Hassanali Estate v. R., [1997] 2 CTC 2224, 97 DTC 905

Sarchuk T.C.J.:

This appeal is with respect to an assessment of tax for the 1989 taxation year. In computing his income for that year, Count Sajan Hassanaii (the Count) deducted the amounts of $725,000.00 and $111,584.15 as business expenses. These amounts were disallowed by the Minister of National Revenue (the Minister).

From 1969 to 1986, for a period of approximately 15 years, the Count and Helga Georg (Georg) cohabited. During this period, the Count repeatedly made promises to marry Georg as soon as his wife, from whom he was separated, died. On or about January 7, 1975, the Count purchased Kennedy Towers, a 183-suite apartment building at 720 Kennedy Road, Scarborough, Ontario (the building). He and Georg moved into one of the apartments at the end of 1974 and took over responsibility for its maintenance and repair on January 1, 1975, just prior to the Count becoming the legal owner. From that date until the spring of 1986, Georg provided valuable services to the Count in respect of the building on a daily and regular basis, including the services as property manager, superintendent, maintenance and cleaning. Throughout this period, the Count operated the building as a commercial enterprise with a reasonable expectation of profit. Considerable amounts of income were earned and the property appreciated substantially in value. In the spring of 1986, the Count’s wife died. However, he did not marry Georg but married another woman at which time, not surprisingly, the Count’s relationship with Georg and her employment in respect of the building ceased.

By notice issued March 13, 1986, Georg commenced an action in the Supreme Court of Ontario against the Count, claiming inter alia an interest in Kennedy Towers, an interest in the Count’s principal residence, an interest in all of the other real and personal property acquired by the Count and Georg as a result of their joint efforts during the period of time they cohabited, as well as support and costs of the action. The action proceeded to trial before the Honourable Mr. Justice Walsh on the 4th, 5th, 6th and 7th days of July, 1988 and on the 23rd, 24th, 25th, 26th and 30th days of January, 1989. On January 30, 1989, Walsh J. rendered the following judgment:

1. THIS COURT ORDERS AND ADJUDGES that the Defendant do pay to the Plaintiff the sum of $725,000.00.

2. THIS COURT ADJUDGES AND DECLARES that until the said sum has been paid in full the Plaintiff shall have a proprietary interest or charge in the lands and premises known as 720 Kennedy Road, in the City of Scarborough in the Municipality of Metropolitan Toronto, which lands are more particularly described in Schedule A hereto annexed.

3. THIS COURT FURTHER ADJUDGES AND DECLARES that until the said sum has been paid in full the Plaintiff shall have exclusive oc- cupancy of apartment 1412 at 720 Kennedy Road in the City of Scarborough in the Municipality of Metropolitan Toronto, without payment of any kind.

4. AND THIS COURT DECLINES to make any order as to costs.

The amount of $111,584.15 in issue represents the legal expenses incurred by the Count in defence of the action in the Supreme Court of Ontario.

The evidence adduced on behalf of the Appellant includes the pleadings in the above action, the transcripts of the evidence taken [1] , the Reasons for Judgment, the reports of Michael Bolahood (Bolahood) [2] and KPMG Peat Marwick filed in the Supreme Court action and a series of work orders [3] . Both Bolahood and Michael A. Beber (Beber) who was involved in the preparation of the Peat Marwick reports, gave evidence in this appeal.

The position of the Appellant is that the award in the amount of $725,000.00 was made to redress Georg for the unpaid work and services she performed in respect of the business operation of Kennedy Towers during the 16 years that she was there. The Count had been unjustly enriched by virtue of these services and Georg had suffered a corresponding deprivation. Since the services were provided in the furtherance of the business operation, and more specifically for the purposes of gaining or producing income, the payment ordered by Walsh J. in respect of those services is deductible for income tax purposes in accordance with the provisions of paragraph 18(1 )(a) of the Income Tax Act (the Act).

