Louis-Yvan Morin v. Minister of National Revenue, [1979] CTC 3093, 79 DTC 865

Guy Tremblay:—This case was heard at Quebec City, Quebec, on September 12, 1978.

1. Point at Issue

The question is whether the appellant is correct in regarding Y Morin Associés Inc (the principal purpose of which is providing administrative and financial consultation services) in the 1971, 1972, 1973 and 1974 taxation years as being in fact (and not only in law) a different entity from the accounting partnership Morin, Dufresne, Cloutier, Bédard & Associés, CA.

According to the respondent, the company is only a tool used by the appellant in order to reduce taxes.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of 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. Facts

3.01 The appellant is a chartered accountant and has been carrying on his profession since 1962. He is a member of the accounting firm of Morin, Dufresne, Cloutier, Bédard & Associés, CA, hereinafter referred to as ‘‘the partnership”.

3.02 From 1962 to 1978, the members of the partnership divided profits in the following manner:

1962 to 1965 (three partners): one-third for each partner;

1965 to 1968 (four partners): 30%, 30%, 30%, 10%;

1968 foil: on the merits of each account, evaluated depending on the period and the type of work done by the partner.

3.03 In March 1970, a company was formed under the name of “Morin, Dufresne, Cloutier, Bédard Inc”. The purposes of the company, as they appear in the letter patent filed as Exhibit A-4, are the following:

1. to act as a financial consultant;

2. to act as a management consultant;

3. to manage or supervise the business and the operations of companies or businesses, municipalities, corporations, governments and any person or association;

4. to invest the company’s funds in shares, bonds, debentures and other securities and in real estate and to hold, manage and realize on these investments.

3.04 By supplementary letters patent dated August 27, 1971, the name of the company became “Y Morin, Associés Inc” (hereinafter referred to as “the company”).

3.05 The shareholders’ register of the company indicates that the first issue of ordinary shares was on May 1, 1970, namely 16 ordinary shares distributed as follows:

A second issue of shares took place in 1977, that is after the years con- cerned in the case at bar.

3.06 The partnership’s fiscal year ends on June 30 and that of the company on December 31.

3.07 The contention of the appellant regarding the purposes for which the company was formed is, first, that like many public accounting firms it wishes to offer also specific consultative services, which are different from the services generally provided by a public accountant.

As Exhibit A-2, the appellant filed a letter dated July 16,1970, from the Institute of Chartered Accountants of Quebec to the partnership Morin, Dufresne, Cloutier, Bédard et Associés. This letter reads as follows:

I am pleased to inform you that, at a recent meeting, the Council approved use of the firm name Morin, Dufresne, Cloutier, Bédard Inc for the operation of a management consulting firm associated with your firm of chartered accountants, the whole in accordance with the existing regulations.

Please note that this firm name can only be used if both firms consist of the same partners. If one firm includes partners who are not also associated with the other, the firm names must be clearly differentiated.

3.08 Another reason given by the appellant for forming the company was that this made it easier to divide the fees from each account, since division was based on merit, as explained in paragraph 3.02.

3.09 As examples of services rendered to customers other than accounting services, the appellant filed an invoice (Exhibit A-1) made out to Bois- Fontaine Inc. The description of the work is as follows: “For professional services rendered from January to April 30, 1974, on the corporate level—(Yvan Morin) $2,290”. In his testimony, the appellant described his work in more detail. He replaced the board of directors. He dismissed the general manager. He reorganized the administrative staff. In fact, for this company the mandate (which lasted from 8 to 15 months) consisted, (as the result of a loss of one million dollars in the preceding year), principally in seeing what was going on, studying the situation, solving problems and organizing matters so that business would improve.

3.10 For the company, the appellant had as a client the American company which is the principal shareholder in Bombardier.

3.11 For the company, the appellant rendered financial consulting services to CB and B Enterprises. The principal in question wished to diversify its investments in Florida and in Europe. In Florida, inter alia, he created an organization to buy and sell land. He contacted and met with lawyers, accountants and real estate brokers to provide the legal and accounting organization necessary for successful conduct of the business. This mandate lasted two to three years.

