Lenco Fibre Canada Corp v. Minister of National Revenue, [1974] CTC 2033

Roland St-Onge (orally: November 2, 1973):—This is an appeal from an assessment dated December 16, 1971 in respect of the appellant’s 1967, 1968 and 1969 taxation years. The respondent contended that in those years, Lenco Fibre Canada Corp was associated with Lenco Fibre Corporation and Ben Mandelcorn Inc.

The appellant company was incorporated on May 27, 1966 by Mrs Elaine Mandelcorn, the wife of Mr Leonard Mandelcorn, who was the principal shareholder of Lenco Fibre Corporation as well as of Ben Mandelcorn Inc. Apparently, the above two companies were engaged in the processing and marketing of waste products in Canada, whereas the appellant company earned its income by receiving commissions from the two above-mentioned companies for selling their products on the European market.

The respondent contended that one of the main reasons for such separate existence in those years was to reduce the amount of taxes that would otherwise be payable under the Income Tax Act.

Mr Leonard Mandelcorn testified that Ben Mandelcorn was his father with whom he worked for a certain number of years in the business of old mattresses and scrap bags. In June 1958 his father passed away and thereafter he went into partnership with Allan Goldstein to buy artificial waste from DuPont of Canada and Celanese. He went into bankruptcy. Thereafter Ben Mandelcorn Inc was incorporated on October 2, 1958 to deal in old mattresses and scrap bags, whereas Lenco Fibre Corporation was incorporated in 1959 to deal in synthetic wastes. He testified that Ben Mandelcorn Inc and Lenco Fibre Corporation never earned commissions but paid to some people, or firms, in Canada and the United States, but never to people of the European market.

When Leonard Mandelcorn got married in 1957, his wife, Elaine, took an active part in the business by going to persuade suppliers to sell scrap to her husband’s companies. In 1966 she decided to set up her own company (Lenco Fibre Canada Corp) which would simply act as a commission seller for a fee. At that time a commission was paid to intermediaries and the husband’s companies decided. to consider and treat Mrs Elaine Mandelcorn as another seller for the associated companies, even if prior to the incorporation of the appellant company she was receiving salaries from the said husband’s companies. Apparently, the scrap was sold at prices of 32 cents and 37 cents on the Canadian and American markets and at 62 cents on the European market.

Although the years under appeal were the most difficult to cope with because of price fluctuation, the volume of sales was greater and the husband’s companies lost only 4% of their sales after Mrs Mandelcorn incorporated her own company. At that time the husband’s companies had an office at 4550 St Dominique, Montreal, and the appellant company’s office was at 3 Minden Road, Hampstead, the residence of the husband and the wife.

Upon cross-examination the husband admitted that his wife was the only one to draw moneys from his companies and that from 1961 to 1966 she received the following amounts: in 1961, $1,200; in 1962, $2,500; in 1963, $3,500; in 1964, $3,400; in 1965, $5,800; and in 1966, $11,500; that although he had said he could not travel because he had to stay in Canada to look after the business of his companies, every time she went to Europe he had accompanied her; that in the oral negotiations with the customers he had the last say and was always with her to close the negotiations; that all the invoices were effected by his associated companies; that the commissions were paid to her when it was her customer and in case the merchandise was returned, she had to pay back the said commission. Finally, he admitted that he was the one who decided when she was going to get a commission even if she had the power to bind his companies. He also admitted that ten days prior to the incorporation of the appellant company, his wife had a qualifying share in Lenco Fibre Corporation and she transferred it before the incorporation of the appellant company; that in 1967 the appellant company had no telephone listing and in 1968 and 1969 was advertised in light print in the telephone book under the family tele- phone number; that the sole source of income of the appellant company was commissions paid by his two associated companies.

