Michael J Fawcett v. Minister of National Revenue, [1980] CTC 2064, 80 DTC 1059

Guy Tremblay:— This case was heard in Vancouver, BC on February 21 and 22, 1979.

1. Point at Issue

The point is whether the appellant is correct in considering as capital gain the amount of $31,579 received in 1972 from the company Pan-Abode Buildings Ltd, a British Columbia Company engaged in the manufacture of pre-cut cedar buildings. According to the appellant, the said amount was received in consideration for his abdication from all further negotiations to acquire the shares of Pan-Abode so letting the Capozzi family acquire them. According to the respondent, the payment of the said amount represents a finder’s fee paid by the principals of Pan-Abode to the appellant.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results especially from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. The Facts

The facts indeed are not in dispute. The proven facts are well summarized in the appellant’s submission, the Board only completed some paragraphs and made minor changes to include the proof of the respondent.

3.01 The appellant is a lawyer who resides in the City of Vancouver, British Columbia.

3.02 In 1969, he was directed by Mr Klyne, the Chairman of McMillan Bloedel, to check, among other things, the possibility of acquiring the majority of shares of Pan-Abode, a British Columbia Company, engaged in the manufacture of pre-cut cedar buildings. After the study of Pan-Abode, the appellant recommended that McMillan Bloedel acquire the shares of PanAbode. McMillan Bloedel did not follow the recommendation. In 1970, the appellant left the company.

3.03 The appellant, however, was still interested in Pan-Abode as he had enjoyed a special relationship with the majority shareholder of Pan-Abode (37.5%), Mr John Hecht, in excess of 20 years.

3.04 As a result of this special relationship and as a result of the appellant’s knowledge of a business known as Pan-Abode Buildings Ltd, the appellant, in 1971, and pursuant to Mr Hecht’s encouragement sought to obtain the necessary persons and financing for the acquisition of the said Pan-Abode Buildings Ltd.

3.05 Because of the deteriorating health of the major shareholder, a Dr Steiner, and because Mr Hecht didn’t have any children, the latter informed the appellant that he would accommodate the appellant with respect to the terms of sale.

3.06 There was no price set for the acquisition of Pan-Abode Buildings Ltd bu the appellant, through this prior knowledge and his discussions with Mr Hecht, felt that this company could be acquired for something between $2.1 million and $2.3 million.

3.07 The appellant, after these discussions with Mr Hecht, obtained tenative approval from the Bank of Nova Scotia for a loan of approximately $1.1 to $1.2 million. The appellant was also able to interest certain persons in contributing approximately $600,000 in equity financing for shares in a company to be incorporated later. This company would be used to acquire all of the issued and outstanding shares in Pan-Abode Buildings Ltd. The shortfall in the purchase price of approximately $600,000 to $700,000 would be a part of the above-mentioned accommodation suggested by Mr Hecht. In this regard, Mr Hecht indicated that he would accept a payment over a number of years for his shares; he might keep a small number of shares; or he might even personally, or through one of his own companies, acquire the real property upon which Pan-Abode Buildings Ltd operated its business, which said property would be leased back to Pan-Abode Buildings Ltd.

3.08 In relatively short order the appellant had interested a group of people in Vancouver led by a Mr Gerald Hobbs. This group was prepared to commit a total of approximately $250,000 to the equity capital referred to above. The appellant was to arrange through a mortgage on his home and other borrowings a contribution of $100,000. Canadian Enterprises Development Corporation Limited of Montreal (CED Montreal) had also indicated a willingness to advance $250,000.

3.09 The appellant, about this time, discussed with Mr Hobbs the fact that the appellant was making a contribution for this acquisition over and above his cash commitment of $100,000; that is, the appellant had put the group together. In this regard, Mr Hobbs indicated his agreement and said that he thought that it would be appropriate for the appellant to receive some “bonus” shares representing something in the neighbourhood of 5% of the shares that would be issued by the company to be formed to purchase PanAbode Buildings Ltd and in which $600,000 would be invested in the way of capital for shares.