Reference was made by Counsel for the Appellant to Cox v. R., (sub nom. Cox v. The Queen) [4] and to Mohawk Oil Co. Ltd. v. R., (sub nom. Mohawk Oil Co. v. Canada) [5] to support the proposition that the Courts have held that the receipt of a quantum meruit award is taxable as income in the hands of the recipient and that in characterizing a payment for tax purposes, the Court is entitled to look to the significance of the award in the hands of the recipient regardless of what caused the payment to be made.

It is also the Appellant’s position that the legal fees are inherently tied into the determination as they are a direct consequence of the dispute the Count was having with Georg. In incurring these costs, the Count was attempting to keep them as low as possible and by so doing, this would result in an increase in the amount of net income. Accordingly, the legal fees ought to be characterized as an expenditure made in respect of gaining or producing income as well.

The Respondent’s position is that in making a substantial contribution in physical labour towards the improvement, maintenance and management of the building culminating in a tremendous increase in its value, Georg established a right to an interest in the building. This interest was acknowledged by Walsh J. by way of a constructive trust and the monetary award of $725,000.00 was ordered in lieu of such trust. The Respondent contends that, as Cory J. noted in Peter v. Beblow [6] :

... there is no reason why quantum meruit or the value received approach could not be utilized to quantify the value of the constructive trust. The remedy should be flexible so that it can be readily adapted to the situation presented in any given case.

Counsel for the Respondent further contends that Walsh J. did not intend to make the award on the basis of “just providing wages for the services” and that the amount awarded to Georg was simply “a measurement of the value of the contribution she had made to Kennedy Towers” [7] . This conclusion, he says, is supported by the fact that Walsh J. established the award by comparing the net worth and incomes of Georg and the Count and not by ascertaining the actual amount of labour Georg performed or the actual market value of such labour.

The Respondent therefore contends that the expenditure of the $725,000.00 and the legal fees, also claimed as a deduction from income for the 1989 taxation year, were not outlays or expenses incurred by the Count for the purposes of gaining or producing income.

The issue to be determined in this appeal is whether the expenses in the amounts of $725,000.00 and $111,584.15 disallowed by the Minister were incurred for the purposes of gaining or producing income from a business or property pursuant to paragraph 18(1)(a) of the Act or were personal or living expenses within the meaning of paragraph 18(1)(h) and subsection 248(1) of the Act. Central to this determination is the further determination as to the proper characterization for income tax purposes of the payments directed by Walsh J. in his Order.

The Award:

The first question is whether the award made by Walsh J. was, as argued by the Respondent, based on “quantification” of a constructive trust or whether it was an award of money on the basis of the value of services rendered. The nature and extent of these services was recapitulated by Walsh J. as follows:

The plaintiff described in great detail and at considerable length the variety of services and all the duties she performed over this period. She detailed for the Court her daily activities, during a rather long period when the building had no superintendent, as commencing with her checking at 5 a.m. for illegal parking, then washing down walls and floors and checking all the garbage chutes on the fifteen floors, returning to their apartment by 6:30 in order to prepare the defendant’s breakfast, to polish his shoes, lay out his wardrobe and run his bath. At about 8 a.m. she would go to the office to receive the service requests, which she would then proceed to fulfil. These requests, it would appear from the voluminous material filed, were complaints by tenants as to various problems in their apartments, such as toilets that would not work, broken electrical appliances, doors windows and locks that were broken, the presence of insects, and other such items requiring repair. She had trained herself to perform these tasks in order to save the costs of plumbers, electricians and carpenters.

She then returned to their apartment and prepared a hot lunch for the defendant, as this was their main meal of the day, following which she would then herself perform any maintenance matters which required attention.

At 6 p.m. she had appointments to show prospective tenants vacant apartments. At 7 p.m. she would ny (sic) the defendant to the garage, as he drove off each night to his Mosque for prayers, and, on his return, would prepare a light meal for their supper.

While the defendant now seeks to belittle and minimize the extent and value of the services the plaintiff performed, it is clear that at the time they were rendered this was certainly not the case.