Mrs Elaine Mandelcorn testified that she had worked for her father who had a hundred employees, that she had a degree in science (chemistry), and had worked for Canadair and Bell Telephone. She corroborated her husband’s testimony and explained that she incorporated the appellant company for her own security because her husband had been in bankruptcy and her father had disowned her and left his estate to her children; that she had paid $500 out of her savings for the shares in the appellant company and did not want to have her husband in the said company; that she had initiated their entry into the European market although her husband was reluctant to travel to Europe and that her company’s only source of income was the receiving of commissions paid by her husband’s companies.

On cross-examination she stated that the appellant company had no staff and no commercial telephone listing but it had a filing cabinet in one room of her residence and stationery bearing its own company name, that she never thought about tax saving, and that her only purpose in causing the appellant company to be incorporated was to be independent and protected against bankruptcy. She also stated that her husband’s companies had the responsibility, in case of refusal of material by the customer, to take back the product, and that her commission was fixed by both of them.

Mr Moses Spector, a chartered accountant who has been preparing the associated companies’ financial statements since 1961, testified that the respondent’s reply to the appellant’s notice of appeal was incorrect in many respects. According to his documents, Mrs Elaine Mandelcorn, while working for her husband’s companies, did not earn a gross salary of $2,000 in 1965 but $5,800 and not $7,000 in 1966 but $11,500, that following the incorporation of the appellant company the sales figures for the two associated companies declined only at a ratio of 4%, whereas Lenco Fibre Corporation sales did not increase at all. He also stated that, for the years under appeal, only the appellant company earned commissions paid by the husband’s companies; that the latter, prior to the appellant company’s incorporation, did not have any European market; that the net income before taxes reported by the associated companies shows an increase in their business of 11% in 1968 and 97% in 1969. He also stated that Mrs Mandelcorn transferred her one qualifying share in Lenco Fibre Corporation because she wanted to incorporate and operate her own company. According to him, she was the one responsible for developing the European market and consequently, it was a good incentive for her to have her own company.

Mr Richer, an accountant and assessor for the income tax Department since 1945, testified that the appellant company was deemed, by the Minister, to be associated with Lenco Fibre Corporation and Ben Mandelcorn Inc because Lenco Fibre Canada Corp was the continuation of the husband’s associated companies’ business; that Mrs Mandel- corn, prior to the incorporation of her company, worked for her husband on a salary basis, whereas thereafter she worked for him for a commission; that the said commissions were not paid according to a set of rules but in order to control the profits realized by the husband’s companies. He also filed Exhibits R-2 to R-7 to show what had been done by the husband’s companies prior to and after the incorporation of the wife’s company. He also stated that commissions were not paid on all the sales; that two commissions were paid, one in July and the other in August to Mrs Mandelcorn for the same sale; that a commission of $600 had been paid to the wife’s company when it should have been only $60; that many errors having the effect of increasing the wife’s company’s profits could have been corrected easily had the parties been dealing at arm’s length. According to him, the commissions were fixed by the husband and the wife in order to keep the profits below the $35,000 limit.

Counsel for the appellant argued that the satisfaction of the Minister in applying subsection 138A(2) was rather doubtful and if the commissions paid by the husband’s companies to the wife’s company were not reasonable, they should have been challenged and disallowed by the Minister under subsection 12(2) of the Income Tax Act; that he does not have to bring any evidence in that respect because the appellant company is assessed under subsection 138A(2) of the Act. He also argued that if the wife’s company did not amount to anything, all she received should have been considered as a gift from her husband and, consequently, the appellant company should not be assessed; that the present case was against the economy of Canada because it prevented the incorporation of another taxpayer who was going to repatriate taxes paid in the United States; that the only way to separate a principal and an agent was to incorporate a company, and that according to the decision in MNR v James A Cameron, [1972] CTC 380; 72 DTC 6325, people are entitled to be incorporated. In abundance of caution he also said that the appellant company was incorporated to provide the marketing in Europe of the waste product processed by the two other companies in Canada, a branch of business which until that time had exclusively been in the hands of American dealers and distributors. Consequently, this kind of business was not taken away from the two other companies but successfully pursued by the appellant company. Mrs Mandelcorn, who owned and managed that company, was responsible for its success.