3.10 The evidence was that Mr Hobbs, who at that time was also a director of CED Montreal, apparently informed CED Montreal that he also believed that Pan-Abode Buildings Ltd would be a good purchase and that the financing that had been arranged, including the issuance of some additional shares to the appellant, was acceptable. The appellant did not have any discussions in this regard with CED Montreal. The respondent filed as Exhibit R-1 a brief of intention of CED dated September 24,1971. Paragraph 8 of this brief reads as follows:

8. Mr Fawcet will receive 5% of the common shares outstanding in the XYZ Corporation following investment of the equity required for the Pan-Abode acquisitions for his contribution in bringing the project forward and handling negotiations with the seller. He will also purchase $100,000 in equity.

It is stated that the said 5% was equal to $31,579.

3.11 The appellant also gave evidence that in his discussions with Mr Hobbs it was suggested and more or less tenatively agreed upon, that following the acquisition of Pan-Abode Buildings Ltd the appellant would hold an executive position in Pan-Abode Buildings Ltd, or in the purchasing corporation or in both companies and that he would be paid a salary of approximately $20,000 per year plus bonuses.

3.12 Apparently, CED Montreal did not wish to make a firm and final commitment with respect to its contribution towards the financing above referred to, until a specific and concrete arrangement regarding acquisition and financing had been made. Since things were still in a state of flux regarding the arrangements that could be made with Mr Hecht, and indirectly through him with Mr Steiner, the appellant thought that it might be best to obtain financing to the extent of approximately $250,000 from a source other than CED Montreal.

3.13 The appellant, while playing squash with an acquaintance by the name of Dr Michael Reimann, discussed in general terms the current status of these negotiations and Dr Reimann responded by saying that he had a client who at that time was quite liquid and was looking for investments. Dr Reimann, who was then employed with Blyth Canada Limited, a brokerage firm, did not disclose the name of his client and the appellant did not disclose the name of Pan-Abode Buildings Ltd at that time.

3.14 The evidence of the appellant is that in October of 1971 he attended a meeting with Dr Reimann and representatives of the Capozzi family who, as it turned out, were the clients that Dr Reimann had earlier referred to.

3.15 At the aforesaid meeting, the Capozzis indicated that they were aware of the fact that Pan-Abode Buildings Ltd was for sale and that they were interested in acquiring the company.

3.16 Approximately, one week later a similar meeting was held, but at that meeting the appellant was advised that the Capozzi family did not wish to invest as a majority shareholder, but wished to acquire all of the shares in Pan-Abode Buildings Ltd through Capozzi Enterprises Ltd which is apparently a family investment corporation. The appellant indicated that he was on the verge of successfully putting a group together to acquire PanAbode Buildings Ltd and that arrangements in this regard had been made with Mr Hecht. The appellant’s evidence is that the Capozzi family was well aware of the special relationship existing between the appellant and Mr Hecht. The appellant indicated that the plan was that he would have shares in a company to be formed for the purpose of acquiring Pan-Abode Buildings Ltd, that he was to be an executive of that company and possibly also of Pan-Abode Buildings Ltd and that he would earn a salary from one or both of those companies. The appellant also indicated he had set up a marketing company to sell Pan-Abode products overseas. In cross- examination, he affirmed that export potentiality was the final element which had influenced the Capozzi family to buy.

3.17 At the aforementioned meeting, the Capozzi family indicated their desire that the appellant and his group abandon any plans regarding a bid to acquire Pan-Abode Buildings Ltd and the Capozzi family asked the appellant what his “position” was worth. Aside from the information regarding an executive position and a salary the appellant informed the Capozzi family that he expected to acquire shares with his own funds and receive additional shares equivalent to 5% of $631,580; in other words, 31,579 shares had a nominal or par value of $1 per share. The Capozzi family informed the appellant that Capozzi Enterprises Ltd would therefore pay the appellant $31,579 if he were to abdicate his position. The Capozzi family was willing to pay cash for all of the shares or all of the assets of PanAbode Buildings Ltd.

