Maxwell C Mahar, Quadra Transport Ltd, Actualwayne Butcher, Deemed v. Minister of National Revenue, [1980] CTC 2246, 80 DTC 1200

Guy Tremblay:— These three cases were heard in Vancouver, British Columbia, on February 23,1979. They were heard together pursuant to an order dated December 28, 1978, in the application of section 174 of the Income Tax Act.

1. Point at Issue

This issue is whether in the taxation year 1974 an amount of $12,146.05 received by Mr Mahar (shareholder) from Quadra Transport Ltd (Quadra) is:

(a) a salary and consequently an income for Mr Mahar and a deduction for Quadra;

(b) an appropriation and consequently an income for Mr Mahar and not a deduction for Quadra; or

(c) a consideration for shares transferred by Mr Mahar to Mr Butcher (shareholder) with a corresponding amount set up as a loan receivable by Quadra from Mr Butcher and consequently is a dividend for Mr Butcher and not a deduction for Quadra.

The respondent has reassessed Mr Mahar on the basis that the amount received is a salary in his hands while contradictorily the respondent has reassessed Quadra on the basis that the amount was an appropriation, and consequently not deductible by Quadra.

2. Burden of Proof

The appellants have the burden of showing that the respondent’s assessment is not justified. This burden of proof is based not on a particular section of the Income Tax Act, but on several judicial decisions, among them a decision of the Supreme Court of Canada rendered in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. The Facts

3.01 Quadra is a Canadian controlled private corporation as defined by paragraph 125(6)(a) of the Act, and was such throughout the 1974 taxation year.

3.02 Quadra’s business consists of holding, managing and operating trucks and trailer units for rent, lease and hire. Its financial years end on January 31.

3.03 Mahar, a truck driver, owned at the beginning of 1974, 65 shares in Quadra.

3.04 Butcher, a hauling contractor owned at the beginning of 1974, 34 shares in Quadra.

3.05 By an agreement dated March 23,1974, Mahar sold Butcher his shares in Quadra. This agreement reads as follows:

THIS INDENTURE MADE THIS 23RD DAY OF MARCH, AD 1974.

BETWEEN:

MAXWELL CECIL MAHAR, of the City of Vancouver, in the Province of British Columbia;

(hereinafter called the “Vendor”)

OF THE FIRST PART

AND:

WAYNE BUTCHER, of the City of Vancouver, in the Province of British Columbia;

(hereinafter called the “Purchaser”)

OF THE SECOND PART

WHEREAS:

The Vendor is the holder of 65 common shares in Quadra Transport Ltd, (hereinafter called “the Company”) and the Purchaser is the holder of 34 Common shares in the Company.

The Vendor wishes to sell his 65 shares to the Purchaser and the Purchaser wishes to buy the aforesaid shares.

The Company has two mail contracts with the Post-Master General of Canada and the Vendor wishes to retain and have assigned to him personally one of the aforesaid mail contracts and the Purchaser is desirous of retaining the second mail contract and performing the same through continued operation of the Company.

The aforesaid mail contracts are insured through the Fidelity Insurance Company of Canada by performance bonds, specifically, number 83-0120-8360-3 for the sum of $2,617 and number 830120-8790-73 for the sum of $8,953.

The Fidelity Insurance Company of Canada requires that the Vendor and the Purchaser personally idemnify with respect to the bonds for both mail contracts.

The Vendor has received certain consideration from the Company in partial payment of his shareholder’s equity, specifically,

GMC Truck 1968 C9E3381106079

GMC 1 Ton Van TC43331504217

Fruhauf Trailer 1948

Volkswagon Panel

1972 Chev 1 Ton Van

The Purchaser is desirous of retaining in the Company certain vehicles hereinafter specified:

Kenworth Tractor 1967 83022

Kenworth Tractor 1966 82542

Can-Car Model No 31-32F 1967 67-3174

Can-Car Model No 31-32F 1967 67-3175

The Company is indebted to the Vendor by way of shareholder’s loan in the sum of $2,852 after deduction of the value of the vehicles transferred to the Vendor.

NOW THEREFORE this indenture witnesseth that in consideration of the mutual covenants herein contained the parties hereto covenant and agree each with the other as follows:

1. The Vendor covenants and agrees to transfer to the Purchaser his 65 shares in the Company, such shares to be held in escrow pending completion of all the conditions and covenants contained herein.

2. The Purchaser covenants and agrees to personally guarantee to the Vendor payment of the sum of $2,852 and shall execute such security as the Vendor may require.

