Pauzé v. R., [1999] 2 CTC 2625, 98 DTC 2109

Archambault T.C.J.:

Mr. Pauzé is contesting the notice of assessment made by the Minister of National Revenue (“the Minister”) on August 23, 1996 for the 1991 taxation year. The Minister claimed the sum of $11,130.75 from Mr. Pauzé pursuant to s. 160 of the Income Tax Act (“the Act”) as tax owed by the company Référium Inc. (“Référium”) in 1991. The Minister applied s. 160 of the Act because Référium had paid a dividend of $70,000 to Mr. Pauzé in that year. Mr. Pauzé submits that the dividend was paid to him in return for services he rendered to the company and that s. 160 of the Act does not apply.

Facts

Référium operates a communications and marketing executive search business. Its fiscal year ends on February 28. Mr. Pauzé purchased all the shares in Référium in 1979, paying $42,000 for them. From 1976 onward, Mr. Pauzé was the sole shareholder and sole director of this company.

Mr. Pauzé reported earnings from three sources — a base salary, reimbursement of expenses and advances — totalling about $150,000 to $170,000 a year. It was his accountant who determined at the end of Référium’s fiscal year whether the advances would be treated as a dividend or as salary. A dividend was generally declared in January or February. Mr. Pauzé did not know whether by-laws had been drafted. He answered that he relied on his accountant for such matters. The income tax returns filed at the hearing gave the following information on taxable salary and dividends reported as income for Mr. Pauzé for the 1989 to 1992 taxation years:

In the fiscal year ending February 28, 1991 Référium paid Mr. Pauzé a dividend of $70,000. For that fiscal year Référium was required under the Act to pay $11,130.75. Mr. Pauzé admitted that Référium had closed down its operations around December 1992. From that time on, he continued operating his executive search business through a new company.

Référium’s accountant, Mr. Morin, also testified at the hearing. As a partner in the chartered accountants’ firm of Morin, D’Août, he prepared the 1992 financial statements. In 1991 he was an employee of Coopers & Lybrand, Laliberté, Lanctôt, which had prepared Référium’s financial statements for 1991. However, he did not personally participate in preparing those financial statements. Mr. Morin admitted that it was common practice in some independent businesses to advance money to their sole shareholders, and before the end of the financial year, to treat these advances as a dividend. He stated that there was no particular advantage to declaring dividends rather than paying a salary during those years. However, he admitted that the payment of a dividend conferred a benefit on Mr. Pauzé in terms of liquidity since there were no source deductions in the case of a dividend. He further admitted that when a company pays a dividend it does not have to contribute to Quebec’s health insurance plan or to the Quebec Pension Plan.

Analysis

The assessment was made pursuant to s. 160(1) of the Act, which reads as follows:

160.(1) Where a person has, on or after the 1st day of May, 1951, transferred property, either directly or indirectly, by means of a trust or by any other means whatever, to

(a) his spouse or a person who has since become his spouse,

(b) a person who was under 18 years of age, or

(c) a person with whom he was not dealing at arm’s length,

the following rules apply:

(d) the transferee and transferor are jointly and severally liable to pay a part of the transferor’s tax under this Part for each taxation year equal to the amount by which the tax for the year is greater than it would have been if it were not for the operation of sections 74 to 75.1, in respect of any income from, or gain from the disposition of, the property so transferred or property substituted therefor, and

(e) the transferee and transferor are jointly and severally liable to pay under this Act an amount equal to the lesser of

(i) the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the properly, and

(ii) the aggregate of all amounts each of which is an amount that the transferor is liable to pay under this Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year,

but nothing in this subsection shall be deemed to limit the liability of the transferor under any other provision of this Act.