3.18 The appellant, because of his special relationship with Mr Hecht, felt morally obliged to immediately inform Mr Hecht that the Capozzi family, through Capozzi Enterprises Ltd, was prepared to pay cash for either all of the assets or all of the shares of Pan-Abode Buildings Ltd which, for obvious reasons, would be a better arrangement for Mr Hecht and presumably Dr Steiner, who was the majority shareholder.

3.19 Mr Hecht indicated to the appellant that a fair amount of compensation to him for his abandonment or abdication of any place in the bidding on the takeover of Pan-Abode Buildings Ltd would be approximately $100,000. The appellant informed Mr Hecht of the Capozzi family’s offer to pay him $31,579 and to give him certain privileges regarding the off-shore marketing rights of Pan-Abode products.

3.20 Mr Hecht and the plaintiff therefore more or less arbitrarily agreed that “to make up the difference’’ Mr Hecht would personally, or through one of his separate companies, pay to the appellant $45,000 to remove himself from the competition, particularly because of the fact that the Capozzi family was obviously in a position to make a better offer than that which the “Fawcett group” could possibly make.

3.21 In November of 1971, the appellant therefore agreed to these terms with both Mr Hecht and the Capozzi family. Nothing at that time or at any time was ever put in writing with Mr Hecht and nothing further developed with respect to the Capozzi family because, according to the evidence of the appellant, Blyth Canada Ltd was in the midst of commencing an action against Capozzi Enterprises Ltd for a finder’s fee equivalent to 5% of the total purchase price of approximately $2.3 million.

3.22 The position taken by Blyth Canada Ltd was that the firm, as represented by Dr Reimann, had found, on behalf of Capozzi Enterprises Ltd an investment, namely, Pan-Abode Buildings Ltd and accordingly it was entitled to a finder’s fee.

3.23 In early April of 1972, the appellant, in order to obtain the funds promised by the Capozzi family, ie $31,579, presented to the Capozzi family a form of receipt (Exhibit A-2). The receipt refers to Capozzi Enterprises Ltd and the sum of $31,579. This document reads as follows:

April 4, 1972

RECEIPT

Receipt is hereby acknowledged of $31,579 from Capozzi Enterprises Ltd.

The said $31,579 constitutes payment in full of the cash element of the consideration agreed to be paid to Mr Fawcett at a meeting with Mr H P Capozzi on November 1, 1971, for the surrender by Mr Fawcett of his position with respect to the then contemplated acquisition by him and associates of Pan-Abode Buildings Ltd in order to have Capozzi Enterprises Ltd free to acquire that company.

M J Fawcett

The Capozzi family rejected the wording in that receipt as they wanted some commitment by the appellant that the funds would be used somehow or another in the promotion of Pan-Abode Buildings Ltd.

3.24 The appellant knew that that was not the reason for the payment of this sum, as related above. A reference to the promotion of these products was not of any concern to the appellant. He wished, indeed, to commence a marketing company in any event and he had already gratuitously advised the Capozzi family that he wanted the business of Pan-Abode Buildings Ltd, upon the sale of that company, for off-shore marketing rights. The appellant therefore signed a form of receipt prepared by the Capozzi family lawyer’s (Exhibit A-3) which reads as follows:

April 5, 1972

RECEIPT

Receipt is hereby acknowledged of $31,579 from Pan-Abode Buildings Ltd. It is understood that Mr Fawcett will employ these funds in the promotion of products of Pan-Abode Buildings Ltd or companies which do business with Pan-Abode Buildings Ltd.

M J Fawcett

He also signed a covering letter prepared by the Capozzi family lawyer’s (Exhibit A-4) which reads as follows:

5 April 1972

TO: Capozzi Enterprises Ltd

During 1971, I was considering the formation of a holding company to be used as a vehicle for the acquisition of a manufacturing company in Vancouver. For this purpose, I required capital.

