Minister of National Revenue v. Anthony Thomas Leon, Edward Leon and Lewie Leon,, [1976] CTC 532, 76 DTC 6299

Heald, J (concurred in by Ryan, J and MacKay, DJ):—The above three actions are appeals from a judgment of the Trial Division dismissing the Minister’s appeal from a decision of the Tax Review Board vacating income tax assessments in respect of each of the above respondent’s 1965, 1966, 1967 and 1968 taxation years.

The respondent Edward Leon held beneficially all the issued shares in Timmyal Limited, an Ontario corporation incorporated on January 2, 1963. The respondent Anthony Thomas Leon held beneficially 75% of the issued common shares and 100% of the issued preferred shares in Antomel Limited, an Ontario corporation also incorporated on January 2, 1963 (said respondent’s wife, Ellen Leon owning the other 25% of the issued common shares). The respondent Lewie Leon held beneficially all of the issued shares in Midgemar Limited, also an Ontario corporation incorporated on January 2, 1963.

By an order made on consent, all relevant evidence adduced at the trial of the action MNR v Ablan Leon (1964) Limited (File No A-226-74),* which appeal was heard by the Court immediately prior to the hearing of these appeals, will apply to these appeals.

Upon incorporation, Timmyal Limited, Antomel Limited, Midgemar Limited, Geomar Limited (an Ontario corporation, all of the issued shares of which were beneficially owned by George Leon, a brother of these three respondents) and Jomila Limited (an Ontario corporation, all of the issued shares of which were beneficially owned by Joseph Leon, another brother of these three respondents) formed a corporate partnership by means of which the business of Alban Leon Distributors was to be operated, said corporate partnership agreement being also dated January 2, 1963. The Alban Leon Distributors’ furniture business was, in fact, operated by this corporate partnership until May 1, 1964.

By agreement for sale purporting to bear date May 1, 1964 said corporate partnership purported to sell the business of Ablan Leon Distributors, as of April 28, 1964 to Ablan Leon (1964) Limited and the seven primary family trusts purportedly established and referred to in action No A-226-74—MNR v Ablan Leon (1964) Limited.

By letter dated September 14, 1965 to Miss Marjorie Leon, Mr Mark Perlmutter, the chartered accountant advising the Leon family on these matters, advised that the five former corporate partners should not be used as management companies because, in his view, pursuant to paragraph 39(4)(d) of the Income Tax Act and the discretionary provisions of subsection 138A(2), these companies would be regarded as associated corporations taxable at the 52% corporation rate. Accordingly, he recommended that the business pay a management salary to the three respondents and not pay a management fee to their respective companies.

In a further letter dated November 2, 1965 to Miss Marjorie Leon, Mr Perlmutter stated:

However, if these companies are going to provide management services Ablan Leon Distributors as their major activity, it seems to me extremely likely that a direction may be made under Section 138A(a) treating the companies as associated corporations in any event, and the benefit of separate companies may very well be lost. If, however, it is decided to take this risk and to proceed to use the five companies as management companies, it is extremely important that there be written agreements entered into by each company with the Partnership, for the provision of

See p 506.

management services in return for an agreed fee and that there be contracts entered into between each management company and the individual concerned, whereby he undertakes to provide his services on a full-time basis for his company. As we discussed at our meetings, the whole question of the deductibility of the management fee may in itself become a tax problem. It is our considered opinion that the Partnership pay a management salary to the Messrs. Leon, and not pay a management fee to their respective Companies.

The respondents elected not to follow Mr Perlmutter’s advice and decided that the partnership would pay a management fee to their respective companies who would in turn pay a lesser amount by way of salary to the three respondents.

The agreements between Abian Leon Distributors and the three management companies and between the three management companies and the three respondents were dated May 1, 1964 but were in fact executed at some unknown date subsequent to May 1, 1964. The evidence did not estabiish precisely when the management agreements were executed but it was likely at a date after November 2, 1965.

The management agreements between Ablan Leon Distributors and the three management companies provided in paragraph 1 thereof that the stores to be managed were to be designated by Ablan Leon Distributors. Paragraph 5 stipulated that bonuses were to be paid to the management companies pursuant to a subsequent agreement to be entered into between the parties. At the trial, no evidence was adduced of any written designation of stores or of subsequent agreements as to bonuses.

In the case of Antomel and Midgemar, there was no evidence of anything undertaken by or through the companies apart form Abian Leon Distributors.