3. The Purchaser covenants and agrees that he will execute a postponement agreement with respect to any shareholder’s loan due to him by the Company until such time as the sum of $2,852 has been paid to the Vendor.

4. The Purchaser covenants and agrees that he will idemnify and save harmless the Vendor from all and any claims arising out of the mail contract covered under the Fidelity Insurance Company of Canada, performance bond No 830120-8790-73.

5. The Vendor covenants and agrees that he will indemnify and save harmless the Purchaser from all and any claims arising out of the mail contract covered under the Fidelity Insurance Company of Canada, performance bond no 830120-8360-3.

6. The Purchaser covenants and agrees that he will execute a Chattel Mortgage in favour of the Bank of Nova Scotia on behalf of the Company with respect to the vehicles retained in the Company and shall idemnify the Vendor from any and all claims which the aforesaid Bank may have by reason of the indebtedness of the Company to the aforesaid Bank.

7. The Purchaser covenants and agrees that he will produce for the Vendor’s inspection, quarterly financial statements with respect to the Company until such time as the sum of $2,852 has been paid in full.

8. The Purchaser covenants and agrees that he will permit the Vendor to inspect the records of the Company at all times notwithstanding the provisions of the Companies Act, RSBC 1960, and amendments thereto.

IN WITNESS whereof the parties hereto have hereunto set their hands and seals the day and year first above written.

SIGNED, SEALED AND DELIVERED BY

MAXWELL CECIL MAHAR in the

presence of:

MAXWELL CECIL MAHAR

SIGNED, SEALED AND DELIVERED by )

WAYNE BUTCHER in the presence )

of: )

)

WAYNE BUTCHER

)

3.06 Two paragraphs are in dispute in this agreement. They are the sixth and the eight unnumbered paragraphs. They read as follows:

The sixth unnumbered paragraph.

The Vendor has received certain consideration from the Company in partial payment of his shareholder’s equity, specifically,

GMC Truck 1968 C9E3381106079

GMC 1 Ton Van TC43331504217

Fruhauf Trailer 1948

Volkswagon Panel

1972 Chev 1 Ton Van

The eight unnumbered paragraph.

The Company is indebted to the Vendor by way of shareholder’s loan in the sum of $2,852 after deduction of the value of the vehicles transferred to the Vendor.

3.07 In his testimony, a member of the firm of accountants MacGillivray & Company, Mr A M Bruyneel, CA (who in February 1974 discussed with Mr Mahar and Mr Butcher the setting of the accounting mechanics of the sale of the shares of Mahar to Butcher) explained that the figure of $2,852 which appeared in the 8th paragraph comes in short from the following figures:

The calculation of the value of the shares, the summary of the shareholder’s account and a balance sheet on January 31,1974 are detailed in 4 pages filed as Exhibit A-M-2. These 4 pages are, according to Mr Bruyneel, the working papers he made in view of the agreement of sale.

3.08 The “Summary of Shareholders’ Accounts’’ read as follows:

3.09 In the Assets of the balance sheet as it would be after the transaction one of the items reads:

Mr Bruyneel affirmed that this accounting demonstrates that Mr Butcher had taken assets from the company to pay Mr Mahar and that is why, after the transaction, Mr Butcher had a debt of $12,009 to Quadra.

3.10 Concerning the amount of $2,852 due to Mr Mahar, Mr Bruyneel had provided in his working papers interest and a guarantee:

Mr Mahar’s shareholder’s account of $2,852 should bear interest, should have some reasonable repayment terms agreed to, and should be secured as follows:

(1) a second charge on all assets of the company;

(2) a personal guarantee of Wayne Butcher;

(3) all 100 shares to be held in escrow until purchase price paid in full.

In substance, those provisions appear in the agreement, paragraphs 1, 2, 3, 6 and /.

3.11 The witness, Mr Bruyneel, said that he was not present when Mr Mahar and Mr Butcher signed the agreement on March 23, 1974. He had phoned the lawyer and given the explanation. He only read the agreement the first time a few years after.