3.12 He also administered the portfolio of an important businessman, diversifying investments and so on.

3.13 In addition, he was authorized to purchase and sell businesses.

3.14 He was given a mandate by the principal shareholders in a company to audit it and give his conclusions. The appellant decided to close down the business. He had to negotiate with suppliers, take over the inventory and so on.

3.15 The company did not provide management services to the partnership, although it did so to other organizations.

3.16 As Exhibits 1-2, I-3, 1-4 and I-5, accounts submitted to clients during 1971, 1972, 1973 and 1974 were filed jointly and total as follows:

3.17 TheClients to whom the foregoing invoices were sent and whose names recur most often were: Claire B Beaudoin, P A Beaudoin Inc, Placage Automatique Drummond Inc, Placements Bombardier Ltée, J A Fontaine & Fils Inc, Unique Art Inc, Provincial Mobile Inc, Rodrigue Bédard Enr, Allard 5-10-15 Ltée, CB & B Enterprises, Gill Truck Plaza Inc, Imprimerie Laflamme Ltée, Industrie L’Islet Inc and Dufresne & Légaré Inc. According to the description of the work done on these accounts, some of it was purely accounting work and some involved administration, investment consulting, reorganization and so forth.

3.18 The appellant was the principal agent in providing the company’s services to clients. However, there was no contract between him and the company to this effect. It was sometimes necessary for him to get help from others. During 1971 to 1974, he was not paid any dividends or salary.

3.19 According to the appellant, certain clients were both clients of the partnership (for accounting work) and of the company (for administrative work, financial consulting, and so on). Remuneration for purely accounting services was ultimately retained by the partnership. Remuneration for other work was paid to the company once a year. Invoicing was done on the same invoice, without distinguishing between amounts owed to the partnership and to the company. The great majority of clients were persons who came to the partnership or the company through the appellant’s personal intervention. Except for certain special ones, these clients did not know of the company’s existence.

3.20 The company filed tax returns in which it stated:

3.21 The fees reported and expenses claimed resulted from a single annual entry carried to the credit of the company in the partnership’s general journal when it closed its books on June 20 of each year.

3.22 As Exhibit I-8, the witness for the respondent submitted, as set forth below, the income reported by the company and that transferred by the partnership:

3.23 Invoices for work done by the company were addressed to clients by the partnership and on partnership paper on the company’s behalf.

3.24 Clients sometimes paid bills to the company, but they usually paid the partnership, and the amounts paid by clients to the partnership in settlement of the said invoices were paid to the partnership’s bank account; it was not until the end of the year, when income was distributed between the partners, that a certain amount was credited to the company.

3.25 The appellant admitted that the company’s accounting system was somewhat rudimentary. According to the witness for the respondent it was almost non-existent, in the sense that while there were the principal accounting books (ledgers, purchase books, journals and so on) there were almost no entries. In practice, there was only the entry resulting from transfers by the partnership once a year.

3.26 As to the expenses, the company did no advertising. It paid an administrative fee to the partnership and certain costs (telephone, travel and so on). The company had no written contract with the partnership regarding administration. It was not until 1974 that it began paying a salary ($4,111.09). Additionally, the company purchased a farm.

3.27 This farm, located on the Ille d’Orleans, was the property of the appellant before the company was incorporated. It was purchased by the company in 1971 as an investment. After its purchase, the value tripled. The appellant went there with his family on weekends to “make a show of farming” with the few farming implements on the farm. There were also two horses, some chickens and a dog.

4. Act—Case Law—Comments

4.1 Act

The legal provisions concerned in the case at bar are sections 3, 4, 5 and subsection 137(1) of the old Income Tax Act, and sections 3, 4, 5, subsections 9(1) and 245(1) of the new Income Tax Act.

Subsection 245(1) reads as follows:

Artificial transactions.

(1) In computing income for the purpose of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artifically reduce the income.