According to the evidence, she proved to be a very capable woman, well educated, persuasive, experienced, having been with her husband’s companies on a salary basis from 1961 to 1967. In other words, she was the right person to promote the marketing of the product in Europe. He reminded the Board that the husband did not do so well before his wife started to work for him. Having been in bankruptcy, he could not approach the suppliers, DuPont and Celanese, and his wife had to go and negotiate with them in order to acquire the waste products.

According to Mr Vineberg, Mrs Mandelcorn was so interested and so well prepared for this European market that the incorporation of the appellant company was only an incentive for her to accomplish more. He referred the Board to The Queen v Bobbie Brooks (Canada) Ltd, [1973] CTC 431; 73 DTC 5357, to show that the appellant company was a different business. As to the figures submitted by the respondent, he argued that the sales and net profits of the two other companies showed convincingly that the said companies did not suffer from any kind of amputation. According to him, respondent made a great fuss about one qualifying share that the wife had in her husband’s company and transferred it ten days before the incorporation of her own company. He referred the Board to The J Pascal Hardware Company Limited v MNR, 6 Tax ABC 283; 52 DTC 214, to say that the registered owner is not necessarily the true owner.

Counsel for the respondent argued that when a taxpayer is assessed under subsection 138A(2), he has the onus to show that the Minister was wrong but, according to the evidence adduced in this case, the appellant failed to do so. He said that the husband’s companies’ business was quite successful prior to the incorporation of the wife’s company, that the American intermediaries were paid very low commissions, something like the gift of a television set, but after the incorporation of the wife’s company, she received substantial commissions fixed by her and her husband. He stated that Mrs Mandelcorn’s education had nothing to do with the husband’s business and she acquired her experience by working for him; that in 1966 she received an increase of 150% in her salary and that something had to be done to pay less income tax; that in the same period of time the husband and the wife had tried to deduct travelling expenses in Europe in 1966, which were refused by the Minister. At that time the husband and the wife had to act to pay less taxes, consequently the wife’s company was incorporated because

(1) they could not deduct any more expenses, (2) the profits of the husband’s company were increasing above the $35,000 limit. He also explained that for 1967, 1968 and 1969 the husband’s companies continued to pay commissions to the American intermediaries whereas the wife’s company was getting substantial commissions for sales she did not make.

According to Exhibit R-3, after 1966, or after the incorporation of the wife’s company, the latter received from Lenco Fibre Corporation a commission two and a half times greater than the commissions paid to the Americans although the volume of the sales did not change. In 1968 it received an additional increase of 10% although the sales increase was only 35%.

Prior to the wife’s company’s incorporation, Ben Mandelcorn Inc did not pay any commission to the Americans for the years 1965 and 1966, but for the same volume of sales in Europe in those years it paid to the wife’s company $7,754 and $17,282. Consequently, it shows that the commissions were not in proportion to the volume of sales. He also stated that the wife’s company did not have the staff, the assets and capital, the publicity, the commercial telephone and listing, the office, the stationery and business cards to be branded as a genuine business; that the transfer of the share was indicative that she was going to in- corporate a company in order for her husband to pay less income tax; that Exhibit R-7 shows without a doubt that the husband’s companies had already their main customer in Europe in 1966, being Alpha Fibre Artificial, which made the following purchases: in 1966, $12,080.43; in 1967, $16,958; in 1968, $20,216.20 and in 1969, $603,660.43.

Counsel for the respondent also commented on the Brooks case (supra) cited by his opponent. In that case the appellant, who manufactured dresses, wanted to go into the manufacturing of sportswear. According to the evidence, it was a totally different business whereas in the present appeal Mrs Mandelcorn received substantial commissions for the same work she used to do on a salary basis when working for her husband’s companies. In Classic's Little Books Inc v The Queen, [1973] CTC 94; 73 DTC 5097, the appeal was dismissed and, according to the respondent, it represents the same facts; the wife wanted to start her own business; she owned a share to qualify herself as vice- president and secretary-treasurer; the incorporation of her company was decreasing the husband’s company’s profits, she had already acquired her experience in her husband’s company.

