned. The appellant objected. The assessments were confirmed on the basis that the amounts added to declared income . . are (the appellant’s) income from employment with Global Communications Limited ... in accordance with the provisions of section 3 and subsection 5(1) of the Income Tax Act.”

The principal assumption of fact made on assessment was that:

. . . the interposition of Reasoned between the Appellant and Global and related assignment of the Appellant’s services to Global were arrangements done for a fiscal purpose, lacked a bona fide business purpose, were shams, and a fiscal scheme whereby amounts which in fact and substance were salary, wages or other remuneration earned by the Appellant from Global were transferred or assigned to Reasoned.

The issue in these appeals is whether the Minister was correct in so assessing.

Global and the appellant were not related persons. They appear to have dealt with each other at arm’s length.

It was common ground that at the outset the appellant was employed by Global. The employment agreement was in writing and was to expire December 15, 1975. The appellant’s duties were:

To act as business editor of Global News and to perform such other journalistic functions as may be required from time to time . ..

Clause 5 of the agreement required the appellant to:

. .. devote his full time, efforts and ability to the performance of such services for Global in accordance with the requirements hereof.

Notwithstanding clause 5, the contract did appear to permit the appellant to perform services for others, provided he secured Global’s consent in writing in advance.

Much was made of tax reduction as a purpose underlying the 1975 restructuring. The appellant, in evidence, said that his overall purpose was to make more money and he included tax reduction as a component of this comprehensive description of his purpose.

Another component of the appellant’s purpose was the expansion of his activities as a free lance journalist. At the same time, he wanted to continue as business editor of Global. The appellant had joined the Global organization when it was first formed. As he and the rest of the Global staff gained experience and became more efficient, the appellant concluded that, but for one problem, he could find sufficient time both to discharge his duties to Global and to fulfil his wish to do more free lance work. The appellant experienced no difficulty securing Global’s permission to do free lance work, although apparently no one bothered with the contractual requirement that such permission be in writing. Rather, the problem appeared to be that the appellant, as an employee, was expected to spend a reasonable amount of time each day at the Global premises. This requirement inhibited the appellant’s efforts to promote and perform free lance work.

Another purpose given by the appellant for the creation of the new structure was his desire to charge his mother for financial and economic advice pertaining to her investments. The appellant had, in the past, given her such advice for nothing because he said he was not prepared to charge her for it so long as he had to pay tax at full personal rates on fees received.

It is quite plain that the appellant’s desire to expand his free lance business led to the decision to change the relationship with Global from a contract of service to a contract for services. It is equally plain that the form of the remainder of the new structure was dictated by the appellant’s desire to reduce his tax burden.

The first step in the 1975 restructuring was the incorporation, on October 20, 1975, of Reasoned. The Minister’s counsel did not suggest that this corporation was not properly formed or that there was any failure to pass the necessary resolutions or otherwise observe the niceties of corporate behaviour.

The next step in the reorganization was the appellant’s resignation from his position as an employee of Global. The employment agreement between the appellant and Global was for a term expiring December 15, 1975. It provided for early termination by notice in writing. The appellant resigned on November 30, 1975.

The appellant had entered into an agreement in writing with Reasoned dated October 27, 1975. By that agreement, Reasoned engaged the appellant to render his services as a broadcaster and writer solely and exclusively to it. The term of the employment was, according to that agreement, to commence October 27, 1975, and to run for a period of three years.

Reasoned entered into a contract with Global in writing dated November 19, 1975. By that contract Reasoned agreed to lend the services of the appellant to Global for a period of nine months to commence December 1, 1975. Under the agreement the appellant was to:

. . . act as the business editor of Global News and . . . perform such other journalistic functions in connection therewith as may reasonably be required from time to time.

The latter agreement contained two further provisions which are of some relevance:

1. Reasoned agrees that Raoul Engel shall be subject to the absolute direction and control of Global at all times with respect to the manner and method of performance of the function of business editor as aforesaid: Reasoned hereby undertakes that Raoul Engel will abide by the policies, instructions, and directions of Global from time to time.