4.2 Case Law

The cases cited by the respondent are the following:

1. Isaac Shulman v MNR, [1961] CTC 385; 61 DTC 1213;

2. Ralph J Sazio v MNR, [1968] CTC 579; 69 DTC 5001;

3. MNR v James A Cameron, [1972] CTC 380; 72 DTC 6325;

4. Amelia Rose v MNR, [1973] CTC 74; 73 DTC 5083;

5. Her Majesty the Queen v Gerald J Burns, [1973] CTC 264; 73 DTC 5219;

6. Desmond M Connor v MNR, [1975] CTC 2132; 75 DTC 85;

7. Thomas Pallant v MNR, [1972] CTC 2378; 72 DTC 1321;

8. Alfred C Campeau and Michael Petritz v MNR, [1970] CTC 306; 70 DTC 6223;

9. Jack K Holmes, Douglas L Crowe, Peter C G Power and John M Johnston v Her Majesty the Queen, [1974] CTC 156; 74 DTC 6143;

10. Reginald William Edwards v MNR, [1969] Tax ABC 1069; 69 DTC 738;

11. MNR v Anthony Thomas Leon et al, [1974] CTC 588; 74 DTC 6443; [1976] CTC 532; 76 DTC 6299;

12. Vir K Handa v MNR, [1978] CTC 2256; 78 DTC 1191;

13. Leonard Mendels v Her Majesty the Queen, [1978] CTC 404; 78 DTC 6267;

14. Marvin E Goldblatt v MNR, [1964] CTC 185; 64 DTC 5118;

15. Albert A De Mezey v MNR, [1972] CTC 2186; 72 DTC 1174.

The Board also took note of the case law and theory examined in Natural Retreats of Nova Scotia v MNR, [1979] CTC 2481; 79 DTC 391, namely:

16. Ralph J Sazio (cited above);

17. Dominion Bridge Co Ltd v Her Majesty the Queen, [1975] CTC 263; 75 DTC 5150; [1977] CTC 554; 77 DTC 5367;

18. Massey-Ferguson Ltd v Her Majesty the Queen, [1977] CTC 6; 77 DTC 5013;

19. Leonard Mendels v Her Majesty the Queen (cited above);

20. Alberta & Southern Gas Co Ltd v Her Majesty the Queen, [1976] CTC 639; 76 DTC 6362, [1977] CTC 388; 77 DTC 5244;

21. Anthony T Leon et al v MNR, [1974] CTC 588; 74 DTC 6443; [1976] CTC 532; 76 DTC 6299;

22. “The Business Purpose Test—Who Needs It?”: an article by M J O’Keefe in Canadian Tax Journal, Mar-April 1977, pp 139-150;

23. “Evasion fiscale”: an article by Michelle Rochon in Revue générale de droit, published by the Faculty of Law, University of Ottawa, Vol 9, 1978, pp 438 et seq.

4.3 Comments

4.3.1 Subsection 245(1) and the principle of precedent

The principal transactions to which subsection 245(1) applies are artificial transactions.

In the aforementioned article, “Evasion fiscale” (tax evasion), Michelle Rochon gives an exact definition of artificial transactions and a good summary of the two aspects from which the courts have examined this question:

Artificial transactions are real transactions which the parties intend to carry out, but which are prompted solely or primarily by a desire to avoid taxes. Although the name gives rise to confusion, it is not the operation itself which is artificial but the fiscal result of the transaction. It is here that reference may be had to the concept of an agent and that of the business purpose test. At this point, the discussion is concerned with the intent, the principal reason for the transaction. This is the true scope of s 245(1).

(A) The concept of an agent

4.3.2 The concept of an agent is applicable in cases where the income of one person (an individual or a corporation) becomes the income of another person.

The situation most often found is that of a shareholder in relation to his corporation, the latter being within the scope of sections 3, 4, 9 and 245 of the Income Tax Act and becoming merely a tool in the hands of the shareholder to minimize the tax burden. In such a case the Income Tax Act does not take into account the distinction which exists in corporation law, namely that a corporation is an entity distinct from the shareholder (an individual or another corporation). The income is taxed in the hands of the shareholder. When in practice the Court recognizes the existence of two entities, it does not apply section 245 (see Ralph J Sazio v MNR, cited above) and income is then taxable in the hands of the corporation, not the shareholder.