On these facts, Walsh J. concluded that:

There can be no doubt whatsoever that the facts here clearly establish a case of unjust enrichment, and I so find. Once a finding of unjust enrichment is made, the Court, must next determine the most appropriate remedy to rectify such enrichment. It is urged on behalf of the plaintiff that this can best be accomplished by the imposition of a constructive trust. It’s the defendant’s submission, however, that the circumstances here do not justify the imposition of a constructive trust and the making of a proprietary award, as sought by the plaintiff. In the defendant’s submission, the relief should be granted in persona, (sic) either by making a monetary award to the plaintiff on a quantum meruit basis or by way of equitable compensation.

In Sorochan v. Sorochan, (1986) 2 R.F.L. (3d) 225, Chief Justice Dickson stated at page 236:

The constructive trust constitutes one important judicial means of remedying unjust enrichment. Other remedies, such as monetary damages, may also be available to rectify situations of unjust enrichment. We must, therefore, ask when and under what circumstances it is appropriate for a court to impose a constructive trust.

And then he continues:

In this regard, the first issue to be considered is the casual connection requirement ...

And he then examines various cases under this heading and, at page 239, states:

These cases reveal the need to retain flexibility in applying the constructive trust. In my view, the constructive trust remedy should not be confined to cases involving property acquisition. While it is important to require that some nexus exist between the claimant’s deprivation and the property in questions, the link need not always take the form of a contribution to actual acquisition of the property. A contribution relating to the preservation, maintenance or improvement of property may also suffice. What remains primary is whether or not the services rendered have a ‘proprietary relationship’ ... to use Professor McLeod’s phrase. When such a connection is present, proprietary relief may be appropriate. Such an approach will help to ensure equitable and fair relief in the myriad of familial circumstances and situation where unjust enrichment occurs.

And continuing at page 249 he states:

In addition to the casual connection requirement, it is often suggested that the reasonable expectation of the claimant in obtaining an actual interest in the property as opposed to monetary relief constitutes another important consideration in determining if the constructive trust remedy is appropriate.

And then he continues by stating:

In assessing whether or not an in rem remedy is appropriate, a final consideration in this case is the longevity of the relationship.

Nonetheless, Walsh J. concluded that:

On the evidence, the plaintiff here has clearly met all three tests formulated by Chief Justice Dickson. However, notwithstanding this finding, given the nature of the property — a 15-storey, 183-suite apartment building — the awarding of a proprietary interest therein, with all that entails, is, in my view, in the particu- lar circumstances of this case, neither appropriate nor desirable* [8] An examination of the equities and circumstances of the parties reveals that he values this building at $8 million and derives rental income therefrom of over $363,000 per year and declares his net worth — after deducting a commitment of some $500,000 to charity — of almost $7 million. By contrast, the plaintiff’s financial statement discloses her only assets to be two fur coats given her by the defendant, furniture worth $500 and jewellery having a value of some $2600. The only income she now receives are welfare payments.

After a most careful and anxious consideration of all the circumstances, I feel that an award of $725,000 is both a fair and realistic amount to require the defendant to pay to the plaintiff to redress her deprivation herein. I impose a trust or proprietary interest to the extent necessary that such shall be and constitute a proprietary interest or charge against this building — known for municipal purposes as 720 Kennedy Road, Scarborough — until such sum as I have awarded is paid in full. And in addition, the plaintiff shall retain the exclusive right to occupy Suite 1412 therein, without payment of any kind, for a like period.

Once Walsh J. concluded that the action of Georg for unjust enrichment was satisfied and her right to claim relief was made out, it became necessary for him to consider the nature of the relief to be granted to her. As was noted by McLaughlin J., speaking for the majority, in Peter v. Beblow,? [9]

... At this point, a second doctrinal concern arises: the nature of the remedy. “Unjust enrichment” in equity permitted a number of remedies, depending on the circumstances. One was a payment for services rendered on the basis of quantum meruit or quantum valebat. Another equitable remedy, available traditionally where one person was possessed of legal title to property in which another had an interest, was the constructive trust. ...