[Emphasis added. I

The only condition for applying s. 160(1) of the Act which is disputed by Mr. Pauzé in this appeal is the one in s. 160( 1 )(e)(i) of the Act. In other words, the question to be answered is the following: was the amount of the dividend paid in consideration of the services rendered by Mr. Pauzé to Référium? According to Mr. Pauzé, he received earnings of about $150,000 to $170,000 and, as his salary was only $3,600 in 1991 and $25,327 in 1990, he considers it clear that the $70,000 dividend was paid to him in consideration of his services and that the value of those services was at least $70,000. In support of his arguments Mr. Pauzé cited the decision in Davis et al. v. The Queen, 94 D.T.C. 1934, in which a judge of this Court relied on the following obiter dictum of Dickson C.J. in The Queen v. McClurg, 91 D.T.C. 5001, at p. 5012:

I find this conclusion to be completely supported by the evidence. Wilma McClurg played a vital role in the financing of the formation of the company. Although I agree with Desjardins J. that, with respect to a shareholder, “dividends come as a return on his or her investment” (at p. 370), in my view there is no question that the payments to Wilma McClurg represented a legitimate quid pro quo and were not simply an attempt to avoid the payment of taxes.

Contrary to the argument of counsel for Mr. Pauzé, I am not bound by Mr. Pauzé’s testimony that he received employment income from three separate sources, namely in the form of a base salary, the reimbursement of expenses and advances treated as dividends. The question this Court has to resolve is one of mixed law and fact. As Mr. Pauzé was both an employee and the sole shareholder in Référium, he could be paid both as an employee and as a shareholder. As an employee he could receive a salary for the services he rendered to Référium, and as a shareholder he could receive a dividend representing that company’s accumulated profits. The fact that Mr. Pauzé considered the reimbursement of his expenses to be a form of pay is a very revealing indication that he may have been mistaken as to the tax treatment of the money paid to him by Référium.

Furthermore, I have no doubt that Référium really intended to pay its sole shareholder a dividend. The company was advised by a chartered accountant who was fully aware of the difference between a salary and a dividend. It was precisely because he was well aware of the rules regarding the payment of dividends that he paid only a salary of $73,176 in 1992, unlike previous years. As it had an accumulated deficit of $74,346 at the close of its fiscal year ending February 29, 1992, Référium could not pay a dividend.

The accountant also knew that when a company pays a dividend it does not have to make source deductions and may avoid paying certain payroll taxes. In paying the $70,000 dividend Référium did in fact wish to pay a dividend, not to pay money in consideration of services rendered.

As my colleague Judge Dussault said in Gosselin v. R., 1996 Car- swellNat 2472 (TaxPartner, Carswell CD-ROM), at paragraph 16, a company which pays dividends does not receive any consideration from its shareholders: [1]

The right to a dividend is a right to share in a company’s profits. With respect for those who hold the contrary view, that right arises from only one source: the ownership of shares that carry the right, and nothing else. The dividend is income from "property” and is not pay or compensation for vic rendered. The fact that dividends are given favourable tax treatment when they are received by individuals, under the gross-up and tax credit provisions, is because they represent the result of this very division of a company’s profits, profits which have already, in theory at least, been taxed at this initial stage, and on which the pur- pose is to limit or reduce the impact of double taxation when they are received by individuals. This scheme clearly does not apply to payment for services rendered....

[Emphasis added. I

My colleague Judge Bell also adopted the same approach in /55579 Canada Inc. et al. v. The Queen, 97 D.T.C. 691, in which he stated the following at pp. 693-94: “A dividend is a payment related, by way of entitlement, simply to the interest of the payee as a shareholder”. He also set out the reasons why he did not follow the decision in Davis, supra. I concur with him in this respect.

I would also add that when an employer pays money in consideration of services rendered by an employee it is salary. If Référium had really paid Mr. Pauzé a salary, it should have made source deductions and could have been required to pay certain payroll taxes. If the amount of $70,000 actually represented consideration for services rendered, that is, a salary, it would have been subject to a higher tax than if it were a dividend. Mr. Pauzé would not have been entitled to the dividend tax credit provided for in s. 121 of the Act. Well aware of this, the accountant decided to pay a dividend rather than a salary.

As I conclude that the sum of $70,000 was paid as a dividend and was not paid for consideration, I have no choice but to uphold the assessment.

Before concluding, I would add that Mr. Pauzé’s counsel initially argued that a dividend was not a transfer of property within the meaning of s. 160 of the Act. Apparently, a recent and as-yet-unreported Federal Court of Appeal judgment affirmed Judge Rip’s decision in Algoa Trust et al. v. The Queen, 93 D.T.C. 405, and counsel accordingly withdrew this argument.

For these reasons, Mr. Pauzé’s appeal is dismissed without costs.

Appeal dismissed.