In the case of Timmyal, Edward Leon devoted a portion of his time to managing and supervising stores known as Times Furniture Stores, including Times Willowdale. Times Willowdale was not a business owned and carried on by Ablan Leon Distributors but was owned by Lewie Leon Limited and Hafurn Sales Limited in equal proportions. Hafurn Sales Limited was not a Leon enterprise. Paragraph 8 of the management agreement between Ablan Leon Distributors and Timmyal stipulated that Timmyal was not to be employed or engaged in any similar business without the written consent of Abian Leon Distributors. Times Willowdale was a similar business, and Ablan Leon Distributors did not consent in writing to Timmyal’s management thereof contrary to said paragraph 8. There was no evidence of any management agreement between Timmyal and either or both of Lewie Leon Limited or Hafurn Sales Limited nor between Ablan Leon Distributors and either or both of said two companies. There was no evidence of anything undertaken by or through Timmyal apart from Ablan Leon Distributors and Times Furniture Stores.

In the case of Timmyal and Midgemar, during the years under appeal, the companies had no telephone directory listing—their offices were those occupied by the respondents Edward Leon and Lewie Léon in their respective capacities with Ablan Leon (1964) Limited. Neither company had a printed letterhead and their respective financial statements showed no payment for rent. In the case of Antomel, during the years under appeal, it had no telephone directory listing; its office was that occupied by the respondent Anthony T Leon in his capacity as president of Ablan Leon (1964) Limited; it had no printed letterhead; its financial statements show no payment for rent and it had no employees other than the respondent Anthony T Leon and a messenger who was paid $50 per month.

In the case of all three respondents, the role of each of them in the Leon furniture business did not change materially after May 1, 1864 as a result of the “reorganization” of the business but only as necessitated by the growth of the business.

Based on the evidence adduced, the learned trial judge made the following findings of fact, inter alia:

(a) that each of the respondents had control in and over each of their management companies (Timmyal, Antomel and Midgemar), and since between them they controlled Ablan Leon (1964) Limited, they were in a position to exert influence in the matter of the bonuses to be paid to the management companies;

(b) that each respondent was, for all practical purposes, in a position to control the salary paid by his management company to himself;

(c) none of the three management companies had any employees or at least none of any significance other than the particular respondent who controlled the particular management company;

(d) each of said three management companies were without some of the common and usual facilities of a business such as a telephone or an office of its own;

(e) ail of the services each of the management companies were to supply under their respective management agreements were performed by the particular respondent controlling the particular management company and that which was important to the business of Ablan Leon Distributors was the services of the three respondents as distinguished from the three management companies;

(f) the sole purpose of the interposition of the management companies was to reduce the respondents’ liabilities for income tax, and the utilization of the management companies for that purpose was accomplished through the respondents’ control of Ablan Leon Distributors along with the co-operation of George Leon and Joseph Leon who also had financial interests in it.

Respondents’ counsel urged us to accept the findings of fact of the learned trial judge and counsel for the appellant agreed. (See, for example, appellant’s memorandum of fact and law—Anthony Thomas Leon case—page 7.) A perusal of the evidence satisfies me that said findings of fact, as above enumerated, were clearly justified on the evidence, and should be allowed to stand.

After making these findings of fact, the learned trial judge went on to state at pages 12 and 13 [[1974] CTC 588 at 594] of his judgment:

Each of Antome! Limited, Timmyal Limited and Midgemar Limited were separate, distinct and existing corporate entities. It is a commonplace that notwithstanding a shareholder may be in control of a corporation of which he is a shareholder, the shareholder and the corporation are also separate and distinct entities.

I find:

(a) that Ablan Leon Distributors entered into an agreement with each of the three corporations namely Antomel Limited, Timmyal Limited and Midgemar Limited whereby those corporations respectively were to provide management services to Ablan Leon Distributors;

(b) that those corporations did supply the services they respectively undertook to provide for Ablan Leon Distributors; and

(c) that those corporations were entitled to be paid for those services.

It seems to me to be irrelevant under the circumstances of these three matters that it was intended that the services which the corporations were to provide would be and were performed by the respondents.

It is my view that the plans involving the management corporations in the Anthony Thomas Leon, the Edward Leon and the Lewie Leon matters were implemented and what was projected was actually carried out.

I am satisfied that the onus which rests upon each of Anthony Thomas Leon, Edward Leon and Lewie Leon, heavy as it is under the circumstances here, has been met.

It follows that Antomel Limited, Timmyal Limited and Midgemar Limited were carrying on active commercial businesses and that the provisions of the Income Tax Act regarding “personal corporations” would not apply.

The appeals in the Anthony Thomas Leon, Edward Leon and Lewie Leon matters are dismissed with costs.

Appellant's counsel, while agreeing with the findings of fact of the learned trial judge, does not agree with the conclusions which he reached as to the disposition of these particular assessments. It is the submission of appellant’s counsel that from the above findings of fact there should flow a conclusion that the moneys paid by Ablan Leon Distributors to the management companies owned by the three respondents during the years under review is income taxable in the hands of the three respondent brothers rather than in the hands of the management companies.