It is apparent that Walsh J. was clearly aware of the availability of a constructive trust as a means of remedying Georg’s deprivation. It is equally clear that he specifically rejected her contention that the circumstances warranted a proprietary interest in the property based on a constructive trust. I add that, contrary to the position advanced by the Respondent, “a finding that a plaintiff is entitled to a remedy for unjust enrichment does not imply that there is a constructive trust”. [10]

To determine the basis upon which the award was made I have reviewed, in addition to the Reasons for Judgment, most of the relevant testimony including the various exchanges between Walsh J. and Beber, the author of the Peat Marwick reports. Although Walsh J. refers to the relevant financial position of both parties, I am not convinced that the award was intended to quantify that portion of the assets accumulated by Georg and the Count on the basis of contributions made by each. As well he does not appear to have seriously directed his attention to a division of the “family assets” although the evidence before him referred to other assets which the Count owned. Nothing before me suggests that Walsh J. had regard to the amount by which Kennedy Towers had been improved and then determined the extent of the interest to which Georg was entitled proportionate to her contribution. Rather I am satisfied that the award made by Walsh J. represented his view of the appropriate compensation to Georg on a value received or quantum meruit basis for the services she rendered on the ground of an implied obligation to pay arising from the need to remedy unjust enrichment. Although the Reasons for Judgment are not specific with respect to the basis upon which the amount of $725,000.00 was calculated, the transcripts of the testimony before Walsh J. suggest that the focus of Georg’s case was directed toward the services provided by her and, I note, the only expert testimony adduced related principally to the value of those services. While it is not possible in cases such as this to calculate the value of the services received by the Count on a strict accounting basis, the award was approximately equal to the value of the reasonable expectation of Georg for services provided by her as property manager, superintendent and with respect to her labour involved in maintenance and repairs. [11]

Having concluded that the amount in issue represents quantum meruit payment for services rendered by Georg, it is necessary to consider its characterization for income tax purposes. The Reasons for Judgment of Walsh J. make it evident that the vast majority of the services provided by Georg were related to the management of Kennedy Towers. Furthermore, it is in- disputable that Georg owed no duty at common law, in equity or by statute, to perform the duties of property manager, superintendent, or to provide maintenance and janitorial services to the Count’s property. The monetary award to Georg for services rendered when viewed in the context of the evidence before Walsh J. can most readily be equated with the commercial value of those services. On balance, I have concluded that the services performed were of a character that had they been provided for immediate compensation in the ordinary course, payment therefor would have given rise to taxable income in her hands. Correspondingly, from the perspective of the Appellant in this case, the cost of those services, if incurred at the time they were provided, would have been expenses incurred by the Count in the operation of the rental property. It follows therefore that the amounts paid by the Count pursuant to the Order of Walsh J. fall within paragraph 18(1)(a) of the Act and are deductible by him.

Legal Fees:

It is the Appellant’s position that as a general rule legal expenses that relate to damage awards that are treated as income items attract the same characterization. [12] In my view that is not necessarily the case. Such a rule may be applicable to general damage cases but in circumstances such as in the present appeal, it is more appropriate to determine the character of the benefit sought by the Count in his defence of the action against him.

No evidence was adduced by the Appellant as to the objective of the Count’s defence nor was a transcript of the submissions made on his behalf before Walsh J. produced. There is but one reference to the Count’s submission found in the Reasons for Judgment and it provides little assistance regarding the nature and extent of the Count’s defence. Accordingly, I found it necessary to look to the pleadings for assistance. In her Statement of Claim, Georg sought a declaration that she was entitled, inter alia, to an undivided one-half interest in the Appellant’s real property including Kennedy Towers, a residence and a commercial plaza [13] , as well as an Order of support pursuant to the Family Law Act, R.S.O. 1990, c. F-3 (Ontario). Her claim was based on the allegation that their common intention was to use all of the profits derived from the operation of the commercial buildings to improve the properties, reduce the outstanding mortgages with the goal of selling the buildings and sharing the profits. [14] It was pleaded by Georg that as a result of her contributions a presumption arose that there would be a resulting trust to the extent of an undivided one-half interest in the property. [15] In the alternative, Georg pleaded unjust enrichment by the Count resulting in a constructive trust arising in her favour to the extent of a undivided one-half interest in the property and assets owned by the Count, or at least an undivided one-half interest in Kennedy Towers and the residential premises at 51 Hill Crescent.

