June M Meronek v. Minister of National Revenue, [1977] CTC 2111

A W Prociuk (orally: October 15, 1976)—The appellant, June M Meronek, widow of the late Harry Meronek, appeals from the respondent’s reassessment of her income for the taxation years 1969, 1970, 1971 and 1972, wherein the following amounts were added to her income for the respective years and taxed accordingly: for the taxation year 1969, $24,999; for the taxation year 1970, $17,500; for the taxation year 1971, $49,879; and for the taxation year 1972, $8,000.

These sums were added on the ground that she acquired certain preferred shares and outstanding notes of Equipment Distributors Ltd for a nominal sum with the intention of turning same to account within the meaning of paragraph 139(1 )(e) of the former Income Tax Act and subsection 248(1) of the present Act.

Alternatively, the respondent states that the appellant has had benefits conferred upon her by the said Equipment Distributors Ltd in the said sums and in the said years, whereas the appellant contends that this was a fortuitous non-taxable capital return on her small investment. The facts are essentially not in dispute.

Mrs Meronek testified personally in support of her appeal. Her late husband Harry, his brother John, and one Ernest C Stilling were the principal shareholders of Merstill Management Ltd, hereinafter referred to as “Merstill”, a holding company incorporated pursuant to the laws of the Province of Manitoba, which in turn owned Markwell Industries Limited, a farm machinery manufacturing company doing business since 1969 in the City of Winnipeg, Manitoba.

Harry Meronek was a chemical engineer, his brother John was a materials engineer, and Stilling was a chartered accountant. They did well in this manufacturing business, but it was seasonal work and they were anxious to branch out into industrial manufacturing in order to have year-round employment for themselves and their employees.

Equipment Distributors Ltd, hereinafter referred to as “Distributors”, in 1964 and prior thereto, was in a type of industrial manufacturing business that appealed to the officers of Merstill and, after some discussion with Distributors, Harry Meronek wrote to Distributors on February 1, 1965, setting forth the terms of purchase in a letter and attached memorandum thereto. (See Exhibit A-1.)

It is obvious that Distributors was in financial difficulties, and it was a term of the offer that all liabilities be settled by Distributors before the takeover date of the entire business as a going concern. I also note that Distributors was in a tax loss position, and this was probably another factor that made the purchase of this concern advantageous for the purchasers, although I do not think that this was the governing factor. There was no evidence adduced on this latter point.

An agreement for sale, with a takeover date of March 1, 1965, was executed. (See Exhibit A-2.) Distributors and its primary financial guarantor, McWilliams, settled its outstanding liabilities. McWilliams also paid off the bank loan which he had guaranteed, and obtained a promissory note from Distributors, prior to the takeover by Merstill, in the amount of such payments totalling $147,426.07, which together with the preferred shares, was assigned to the appellant, (wife of Harry Meronek), to Mary Meronek, (wife of John Meronek), and to Ann Stilling, (wife of Ernest Stilling), in equal shares, for a consideration of $1 from each.

The issued and outstanding common shares of Distributors were transferred to Merstill. Distributors, now owned by Merstill, commenced manufacturing industrial equipment, with some success.

On February 20, 1967 an agreement filed as Exhibit A-4 was executed to the effect that Harry Meronek purchased the interests of Stilling and John Meronek, and the appellant acquired the interests of Ann Stilling and Mary Meronek in Distributors, for a consideration of $1.

Harry Meronek also had less than a one-third shareholder’s interest in Aerofoam Chemicals Ltd. By arrangement with Distributors, of which Harry Meronek was now the principal shareholder, Aerofoam Chemicals engaged Distributors for management purposes, and Distributors was paid management fees for services rendered by its shareholder, Harry Meronek, to Aerofoam.

In the years under appeal, Distributors made sufficient profits from its operations and management fees to enable it to retire its liability to the appellant and to redeem its preferred shares in each year in the amounts stated earlier, which gave rise to this appeal.

Counsel for the respondent argued that, from the outset, this was a carefully preconceived scheme or plan by the late Harry Meronek for use as a method of channelling tax-free money from his business for his own purposes. He cited three cases in this regard, the principal one being MNR v Sissons, [1969] CTC 184, 69 DTC 5152, a decision of the Supreme Court of Canada wherein Mr Justice Pigeon, for the Court, reviewed the judgment of Mr Justice Gibson in the same case in what was then the Exchequer Court of Canada ([1968] CTC 363, 68 DTC 5236) and went on to state, at pages 187 and 5154 respectively:

With respect, I am unable to agree for the following reasons.

(a) That the debentures came into existence for a full consideration in a market over which the appellant (respondent in this Court) had no control is irrelevant to the issue which is the character of the operation whereby he Subsequently acquired them. It is also inconclusive, when an investment dealer underwrites a bond issue such is usually the situation, it is nonetheless a business operation.

(b) The loss to the original owners is equally immaterial and inconclusive. If a man in difficult financial circumstances sells a prized possession, say an old painting, to an art dealer for a fraction of what it is worth, the dealer’s profit on the resale is clearly income although the former owner has suffered a capital loss when disposing of it.

(c) That the acquisition was in an arm’s length transaction at market value is also irrelevant and inconclusive. Even if a stock promoter obtains shares in a new mining company at full market price, a profit he makes on the resale, if the promotion is successful, is undoubtedly from a “business”.

(d) As to the fact that the gain arose at least in part from respondent’s efforts, this clearly tends to show not that it is a capital gain but profit from a “business”. One of the characteristics of income from such a source is that it is essentially the result of the businessman’s efforts.

(e) Finally, respondent’s gain cannot properly be considered as having arisen fortuitously. On the contrary, uncontradicted evidence shows that it is the result of a carefully considered plan executed as conceived. It is true that there is some evidence that the profits from the stamp business carried on for the benefit of Sonograph were greater and quicker than anticipated. This does not make them fortuitous in the legal sense.

In my humble opinion, the situation in the instant case is substantially different. The purposes and intention of acquiring the assets of Distributors are not in any way similar to the situation in the Sissons case. Here, the purpose was to manufacture equipment of a different category on a year-round basis. Sales tax requirements necessitated a separate entity and, as well, the new company provided steady employment for Merstill’s principal shareholders and for the company’s employees.

The appellant was a holder in due course of the promissory notes and owner of preferred stock in her own right. For her, this was an investment, however meagre the outlay might have been at the outset. Prior to the assignment and transfer of the notes and preferred shares, McWilliams had been in exactly the same position, and if he could legally enforce his rights, and unquestionably he could, I see no valid reason why the appellant could not do likewise.

McWilliams, in enforcing his rights, would certainly not have been assessed on the proceeds of recovery as proceeds from an adventure in the nature of trade, or on a preferred benefit basis. The fact that the appellant was the wife of one of the principal shareholders, a man who, the evidence convinces me, was a tremendous worker, a good manager and a driving force behind the said company, does not preclude her from claiming what by law is rightfully hers.

She was not an officer of the company, took no part in its business management, and in fact had nothing to do with the companies that produced the income and which eventually honoured the notes and redeemed the preferred stock held by her.

The appeal is therefore allowed and the matter is referred back to the respondent for reassessment accordingly.

Appeal allowed.