The respondents rely on the case of MNR v J A Cameron, [1972] CTC 380; 72 DTC 6325; 2 DLR (3d) 477, affirming [1971] CTC 97; 71 DTC 5068. However, the Cameron case is clearly distinguishable on its facts. In that case, there were findings of fact to the effect that the primary purpose for incorporation of the company and for the resulting agreement was to serve as a vehicle whereby senior employees of the employer could purchase an interest in the employer corporation, said corporation through its controlling shareholder having decided that he did not wish to deal with said senior employees in their personal capacities. In effect, said finding amounts to a finding of a bona fide business purpose for subject transaction. In the case at bar, no such bona fide business purpose is present since the trial judge found “that the sole purpose of the interposition of the management companies was to reduce the respondents’ liabilities for income tax”. What the furniture business of Ablan Leon Distributors desired was the management services and expertise of the three respondents. These services could have just as easily been provided without the intervention of the management companies (which was the procedure recommended by the tax adviser, Perlmutter). Thus there was no bona fide business purpose, merely a tax purpose, for the interposition of the management companies.

Respondents’ counsel is quite correct in stating that for incorporation of Timmyal, Antomel and Midgemar there was a bona fide business purpose in that prior to May 1, 1964 these three companies along with Jomila and Geomar Limited owned the Ablan Leon Distributors furniture business. However, it is one thing to concede a bona fide business purpose for incorporation and quite another thing to concede a bona fide business purpose for the interposition of the management companies in the transaction of providing management services. In my view, for the respondents to be successful in this appeal they must establish a bona fide business purpose in the transaction, which on the evidence in these cases, they have failed to do. It is the agreement or transaction in question to which the Court must look. If the agreement or transaction lacks a bona fide business purpose, it is a sham. lt is, in my view, possible to have a company, the incorporation of which is not a sham, because of the existence of a bona fide business purpose for the incorporation, engaging in a transaction which is a sham, because of the absence of a bona fide business purpose for said transaction. The cases at bar are, in my opinion, examples of such a situation. The judgment of the Supreme Court in the Cameron case (supra) makes it clear that the Court was directing itself to the question as to whether or not the agreement was a sham. In the Cameron case (supra) there was a bona fide reason for the agreement or transaction, and the savings in income tax were incidental. In the case at bar, there is no bona fide business reason for the agreements and the sole purpose of the agreements is the savings in income tax.

The case of Holmes v The Queen, [1974] FC 353 at 371 and 373; [1974] CTC 156 at 168; 74 DTC 6143 at 6151, is another case where the Court looked at the agreement or transaction in question from the point of view of whether “genuine business reasons” existed for payment of a management fee under the contract.

The judgment of President Jackett (as he then was) in Lagacé v MNR, [1968] 2 Ex CR 98; [1968] CTC 98; 68 DTC 5143, is also, in my view, germane to the situation here present. At page 109 [107, 5149] of the judgment, the learned President said:

The most significant feature of the appelants’ contention in this Court, as it strikes me, is that it is inherent in the contention that profits that would otherwise have accrued to the appellants have ended up in the name of a company controlled by them, not because of bona fide business transactions between the appellants and such compny, but because of transactions that have been arranged between them to implement a contract between the appellants and a third person to accomplish objects desired by the third person. In other words, the contention is based on the assumption that profits of the appellants’ business operations were put into the hands of the company by a device and that the profits were not the result of the company having embarked on business transactions. In my view, therefore, the short answer to the contention, even assuming the facts to have been established, is that, for purposes of Part I of the Income Tax Act, profits from a business are income of the person who carries on the business and are not, as such, income of a third person into whose hands they may come. This to me is the obvious import of sections 3 and 4 of the Income Tax Act and is in accord with my understanding of the relevant judicial decisions.

As in that case, here also it can be said that the remuneration or operating and managing the business is the income of the individuals who actually operate and manage the business, and not the income of a third person such as the three management companies into whose hands the income may come.

Pertinent also to a discussion of this issue is the view expressed by Lord Denning in Littlewoods Mail Order Stores Ltd v McGregor (1967), 45 TC 519, where he said at page 536:

The doctrine laid down in Salomon v Salomon, [1897] AC 22, has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the Courts cannot see. But that is not true. The Courts can, and often do, draw aside the veil. They can, and often do, pull off the mask, They look to see what really les behind. . . .

In the case at bar, when the veil is pierced and the mask removed, it is clear that the three individual respondents who in fact “ran” the Ablan Leon Distributors furniture business, a very large business, also, in fact, earned the remuneration which was “diverted” to the management companies where the income attracted a lower rate of income tax. This portion of their remuneration was then recouped by them through redemption of preference shares. Thus, the interposition of the managment companies between the employer and the employee was a sham pure and simple, the sole purpose of which was to avoid payment of tax. Accordingly, in my opinion, the transactions cannot be allowed to stand, the Minister’s appeals should be allowed in all three cases and the assessments under review should be restored. Since all three appeals were argued together, the appellant should be entitled to only one set of costs against the respondents.