I confirm that the purpose of Blyth Canada’s introduction of Capozzi Enterprises Ltd (Capozzi) to me in October, 1971 was for the purpose of interesting Capozzi in making an investment in my holding company. The holding company was not incorporated and my arrangements to finance the acquisition of the manufacturing company were abandoned.

M J Fawcett

The appellant’s evidence is that he assumed that the wording in the covering letter regarding the introduction of Capozzi Enterprises Ltd for the acquisition of a manufacturing company was designed to assist the Capozzi family in defending the action instituted in the Supreme Court of British Columbia by Blyth Canada Ltd.

3.25 The reasons for judgment (Exhibit A-5) allowed the claim of Blyth Canada Ltd in part, that is, that the plaintiff was entitled to a 5% finder’s fee, not of the total purchase price, but only of the sum total of cash sought for funding of the proposed purchasing corporation by the Fawcett group, that is, 5% of $630,000 or $31,579.85. The Supreme Court of British Columbia therefore held that Blyth Canada Ltd was entitled to a finder’s fee.

3.26 Immediately following upon the execution of the receipt prepared by the Capozzi family (Exhibit A-3) the appellant was issued a cheque for $31,579. This cheque was, to the appellant’s surprise, however, issued by Pan-Abode Buildings Ltd rather than Capozzi Enterprises Ltd. The appellant thought this somewhat peculiar, but for his purposes it was academic as to which company paid him these funds.

3.27 In 1973, Mr Hecht, through a corporation that he owns, paid $15,000 to the appellant on account of the $45,000 previously agreed to. The balance of $30,000 was paid either to the appellant or to others on his behalf in subsequent years.

3.28 In July of 1977, the appellant was reassessed for his 1972 and 1973 taxation years. The respondent included in the income the amounts of $31,579 and $15,000 respectively.

3.29 The appellant duly filed notices of objection to the said notices of reassessment and, in due course, the Appeals Division allowed the notice of objection in full with respect to the 1973 taxation year. Following upon that an appropriate notice of reassesment was issued, deleting from income for the 1973 taxation year the amount of $15,000. The notice of reassessment was confirmed, however, with respect to the sum of $31,579 received in the 1972 taxation year. The appellant duly filed a notice of appeal to the Tax Review Board.

4. Law—Precedent Cases—Comments

4.1 Law

The main sections of the Income Tax Act are sections 3, 9 and 248 (definition of business). They can be quoted if necessary.

4.2 Precedent Cases

The precedent cases cited by the parties are the following:

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

2. Her Majesty the Queen v Robert B Atkins, [1976] CTC 497; 76 DTC 6258;

3. Vincent Rother v MNR, 12 Tax ABC 379; 55 DTC 227;

4. Domenic Ci relia v Her Majesty the Queen, [1978] CTC 1; 77 DTC 5442;

5. J C Doyle v MNR, [1970] CTC 365; 70 DTC 6262;

6. Pepsi-Cola Canada Limited v Her Majesty the Queen, [1978] CTC 801; 78 DTC 6546;

7. Gunter Gahrns v Her Majesty the Queen, [1978] CTC 651; 78 DTC 6436.

4.3 Comments

4.3.1 The amount of $31,579 received by the appellant from Pan-Abode is considered by the parties:

(a) aS an income, because it is a receipt for past services or a profit from a business (an adventure of the nature of trade); or

(b) as a taxable capital gain; or,

(c) a non-taxable receipt on account of capital.