The Count’s defence was that no spousal relationship or cohabitation existed; [16] that Georg was employed and paid for any services rendered; that Georg did not make, directly or indirectly, any substantial contribution toward the acquisition, maintenance and improvement of the defendant’s assets other than as an employee and that the Count at no time intended to share any of these assets with the plaintiff, informed her that his assets were to be shared with her or acted through his conduct or words so as to reasonably lead her to believe that she was to share his assets.

My review of the material available has led me to the conclusion that the Count’s defence was instituted primarily to preclude a finding that Georg was entitled to a proprietary interest in any of the Count’s properties, and in particular, Kennedy Towers. Put another way, the defence was undertaken to preserve the Count’s capital assets. To achieve this end, in addition to denying her entitlement to a resulting or constructive trust, it was necessary to take the position, in the alternative, that any contribution that Georg may have made either directly or indirectly, toward the acquisition, maintenance and improvement of the Count’s assets was done as an employee. [17] This is certainly consistent with the Count’s submission to Walsh J. that the relief to Georg, if any was to be granted, should be in personam by making a monetary award to Georg on a quantum meruit basis.

It is difficult to view the alternative position advanced by the Count as the primary purpose of the expenditure for legal services. An immediate distinction must be drawn between the primary purpose of the expenditure and indirect and ultimate results therefrom. [18] In this context, it is instructive to refer to the decision of the Federal Court of Appeal in R. v. Jager Homes Ltd.^ [19] In that case, a petition was brought against Jager Homes seeking to have it and an associated corporation wound up. This petition apparently resulted from marital difficulties between the two principal shareholders and officers of the companies. The companies defended themselves and claimed a deduction for the legal expenses incurred in doing so. The Minister took the position that the legal fees were on account of capital and disallowed the deductions. The Tax Review Board allowed the taxpayers’ appeals and the Federal Court, Trial Division, dismissed the Crown’s appeal from the Board decision. [20] The Crown further appealed to the Federal Court of Appeal. The appeals were allowed, the Court finding that the legal fees were incurred to preserve the business entity, structure or organization of the taxpayers. In the course of his reasons, Urie J. stated:

From all of the evidence it is reasonable to conclude that the real objective of the plaintiff in the actions was to use the threat engendered by the petitions for winding up to obtain a settlement of her financial claim in her divorce action or, if no settlement were achieved and the petitions were granted, as a consequence of the winding up, to receive her ratable share in the distribution of the assets. The defence was clearly instituted to prevent the latter occurrence. That was the primary purpose of the defence in the litigation. The indirect and ultimate result of succeeding in that defence would be that the income earning capacity for each company would continue. To use the words of Dixon J. in the Sun Newspapers case, supra, “The expenditure in question is a large non-recurrent unusual expenditure made for the purpose of obtaining an advantage for the enduring benefit of the appellants’ trade ...” In other words, the payments for legal fees were made to preserve the business entity, structure or organization not as the kinds of expenditures which are made to earn profits from the operation of such business entities.

As I see it, therefore, the legal expenses incurred were not on the income account and, as a consequence were not deductible in the computation of the Respondent’s taxable income because they did not fall within the exception contained in subsection 18(1)(a) of the Act. They were, as I see them, made on account of capital and, thus, were not deductible unless they were incurred for the purpose of gaining or producing income. For the reasons already given, I am of the opinion that they were not so incurred. Rather they were outlays on capi- tal the deduction of which was prohibited by virtue of subsection 18( 1 )(b) of the Act.

As was the case in Jager Homes, the Count was successful in his defence in that he preserved his business entity. That was his immediate and most urgent purpose in making the expenditure and therefore, it must be attributed essentially to that purpose. Accordingly, the legal costs in issue are not deductible.

The appeal is allowed in part and the matter is remitted to the Minister for reconsideration and reassessment on the basis that the amount of $725,000 is deductible to the Appellant in accordance with the provisions of paragraph 18(1)(a) of the Act. The Appellant is allowed costs, such costs to be taxed.

Appeal allowed in part.