2. Reasoned further undertakes to make Raoul Engel available at such time or times as will enable him to devote his full time, effort and ability to the performance of the services herein contracted for.

The term of the agreement was extended from time to time so that it governed the relationship between Reasoned and Global throughout the period under consideration in these appeals.

It may be convenient to note at this point that the last quoted provision of the agreement between Reasoned and Global did have the effect of requiring the appellant, indirectly, to spend only so much time in working for Global as was necessary to do the work of the business editor and other connected journalistic functions. In short, the appellant was free to arrange his working hours as he wished, provided he produced the results required by Global.

It was contended by counsel for the respondent that the provisions as to direction and control effectively made the appellant the employee of Global. I cannot accept that contention. Employment is a relationship which is founded in contarct. In The Queen v Gerald J Burns, [1973] CTC 264; 73 DTC 5219, Sheppard, DJ said at 265 [5220]:

The question of who was the employee of GWG must depend upon who had privity of contract with GWG so as to permit action for the salary or commission, and so as to establish the relation of employee and employer.

Following the appellant’s resignation, privity of contract no longer existed between the appellant and Global.

It was further contended that the appellant did not resign from Global prior to December 15, 1975. The argument was based on the fact that no copy of a written resignation was produced in evidence. The appellant testified that his copy had been lost. I am satisfied that the appellant was correct in stating that he did resign effective November 30, 1975, both because of the recital in Exhibit A-1, Tab 2, and because the appellant and Global conducted themselves in a manner consistent with the termination of the master-servant relationship at that time. Payment made by Global for work done by the appellant after November 30th was made to Reasoned.* [1]

It was argued that the new structure, and in particular the agreement between the appellant and Reasoned, was a sham. Counsel for the respondent pointed to the overlap period between October 27, 1975, when the exclusive services agreement between the appellant and Reasoned came into effect, and November 30, 1975, when the old employment contract between the appellant and Global was terminated. This overlap arose, according to the appellant’s evidence, because Global’s lawyers delayed in approving the new Reasoned-Global contract which was originally intended to come in force November 1st.

In my view, the failure of the appellant and Reasoned to amend their agreement is not, when considered in relation to the other evidence, indicative of sham, that is to say, a document not intended by the appellant and Reasoned to govern their relationship. The failure to amend the agreement between the appellant and Reasoned appears to indicate nothing more than a minor oversight in giving written expression to a common intention to defer the date of commencement of the agreement. Following November 30, 1975, all payments made by Global were not only made to Reasoned; all were deposited in the Reasoned bank account. All payments made by others for whom the appellant did free lance work during that subsequent period were similarly deposited in the Reasoned account. The appellant, who apparently had been well warned to exercise great care in giving effect to the legal relationships flowing from the new structure, made every possible effort to ensure that Global and all persons who sought his free lance services were informed from the very beginning that it was Reasoned which supplied such services. Further, all invoices sent were clearly prepared as invoices from Reasoned. In summary, the agreement between the appellant and Reasoned was intended to create a relationship between them of master and servant, whereby the appellant, as servant would perform the journalistic services sold by Reasoned, whether to Global or to others. I can see no basis for any suggestion that the relationship which the contract purported to create was not intended to be created or was not adhered to. There is no sham here.

Furthermore, the agreement between Global and Reasoned was not treated by either party as a sham. This is evident from:

(a) Global’s action in paying Reasoned after November 30, 1975;

(b) Global’s action in terminating employee benefits after November 30, 1975; and

(c) the freedom accorded to the appellant to come and go as he pleased after November 30, 1975.

The Minister contended that the transaction between the appellant and Reasoned had no valid business purpose and should therefore be ignored. In this regard he relied on the decision of the Federal Court of Appeal in MNR v Anthony Leon, Edward Leon and Lewie Leon, [1976] CTC 532; 76 DTC 6299, and on an unreported decision of the House of Lords in CIR v Burmah Oil Company Limited. He pointed out that all money paid by Global for December 1975, for 1976 and for 1977, was paid for the services of the appellant. On the basis of the authorities mentioned, he submitted that I should ignore the non-arm’s length transaction between the appellant and Reasoned and look at the end result. That end result was, he contended, the receipt by the appellant of the money which was paid by Global. I do not quite look at it that way. The end result that I see is that the money paid by Global was paid to, received by, and the property of Reasoned.