4.3.2 The $31,579, an income?

The Board agrees with the content of the quotation of J Collier in the case Pepsi-Cola Canada Limited v Her Majesty the Queen cited above, made by the respondent in this submission concerning the character of the receipt:

I agree with the plaintiff’s submission that one of the essential questions in this case is the character of this receipt. That character must be determined from the point of view of the recipient, not from the point of view of the payer. But the payer’s view, as to the basis for the payment, is, nevertheless, relevant. His motivations may not be. Authority for those propositions can be found in Chibbett (HM Inspector of Taxes) v Robinson and Sons, where Rowlatt, J said:

This case, like all cases of a similar nature, is very troublesome: because all these cases turn upon nice questions of fact, and at least I find very great difficulty in apprehending any permanent and clear line of division between the cases which are within and the cases which are without the scope of the Income Tax Acts. I think everybody is agreed, and has been agreed for a long time, that in cases of this kind the circumstances that the payment in question is a voluntary one does not matter. As Sir Richard Henn Collins said, you must not look at that the point of view of the person who pays and see whether he is compellable to pay or not; you have to look at the point of view of the person who receives, to see whether he receives it in respect of his services, if it is a question of an office, and in respect of his trade, if it is a question of trade, and so on. You have to look at his point of view to see whether he receives it in respect of those considerations. That is perfectly true. But when you look at that question from what is described as the point of view of the recipient, that sends you back again, looking, for that purpose, to the point of view of the payer: not from the point of view of compellability or liability, but from the point of view of a person inquiring what is this payment for; and you have to see whether the maker of the payment makes it for the services and the receiver receives it for the services.

The evidence showed that the point of view of the appellant was that in accepting the payment of $31,579 he renounced the possibility of acquiring the 5% of the shares of Pan-Abode, any future income coming from them, an executive position and a salary. The amount of $31,579 was calculated on the basis of 31,579 (5% of 631,580) shares having a nominal or par value of $1 per shares (Paragraph 3.17 of the fact.)

The 5% of shares of Pan-Abode Buildings Ltd, however, would have been transferred to the appellant by his group of purchasers because of “his contribution in bringing the project forward and handling negotiations with the seller” (Paragraphs 3.09 and 3.10 of the facts, Exhibit R-1). The equivalent value was given by the Capozzi family. Can it be said that it was for the same reasons? The point of view of the payer, the Capozzi family, is that the amount was paid to ensure that the appellant and his group be “out of the picture”, or to prevent the appellant from “muddying the waters” regarding the takeover of Pan-Abode Buildings Ltd.

The Board is inclined to consider (as in the Cirella case cited above) the value of the shares only as a yardstick, a basis on which the calculation of an amount was fixed. Indeed, the appellant was not the owner of the shares. It was only a hypothesis that he would become the owner of the shares. In a transaction of that nature, it is well known that problems rise to stop everything. Nobody can say for certain that the transaction with the appellant group would have been completed. Consequently, how can the value of the shares be used except as a yardstick? Can it be said that the amount of $31,579 represented as idemnity (as was the decision in Cirella case) or, a capital for the extinguishment of the appellant’s rights (as was the appellant’s contention in the Doyle case cited above) or an income from an adventure of the nature of trade (as was the judgment in the ame Doyle case).

There is a difference between the present case and the Doyle case cited above. The Doyle case is summarized as follows by Canada Tax Cases:

In 1949 the appellant and several others formed a syndicte with the stated intention of acquiring and selling certain used mining equipment which could be purchased for $108,000 (US funds). An agreement for the resale of this equipment for $1,445,000 was dated October 15,1949. On November 14, 1950 the appellant sold his interest in the syndicate in return for all the issued shares of Boon Strachan Coal Co Ltd, valued at $200,000. In the Minister’s view the latter sum represented income from an adventure in the nature of trade whereas the appellant viewed it as a capital sum received for the extinguishment of his rights.

The decision was mainly based on the fact that the syndicate was “formed for the purpose of the acquisition and sale of the equipment hereinafter described”.

The decision is that it was of no significance that the appellant obtained his profit in a different way from that first contemplated. He was engaged in an adventure in the nature of trade.