3.12 In his testimony, Mr Butcher affirmed or admitted that:

(a) Mahar in late 1973 “expressed a desire to me to sell out his shares of the business and that I would have the first opportunity or first refusal at it’ (SN pps 48, 68);

(b) At one time he discussed the conditions of the sale with Mr Bruyneel after discussing them with someone else from his firm. Mr Bruyneel “was the one that actually put it all down on paper” (SN p 48);

(c) Mr Bruyneel had made an evaluation of Quadra’s assets according to the working paper (Exhibit A-M-2) (SN p 61);

(d) Mr Mahar and himself had made the evaluation of the vehicles transferred to Mahar and of those which should be retained in Quadra (SN p 65);

(e) He recalled Quadra “was worth $21,613 and that 66% interest was worth $14,265” (SN p 66);

(f) The price of sale was figured out on the basis of the evaluation which appears on Exhibit A-M-2 (SN p 66);

(g) He had not given instruction to the solicitor for the drafting and preparation of the agreement;

(h) He had paid the amount of $2,850 to Mahar’s lawyer (SN p 67); (i) Subsequently, he had received the Mahar’s shares (SN p 67);

(j) Quadra did not employ Mahar after he had signed the agreement (Exhibit A-M-1) and that no further salaries were paid by Quadra to Mahar after the agreement was signed (SN pps 70 and 71).

(k) The transfer to Mahar of mail contract with the government, provided in the agreement, was part of the consideration for paying the shares (SN p 121).

3.13 In his testimony, Mr Frank Gration, CGA, affirmed that:

(a) After reading the agreement A-M-1 and specially the clause: “The vendor has received certain consideration from the company in partial payment of the shareholder’s equity”, he thought “so the only way that we could create shareholder’s equity in that amount was to pay bonuses and dividends to the vendors” (SN p 76). He prepared his own working papers (Exhibit A-Q-1);

(b) Concerning the amount of $2,852: “we provided the journal entries to provide a method by which we could pay out a shareholder’s loan and shareholder’s equity to Mr Mahar in accordance with what we felt the agreement said.” (NS p 83);

(c) “Original cost was $18,644. Payments totalling $15,568.45 were made leaving a payable of $3,075.55. This was adjusted to $2,852—the figure demanded by Mahar in a subpoena delivered to Butcher.” (Extract of Exhibit A-Q-1);

(d) He knew Quadra had not bought the shares;

(e) He arranged the entries in the book to try to meet the wording of the agreement: “The vendor has received certain consideration from the company . .

(f) He arranged the entries and the figures so that earnings had been paid in the amount of $12,746.05 in 1974;

(g) in making his own papers (Exhibit A-Q-1) he had on hand the working papers of Mr Buyneel (Exhibit A-M-2) (SN p 89), but he did not have the corporate records (SN p 97);

(h) He did not agree that the figures made by Mr Bruyneel pertained to the agreement (Exhibit A-M-1) “So we took the steps we felt necessary to follow the terms of the agreement” he said (SN p 89);

(i) “We felt the agreement wasn't particularly clearly constructed so we contacted Wayne, as well as contacting MacGillivray & Company and Wayne’s interpretation was not the same as the interpretation that MacGillivray & Company had put on it; and our interpretation of the agreement bore out what Wayne (Butcher) said, and that is how we recorded the items in the books.” (SN p 90);

(j) Quadra had not repurchased its own shares (SN p 91);

(k) He assumed that the evaluation of the equipment was correct (SN p 92);

(l) The amount of $2,850 was considered in the books as “payable wages”. It was in fact paid by Quadra to Mahar (SN p 95);

(m) He said he recorded a dividend payable on shares, which was declared to Mr Mahar after he had left Quadra. He declared in fact a dividend on shares that were not owned by Mr Mahar any longer (SN pps 96 and 97);

(n) Mr Butcher bought Mahar’s shares after the assets had been pulled out of the company “which is what, again we felt the agreement said’’ (SN p 97);

(o) On September 31, 1974, he did not have on hand the corporate records (SN p 99);

(p) “Well, I believe that all we were doing after the fact was recording what the agreement said transpired.’’ (SN p 96);

(q) He interpreted the contract with no legal opinion.

3.14 Mr Mahar in his testimony affirmed or admitted that:

(a) they (himself and Butcher) did not discuss the agreement with the lawyer, they only signed it;

(b) he received the equipment after he had signed the agreement (SN p 105);

(c) he sold 3 trucks after he had signed the agreement and kept the money (SN pps 107 and 110);

(d) Mr Butcher did not have any cash to pay him.

3.15 In filing in its 1974 tax return Quadra deducted in the computation of its income the amount of $12,746.10 as wages paid to Mahar. It was disallowed by the respondent.