Jackett, P of the Exchequer Court stated in E and G Lagacé v MNR, [1968] CTC 98; 68 DTC 5143:

. . . for the purposes of Part I of the Income Tax Act, benefits resulting from a commercial enterprise are income for the person carrying on that enterprise and are not, as such, income of a third party in whose hands they may actually be.

In my opinion this is clearly the meaning of ss 3 and 4 of the Income Tax Act and it is also in accordance with the case law as I understand it.

In the case at bar, who was the person who earned the income? Was it the appellant or the company?

4.3.3 In order to give an adequate reply to this question, it would appear that the following points should be considered:

1. Who did the work from which the company received the profits?

2. Who, before the incorporation, was doing work of the same nature?

3. What effect did the appellant have on practical management of the corporation?

4. What was the company’s pay policy with respect to the appellant?

5. What was the administrative organization of the company?

6. Was there a mutual connection and justification between the existence of the company, its purpose and the services rendered?

4.3.4 In reply to question one, it seems quite clear (paragraph 3.18) that physically the greater part of the work was done by the appellant. While it is true on the one hand that a company can only act through its employees, nevertheless the fact that this employee, almost the only employee, was the appellant, that is to say the principal shareholder, is a point which in the context of the case at bar tends to indicate an operation having an artificial result for tax purposes.

4.3.5 The reply to question two is along the same lines as question one. According to the appellant, the purpose of the incorporation was to help facilitate the division of fees on the merits (paragraph 3.08). This situation, regarding the manner of dividing fees on the merits of each account, had existed from 1968 onwards. The incorporation occurred in 1970 (paragraph 3.05). The appellant did not convince the Board of the necessity or effectiveness of the corporate instrument in assisting with the distribution of fees on the merits. In any case, the fees were only transferred annually from the partnership to the company. The fact that the incorporation thus changed nothing over the preceding period does not work in favour of the appellant’s argument.

4.3.6 Question three, “What effect did the appellant have on management of the company?”, must be answered by saying that the appellant was legally in control (he held 12 out of 16 shares—paragraph 3.05), and in practice he was the principal and almost the only intermediary between the company and the clients (paragraph 3.19 in fine). This point also does not support the appellant’s argument.

4.3.7 The company’s pay policy respecting the appellant, which is the subject of the fourth question, is clear: he received no salary or dividends during the years in question.

In Shulman v MNR, Ritchie, J stated:

Had the main objective of the appellant not been so to order his affairs as to reduce tax, he would have drawn some salary as compensation for the time spent . . . as administrator of Shultup . ..

The non-payment of any direct remuneration of the appellant for the services performed as agent for Shultup is opposed to the usual and natural relationship existing between a company and an agent who devotes from one-third to one-half of his time to the business of the company.

In the case at bar the appellant, according to his testimony on his work, spent most of his time working for the company, yet he did not receive any remuneration.

4.3.8 On the other hand, the administrative organization of the company, which is the subject of the fifth question, appears to favour the respondent’s argument.

Thus, the evidence showed that the company did not have a very complex administrative organization. Certain facts should be noted:

(1) the fact that the company was administered by the partnership (see paragraphs 3.23 and 3.24 of the facts) (collection of accounts by the partnership, on partnership paper, bookkeeping for accounts done by the partnership); (2) the fact that invoicing of partnership accounts was on the same invoice as that of the company (on partnership paper), without distinguishing how much was owed to the partnership and how much to the company (paragraph 3.20 of the facts); (3) the fact that the company’s accounting system was rather rudimentary, with a transfer once a year from the partnership account and fees earned by the company (paragraph 3.25 of the facts); (4) the fact that there was no written contract with the partnership regarding administration; (5) finally, the fact that the great majority of the company’s clients were unaware that it even existed. No advertising was done to distinguish the company from the partnership. The company’s premises were in those of the partnership. The same telephone line was used.

Taken together, all these facts support the argument of the respondent that the person who carried on the business does not appear to have been the company, but Mr Morin through the partnership. The company appears to have been only a tool used to artificially reduce the appellant’s income.

4.3.9 Was there a mutual connection and justification between the existence of the company, its purpose and the services rendered?—that is the sixth question.

