DR George W I Titeley and DR Gerald W B Carvell v. Minister of National Revenue, [1977] CTC 2045, 77 DTC 36

A J Frost:—These appeals, heard concurrently on common evidence, are from Notices of Reassessment dated March 10, 1975, with respect to the appellants’ 1970, 1971, 1972 and 1973 taxation years.

The appellants are engaged in the practice of optometry in the City of Red Deer, Alberta. In 1969 the appellants caused Activ Optical Ltd, hereinafter referred to as "Activ”, to become incorporated, which company carries on the business of dispensing and selling optical goods. The business and the professional partnership occupied the Same premises, used the same staff and, for all practical purposes, were under the direction and control of the appellants.

The shareholdings of Activ are as follows:

Class A Non-participating common shares:

The appellant Dr George W I Titeley	200 shares at 1¢ each
The appellant Dr Gerald W B Carvell	100 shares at 1¢ each

Class B Non-voting, participating common shares:

Mrs Titeley	2,000 shares at 10 each
Mrs Carvell	1,000 shares at 1¢ each

The rights, obligations and conditions attached to the shareholdings gave control to the Class A shareholders, the two appellants. Class B Shareholders had no votes, but were entitled to dividends and a return of capital in the event of a dissolution or winding-up of the companies. Under this arrangement, the appellants paid themselves management fees of $18,000 each and declared dividends in favour of their wives in the years under appeal as follows:

For an investment of $20 Mrs Titeley received $65,250 in dividends in four years, and Mrs Carvell, for her $10 contribution, received a return of $32,625 for the same period. Every $1 invested returned $3,262.50 over a four-year period. The wives, however, did not receive the above funds in cash, but reported them for tax purposes. Payment was accomplished by a journal entry on the books of Activ and the issuance of non-interest bearing notes in favour of the appellants’ wives.

On the evidence, I find:

(1) that the capital of Activ was so thin that for practical purposes it was non-existent;

(2) that Activ was incorporated for sound business reasons and carried on a bona fide commercial operation distinct from the professional practice of the appellants;

(3) that Activ was not a sham company: it served a bona fide commercial function and its existence was known to outsiders;

(4) that the total sales of Activ were not the gross revenues of the professional partnership; although the partnership was the main source of earnings generating about 70% of the revenue, incomesplitting was not established;

(5) that all aspects of the management of Activ were under the control of the appellants and all decisions of importance were made by them, including amounts paid as dividends and fees to be paid for management services; and

(6) that the appellants’ wives never received their dividends in cash or had control over the funds declared payable to them as shareholders; however, in each year under appeal the wives reported the dividends in their income tax returns.

The question at issue in this appeal is whether the appellants conferred a benefit on their wives, using Activ as a facility for this purpose.

There is no doubt that the practice of optometry lends itself to the carrying on of a bona fide business of a merchandising nature that goes hand in hand with the practice of optometry as a profession.

A person coming into the place of business of the appellants (a) had his eyes tested and bought glasses, (b) had his eyes tested and didn’t buy glasses, or (c) bought glasses and didn't have his eyes tested. These transactions were meticulously recorded in the various columns of the memo book in the order in which they occurred. The columns were periodically totalled and journalized in the financial records of the partnership and Activ. As far as the Board could determine, there was nothing wrong with the accounting methods employed in recording transactions, which clearly indicated that Activ was active on a day-to-day basis. Further, the financial statements showed total sales of merchandise, from which was deducted the cost of sales, establishing gross margins of profit that were reasonably consistent from year to year. The balance sheets of Activ appear to accurately reflect the state of the company’s affairs, and the minutes of meetings of the board were in order.

The appellants operated their merchandising business in a legally correct manner as far as the details of operation were concerned. However, the broad question arises: Did the appellants go to such extremes in arranging their affairs that they caused dividends to be paid to their wives which, pursuant to subsection 56(2) of the Income Tax Act, must be considered as taxable to the appellants as if they themselves had received the dividends?

It looks as if the appellants attempted to grasp all, forgetting the risk of losing all as a consequence thereof. There is an old adage to the effect that, if you try to drain the last drop of beer from a stein, the lid will fall down and hit you on the nose.

As respondent’s counsel succinctly said:

Here you have the doctors receiving remuneration from a company for which they do everything and the profits or the fruits of their efforts go to the wives in the form of dividends.

Some time later in his argument, counsel pointed out:

There may be good business reasons for the incorporation of a company when one is carrying on the practice of optometry. I can see arguments in favour of it; good sound business reasons; but, Sir, what are the good sound business reasons for incorporating a company and doing all the work, providing all the services, when you cannot even get a capital return out of that company. That is specifically denied the two doctors in this case. Everything must go to their wives. That, Sir, is not sound business practice.

There is no question but that a business purpose lay behind the creation of Activ. However, business practices require some degree of normality on the part of taxpayers. Schemes cannot be entered into for the blatant avoidance of income taxes. The appellants in the case at bar carried on their business operations as if everything belonged to them. They made all decisions, kept control of every important business detail, and retained for their own benefit those funds which were shown on the books of Activ as dividends to their wives. In my opinion, the appellants went to such lengths in the handling of their affairs that they produced an end result unacceptable for income tax purposes.

Appeals dismissed.