3.16 The respondent added to the computation of revenue of Mahar the amount of $12,146.10.

4. Law— Comments

4.1 Law

The main sections of the law implied in the present case are paragraph 18(1)(a), subsections 15(1) and 15(2):

18(1) In computing the income of a taxpayer from a business or property no reduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

15(1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 84, 88 or Part II applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of common shares of the capital stock of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

15(2) Where a corporation has in a taxation year made a loan to a shareholder, the amount thereof shall be included in computing the income of the shareholder for the year unless

(a) the loan was made

(i) in the ordinary course of its business and the lending of money was part of its ordinary business,

(ii) to an officer or servant of the corporation to enable or assist him to purchase or erect a dwelling house for his own occupation,

(iii) to an officer or servant of the corporation to enable or assist him to purchase from the corporation fully paid shares of the corporation to be held by him for his own benefit, or

(iv) to an officer or servant of the corporation to enable or assist him to purchase an automobile to be used by him in the performance of the duties of his office or employment,

and bona fide arrangements were made at the time the loan was made for repayment thereof within a reasonable time, or

(b) the loan was repaid within one year from the end of the taxation year of the corporation in which it was made and it is established, by subsequent events or otherwise, that the repayment was not made as a part of a series of loans and repayments,

and where the shareholder is a corporation, the amount so included in computing its income for the year shall be deemed to have been received by it as a dividend.

4.2 Comments

4.2.1 The crux of the matter is in the interpretation of the two clauses quoted in paragraph 3.06:

The Vendor has received certain consideration from the Company in partial payment of his shareholder’s equity, specifically,

GMC Truck 1968 C9E3381106079

GMC 1 Ton Van 1043331504217

Fruhauf Trailer 1948

Volkswagon Panel

1972 Chev 1 Ton Van

The Company is indebted to the Vendor by way of shareholder’s loan in the sum of $2,852 after deduction of the value of the vehicles transferred to the Vendor.

It is the Board’s opinion that the civil contract must not be as strictly interpreted as the Income Tax Act. The Board must consider the substance of the contract.

4.2.2. Mahar sold to Butcher his Quadra shares. This is not contested as the two appellants confirmed the fact. The company has not repurchased its own shares. Butcher’s accountant admitted this (paragraph 3.13-j).

On the basis of those two facts the Board must conclude, in interpreting the unnumbered paragraph 6 of the contract, that Quadra has not paid Mahar any partial payment to repurchase the shares. Consequently, if, in fact, assets of the company were transferred to Mahar, it could be that this was done to pay a debt of the company to Mahar (paragraph 3.08), or to pay the debt of Butcher to Mahar for the purchase of shares of Quadra. This is the version given by Mr Mahar and his accountant. The latter was the only one who instructed the lawyer who wrote the agreement. In fact, even if it is ambiguous, it is not so false to say that “the vendor (Mahar) has received certain consideration from the company in payment for his partial equity” when it is understood that it was to pay Butcher’s debt. In theory, the assets were bought by Butcher from the company and transferred to Mahar to pay for the shares. In practice, the transfer was made directly from the company to Mahar on the consent of Butcher. It has been proven that the latter had no cash to pay.

4.2.3 Concerning unnumbered paragraph 8, the only interpretation that can be used to arrive at the figure $2,852 is that the transferred assets ($15,792) were used to pay for all the shares ($14,265)— paragraph 3.12-e) sold to Butcher and a part of Mahar’s loan to Quadra ($1,527) with a remaining balance on the loan of $2,852 ($4,379—$1,527—paragraph 3.07). This balance was paid and Butcher received Mahar’s former shares (paragraph 3.12—h & i). Butcher admitted that the value of Mahar’s shares was 66% of $21,613 (paragraph 3.12-e).

4.2.4 It is the Board’s opinion that this is the only conclusion it could reach after considering the substance of the contract and the evidence.

4.2.5 It is difficult indeed to arrive at the conclusion that Mahar received a salary of $12,146.05 from the company during the year 1974 when Butcher said that Quadra did not employ Mahar after he had signed the agreement (March 23, 1974) and had not received a salary after that date (paragraph 3.12-j).

4.2.6 The amount of $12,146.05 was not an appropriation in the hands of Mahar either according to the meaning of subsection 15(1). It is rather a consequence of the verbal settlement between the parties, which has been confirmed by the written agreement. Butcher admitted that the value of Mahar’s shares was 66% of $21,613 (paragraph 3.12-e).

4.2.7 As evidence was not given to the effect that Butcher paid Quadra for the assets transferred to Mahar, the balance of $12,009 must be considered as income in the hands of Butcher according to subsection 15(2). Quadra Transport Ltd is not allowed to deduct this amount.

5. Conclusion

The appeal of Quadra Transport Ltd is dismissed. The appeal of Maxwell C Mahar is allowed and the matter is referred back to the respondent for reassessment of Maxwell C Mahar and Wayne Butcher in accordance with the above reasons for judgment.

Mahar appeal allowed.

Quadra appeal dismissed.