4.3.9.1 The existence of management and consulting companies attached to many public accounting firms (paragraph 3.07 of the facts) indicates a current practice filling a need in the business world.

4.3.9.2 The purposes of the corporation as indicated in the letters patent (paragraph 3.04 of the facts), the nature of the work done or the services rendered in management and consulting (paragraphs 3.09 to 3.17 of the facts) also clearly seem to support the appellant’s argument that the formation of the company was in response to a real need. This appears to have been the substance; the rest seems to have been mere form.

4.3.9.3 In addition, certain points which seem unfavourable to the appellant can be refuted.

(a) The absence of written contracts is a commonly accepted practice in the business world between individuals who knew each other, Massey- Ferguson Ltd v Her Majesty the Queen, [1977] CTC 6; 77 DTC 5013. Here this fact would seem to be normal between the company and its principal shareholder, between the company and the partnership in which the principal partner is also a shareholder of the company. However, it is clear that a question arises regarding the presentation of evidence that a contract ex- isted. In the case at bar the problem does not arise, nonetheless, since secondary facts (accounting entries in the partnership books) appear to confirm the verbal agreement of the contract of administration.

(b) The existence of rudimentary bookkeeping for the company may be justified by the fact that the books were kept by the partnership. Additionally, it must be realized that although the system of accounting is one necessary part of a business, it is nonetheless an incidental aspect compared with the principal function. The business does not exist for the accounting system, it is the accounting system which exists for the business. It serves to give a better understanding of the business’s financial position, and so to contribute to greater financial success. If the accounting system is inadequate, the business may suffer hardship as a result, but this does not prevent it from functioning.

(B) The commercial purpose of the operation

4.3.9.4 (a) As the fundamental formality of incorporation was compiled with in establishing distinct agreements between the appellant and the company;

(b) as the existence of the corporation appears to be justified both by the current practice of accounting firms forming related companies of the same nature as that of the appellant, and by the consulting and management services requested by clients;

(c) as on account of the services rendered to clients the purposes of the company were substantially carried out;

(d) as the facts thus substantially confirm the fundamental principles of corporate and commercial law, the Board on first sight would be inclined to allow the appeal.

However,

(a) as the appellant is the principal shareholder of the company;

(b) as the appellant was responsible for managing the company;

(c) as most of the company’s consulting and management work was done by the appellant;

(d) as no salary was paid to the appellant;

(e) as the partnership from which the appellant received his salary sent out the company’s accounts on its own paper, without even distinguishing between the part of the account pertaining to the partnership and the part pertaining to the company;

(f) as the company was not in practice known by the clients and for that reason alone appears to have been only a front;

(g) as the evidence concerning one of the principal purposes for which the company was formed, namely the division of fees, did not persuade the Board;

was there a sufficient basis for a finding that the purpose of the transaction was not a business purpose, that in fact it was, as stated in s 245(1), “an operation that, if allowed, would unduly or artificially reduce the income”? It is clear that the question is often one of degree.

It is not always easy to draw the dividing line, but an operation may be regarded as valid to the extent that it complies with the principles of a commercial transaction. However, as M J O’Keefe emphasized in his article The Business Purpose Test—Who Needs It?: “There is a negative judicial reaction or feeling of repugnance toward blatant tax avoidance schemes which causes the courts to strive mightily to strike down such schemes and protect the fisc [sic] against the ingenuity of tax planners if there is no valid business purpose of the transaction”.

In the opinion of the Board, this is not a blatant, obvious plan to avoid taxes; the question is one of degree and the dividing line is not easy to draw.

4.3.9.5 Although the legal formalities exist, and appear at first sight to demonstrate a commercial transaction in substance;

nonetheless, as the burden of proof rests with the appellant and there are too many points working against the appellant’s argument, and tending to favour the view that the corporation was simply the appellant’s agent, seriously vitiating the commercial purpose of the transaction, the Board concludes that it is more in keeping with the Act and the principles laid down by the courts for the appeal to be dismissed.

5. Conclusion

The appeal is dismissed in accordance with the foregoing reasons for judgment.

Appeal dismissed.