Anderson v. R., [1998] 1 CTC 2518, 98 DTC 1026

McArthur T.C.J.:

These appeals were heard together on common evidence and involve the deductibility by each Appellant of the sum of $71,559, for a total of $143,118 for the 1992 taxation year. The Appellants contend that the amount was received as dividend income from Nutrisource Limited and 646902 Ontario Inc. (the companies) and not as income from employment.

The Appellants, John and Joann Anderson are husband and wife. Prior to 1992, they each owned 50% of the shares of the companies and operated them together. The Appellants sold all their shares on July 15, 1992. On that date, the balance in the shareholders’ loan account was $143,118. Subsequently, Flavour Ingredients Limited, the purchaser, in its books of account, reflected the $143,118 (the amount) as a payment of employment income or management fee to the Appellants and credited the shareholders’ loan account with an equal amount. The amount was expensed by the purchaser as management fee and allocated equally between the Appellants. No T-4 was prepared by the purchaser and no amounts were withheld by the purchaser to be remitted to the Receiver General for Canada. The amounts were not included by the Appellants in the computation of their income for the 1992 taxation year and the Minister accepts that this failure was due to inadvertence.

Mr. Anderson and his accountant both testified and I accept their evidence which is summarized as follows. In June 1992, the Appellants and the purchaser agreed to a sale price of $500,000 for the shares of Nutrisource. It was further agreed that the companies would have retained earnings of at least $100,000 at the date of closing. The Appellants would cause the companies to pay a dividend on their shares prior to closing in an amount sufficient to reduce the aggregate retained earnings of the companies to the agreed $100,000 amount. To extinguish the indebtedness owing by the Appellants to Nutrisource Limited, it was agreed that the Appellants would cause Nutrisource Limited to pay pre-closing dividends sufficient to eliminate the $143,000 loan owed to Nutrisource by the Appellants. On July 14, 1992, the Appellants declared a dividend payable to themselves equal to the amount of the retained earnings of the Nutrisource in excess of $100,000 as at July 14, 1992. The dividend to have been paid was approximately $148,000 to be satisfied by payment of $5,000 in cash and $143,000 by the extinguishment of the shareholders’ loans.

The agreement upon the closing on July 15, 1992 included an acknowledgement that the Appellants had caused Nutrisource Limited to pay a dividend on their shares prior to closing sufficient to reduce the aggregate retained earnings of the companies to the agreed $100,000 amount and the Appellants agreed that they would not owe any amounts to the Nutrisource companies on closing. There was no reference to the Shareholders’ Loans in this provision. As part of the closing, each of the Appellants received $250,000 for their shares and the companies released them from all amounts owing.

The Appellants anticipated that they would have substantial investment income resulting from the receipt of the $143,000 dividend. In order to offset this dividend income, they acquired an interest in a “tax shelter” within the meaning of the Income Tax Act (the “Act”). Following the purchase of the Nutrisource companies, the purchaser replaced the former accountants of the companies with its own accountants. These new accountants prepared the tax return and financial statements for the Nutrisource companies for the fiscal period ending immediately prior to the aforesaid purchase and sale transaction. The tax return for Nutrisource Limited, as prepared by the new accountants, inadvertently reflected the extinguishment of the Shareholders’ Loans as salary income paid to the Appellants. No T-4 was ever issued in respect of the purported salaries, nor were any amounts withheld in respect thereof. The Appellants relied on their accountants, who prepared their 1992 tax returns, to include all of the foregoing transactions. Through inadvertence the Appellants’ accountants failed to report the dividend in the Appellants’ 1992 tax returns. If, as was intended, the Appellants had reported the dividend in 1992, the grossed-up amount of the dividend would have eliminated their cumulative net investment losses and therefore allowed them to access their capital gains exemptions. As a result, the Appellants’ tax liabilities, as filed, approximated their expected liabilities for the year, if both the dividend and the exemption were reported and claimed.

The question before me is whether the $143,000 was salary income or a dividend. It becomes a question of fact. I accept the Appellants’ evidence and that of their accountant. It is supported by documentation and by inferences that can be reasonably drawn therefrom. There is no evidence that the payments were on account of salaries for services rendered, apart from the purchaser’s accountability, which I find to have been in error. I am satisfied that the following events took place.

1. The Appellants agreed, in June of 1992, to sell their company shares for $500,000.

2. On July 14, 1992, the Appellants declared a dividend to themselves in an amount sufficient to extinguish their shareholder loans.

3. The Appellants acquired an interest in a tax shelter, which was sufficient to offset the dividends they anticipated receiving.

4. The new accountants for the Purchaser inadvertently reflected the extinguishment of the shareholders loans as salary income.

5. The Appellants relied on their own accountants, who inadvertently failed to report the dividend in the Appellants’ income tax returns.

6. The Appellants tax liabilities, as filed, approximated their expected liabilities for the year if both the dividends and the exemptions were reported and claimed. It was for this reason, the accountant explained that he did not pick up his error.

7. The Appellants structured the sale with the tax advice of their accountant. The accountant explained that the position of the Minister is the worst possible scenario. This is not what was designed.

8. The Agreement of Purchase and Sale contemplates a dividend and not a management fee or salary.

9. No services were rendered by the Appellants to the purchaser after closing.

10 There is no evidence to suggest that the $143,118 should be considered

salary income other than the inadvertent characterization of it by the Purchaser’s accountants. It was a taxable dividend. This characterizsation is consistent with the facts.

I view this as an obvious honest mistake and for these reasons, the appeals are allowed, with costs, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the amounts in issue were dividends.

Appeal allowed.