In the present case, what was contemplated in general by the appellant and his group, was firstly the acquisition of all the shares of the company and secondly, the profits coming from them. Consequently, it seems that the whole structure of the company, the entity itself, the source of income which was first contemplated by the group of purchasers included the appellant. However, the group did not buy the shares. Mr Hobbs and his group did not receive an amount from the Capozzi family for the abdication of any place in the bidding on the takeover of Pan-Abode Buildings Ltd. The appellant basically had the same aims. After working on the project, however, a possible purchaser, Mr Hobbs, a leader of a group, indicated that he thought it would be appropriate for the appellant to receive some “bonus” shares (5%) because he would have to put the group together (Paragraph 3.09 of the facts), and also because Mr Hobbs was a director of CED Montreal, (a possible lender) the same “bonus” shares were provided in the memorandum Exhibit R-1, as an executive position and a salary of approximately $20,000 were also provided.

It is clear that the amount received by the appellant was mainly to cause him to renounce those things. Mr Hecht certainly took them into consideration when calculating the fair amount of compensation of $100,000 (Paragraph 3.19 of the facts). Is it possible to divide which part of the amount applied to what item?

The evidence does not show that the executive position and the salary would have been given for the appellant’s contribution “in bringing the project forward and handling negotiations with the seller” (Exhibit R-1). The Board thinks that the executive position and the salary were provided by the possible purchasers because of the experience and know-how of the appellant. It was, in fact, for the asset, the capital represented by the appellant. Can it be said the same thing for the 5% of shares? The evidence clearly stated that it was for rendered services for the appellant’s contribution in bringing the project forward.

Even if it is still the Board’s opinion that the reference to the 5% of shares is only a yardstick to establish a compensation, it remains at first view that this amount by itself more properly refers to the reward of the 5% of shares for rendered services than to the executive position and future salary. If the shares had been given by the former group of purchaser, the value of the shares would have been taxable. The amount would have been in the nature of a finder’s fee for the payer and for the payee. The amount given by the Capozzi family replaces in fact that amount, even if it was not paid as a finder’s fee by the Capozzi. Can the Board, as in the Doyle case, affirm that it was of no significance that the appellant received the amount in a different way from that first contemplated ie as a finder’s fee? The Board, at this point has misgivings about answering in the affirmative.

Another point was that the paid amount of $31,579 was only the equivalent value of the shares but not the future income coming from them. It is true that another amount ($45,000) was paid by Mr Hecht (Paragraphs 3.19, 3.20 and 3.27 of the facts). Can this amount of $45,000 paid by Mr Hecht be regarded as paid for other items: salary, executive position? It is difficult to say there is nothing in the evidence which can lead to that conclusion.

After considering the evidence, however, some points are certain:

(a) It is non-contradicted evidence that the sum of $100,000 would have been a fair amount of compensation for the appellant;

(b) This amount includes compensation for the finder’s fee, for the executive position, the salary of $20,000, the right to buy a number of shares of Pan-Abode Buildings Ltd. The finder’s fee of $31,579 would have been taxable resulting from an adventure in trade if it had been received originally by the appellant from Pan-Abode or from the other shareholders. This amount represented 31.5% of the whole compensation of $100,000. The balance is a receipt on account of capital. It represents, in fact, capital, the source of income: salary, shares, etc;

(c) In fact, the appellant did not receive $100,000, but $76,579 ($45,000 from Mr Hecht plus $31,579 from the Capozzi family);

(d) The part of 31.5% of $76,579 ($24,122) must be taxable. Indeed, it is of no significance that the appellant received the income in a different way from that first contemplated: as finder’s fee paid by the shareholders or Pan-Abode, or later by the Capozzi family for staying “out of the picture”;

(e) The amount of $45,000 received by the appellant from Mr Hecht was considered as non-taxable by the respondent, $7,457 of the amount of $31,579, must be considered as a receipt on account of capital and non- taxable and the remaining $24,122 must be considered as income from an adventure in the nature of trade.

5. Conclusion

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

Appeal allowed in part.