I cannot conclude that either of the authorities referred to has application here. In the Burmah case, Lord Diplock, in speaking of the approach recently adopted by the House of Lords in certain tax avoidance cases, suggests that the approach is limited in its application to transactions between artificial persons, all directed by a single mastermind. His Lordship said:

It does not necessitate the over-ruling of any earlier decisions of this House; but it does involve recognising that Lord Tomlim’s oft-quoted dictum in /RC v Duke of Westminster [1936] AC 1, 19, “every man is entitled if he can ‘to order his affairs so as that the tax attaching under the appropriate’ Acts is less than it otherwise would be”, tells us little or nothing as to what methods of ordering one’s affairs will be recognised by the courts as effective to lessen the tax that would attach to them if business transactions were conducted in a straight-forward way. The Duke of Westminster’s case was about a simple transaction entered into between two real persons each with a mind of his own, the Duke and his gardener — even though in the nineteen-thirties and at a time of high unemployment there might be reason to expect that the mind of the gardener would manifest some degree of subservience to that of the Duke. The kinds of tax-avoidance schemes that have occupied the attention of the courts in recent years, however, involve inter-connected transactions between artificial persons, limited companies, without minds of their own but directed by a single master-mind. In Ramsay the master-mind was the deviser and vendor of the tax-avoidance scheme; in the instant case it was Burmah, the parent company of the wholly-owned subsidiary companies between which the preordained series of transactions took place.

Similarly, in Leon, the persons who carried on the business of Ablan Leon Distributors, to whom the services were provided supposedly by management companies each controlled by one of the three appellant brothers, did not deal at arm’s length with the management companies or with the broth- ers. The principle which the Respondent’s counsel suggested should be adopted from the Leon case is one which the same Court, differently constituted, suggested . . should perhaps be confined to the facts of that case.” [2] *

The present case is rather different. Here, Global dealt with Reasoned following the restructuring. Those dealings were at arm’s length. Those cases do not warrant a conclusion here that it was the Appellant, not Reasoned, which earned the fees paid by Global.

The appellant adopted a method of ordering his affairs which, to use Lord Diplock’s words, has been .. recognised by the courts as effective to lessen the tax that would attach to them if business transactions were conducted in a straight-forward way.” The decision of the Exchequer Court in Ralph J Sazio v MNR, [1968] CTC 579; 69 DTC 5001, has never been overruled. I can find in the present case no greater degree of artificiality than existed in the situation considered in Sazio. There, Cattanach, J, stated at 587 [5006]:

A company, from its very nature, must act through natural persons and there are numerous examples, particularly in the entertainment field, where well known persons have incorporated limited companies to exploit their talents.

In Sazio it was apparently not admitted that tax reduction was a motive underlying the restructuring as was the case here. That difference between the two cases does not, as i see it, warrant a refusal to follow Sazio and to regard the amounts paid by Global as the revenues of the appellant and not the revenues of Reasoned.

It might not be amiss to observe that the Income Tax Act imposes an obligation to pay tax on taxable income. It does not impose any obligation to earn income or to continue to earn income in the same way as in the past. Thus, the appellant was entirely at liberty to decide to work for his company, Reasoned, and to cease to work directly for Global. In Atinco Paper Products Limited v The Queen, [1978] CTC 566; 78 DTC 6387, Urie, J, stated at 577 [6395]:

It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is correct in form, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other Court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carryig out its judicial duties, but in its duty to the public at large.

I can only find that the scheme in question here stands up under the requisite scrutiny.

For the foregoing reasons the appeals will be allowed. The assessments in question will be referred back to the respondent for variation on the basis that the amounts paid by Global to Reasoned were the revenues of Reasoned and not the income of the appellant.

Appeal allowed.