I agree completely with the comments made by counsel for the respondent. This appeal deals more with a question of fact than a question of law. According to the appellant, Mrs Mandelcorn incorporated her own company to open a completely new business in Europe, having the experience and knowledge to operate successfully such a business, her company would be an incentive and a security for her. All this is true. It is equally true that the Minister could have disallowed the excessive commissions and corrected the errors; that the Minister could have taxed the commissions received by the wife as gift; that the wife was very able and persuasive; that the incorporation of a company, a new taxpayer, which would repatriate more income tax to this country, is good; that the principal should be separated from its agent; that according to the Cameron case (supra), and it has always been that way, in that people are entitled to be incorporated, but this is not the issue. Was the appellant company a genuine business or only a front to allow the husband to divide his company’s business profits and stay below the $35,000 limit? This is the issue and if this is the case, the Minister was right in using subsection 138A(2) to deem the appellant company associated with the husband’s company.

Let us look at the evidence. Exhibit R-3 was prepared by using the income tax returns of the associated companies and it shows the sales and commissions paid by Lenco Fibre Corporation and Ben Mandelcorn Inc. Prior to the incorporation of the appellant company, Lenco Fibre Corporation, in 1965, sold for $429,654 and paid commissions of $1,734. In 1966, it sold for $518,060 and paid commissions of $8,555. After the incorporation of the appellant company, it sold in 1967 for $517,231 and paid commissions in the amount of $20,965. In 1968 it sold for $630,775 and paid commissions in the amount of $27,497 and finally, in 1969 it sold for $1,037,399 and paid commissions for $28,543. With respect to Ben Mandelcorn Inc, before the incorporation of the wife’s company, in 1965 it sold for $320,816 and did not pay any commission. In 1966 it sold for $517,387 and did not pay any commission but after the incorporation of the wife’s company, in 1967 it sold for $476,283 and paid commissions of $7,754. In 1968 it sold for $521,915 and paid commissions of $17,282 and in 1969 it sold for $993,401 and paid commissions of $19,483.

The appellant company was incorporated as already mentioned on May 27, 1966, and in 1967 it received commissions in the amount of $21,391; in 1968, $24,753 and in 1969, $51,643. According to these figures it is obvious that after the incorporation of the wife’s company, it started to receive substantial commissions which were in no way whatsoever comparable to those received by the American intermediaries.

It is also in evidence that the wife’s company had been paid by the husband’s companies twice for the same sale—$600 instead of $60— that all the errors committed and which were discovered by the Minister were reducing the husband’s companies’ profits.

Furthermore, there is not a tittle of evidence to show that the appellant company incurred the expenses to earn such substantial commissions. After all, the onus was on the appellant to show that the Minister’s assessments were wrong and it failed to do so. But what struck me the most is the testimony of Mr Mandelcorn when he said his wife was to look after the business in Europe because he had to stay in Canada to look after the buying and the evidence shows that every time his wife went to Europe he was with her and that the commissions to be paid to his wife were set in agreement with her.

Furthermore, when he was heard as a witness, he had to make continuous efforts to stop saying “we did that”, “we negotiated such deals”, “we fixed the commissions”, which shows without a doubt that in fact there was a continuous business association between the husband and the wife when the transactions were effected with respect to the European market.

One has to remember that the most important customer of the appellant company was already a customer of the husband’s companies in 1966. I agree with Mr Vineberg when he says that the wife had the right to incorporate her own company but I disagree with him when he says that the appellant company was incorporated solely for the purpose of carrying out the business of the husband’s companies in the most effective manner.

According to the evidence I have just summarized, this company was a front and one of the main reasons for such separate existence in 1967, 1968 and 1969 was to reduce the amount of taxes that would otherwise be payable under the Income Tax Act. Consequently, in the light of the decision in Classic’s Little Books Inc v The Queen (supra) and for the above reasons, the appeal is dismissed.

Appeal dismissed.