Laidlaw Transport Limited v. Minister of National Revenue, [1974] CTC 2246

Judge K A Flanigan (orally: February 27, 1974):—This is an appeal by Laidlaw Transport Limited against a reassessment of the Minister of National Revenue for the taxation year 1969. The point at issue is, first, whether or not an expense or management sum of $61,317 is an allowable deduction under paragraph 12(1)(a) of the Income Tax Act as a legitimate expense incurred for the purpose of earning income and, secondly, whether or not the matter is covered by subsection 137(1) of the Income Tax Act in that it artificially reduced the income of the taxpayer.

The facts are really not in great dispute. Two witnesses were called, Michael DeGroote, who at all material times was the president of the appellant company and also of a company known as Laidlaw Motorways Limited. Laidlaw Motorways Limited was a company that was formed to cover the amalgamation of Laidlaw Motor Sales Limited and Hepburn Transfer Limited. This was accomplished prior to the year in question. In 1969 “Motorways” was turned into a public company for the purpose of, as alleged by the appellant, raising finances through which the appellant company, which was a wholly-owned subsidiary, would be able to expand.

The obvious question is why, if that was the main purpose of the public financing, did not the appellant company itself undertake the financing? This was answered by both witnesses, Mr DeGroote and Mr Pringle, a chartered accountant with the firm of ‘Coopers Lybrand, and their answer is that since Laidlaw Transport Limited held the operating licences, the advice they received at the material time was that it would be too cumbersome an operation to transfer shares as this would involve at that time the approval of the Ontario Transport Board, or whatever its correct name might be. They therefore, on advice, decided to proceed with Laidlaw Motorways Limited as the vehicle through which to raise the funds.

They experienced some difficulty in finding an underwriter for their proposal and although the operation started in early 1968, they were, by some of the better-known underwriting companies, referred back to their bankers, who were never prepared to move quickly enough to allow them to take advantage of acquisitions that were available.

Subsequently, in the 1969 fiscal year of the company, they prepared and completed a public financing scheme. The result of the refinancing is evidenced, l think, most strikingly by the fact that the income or revenue of the company between 1969 and 1973 increased from about $1 million to some $30 million. As I have said, or has been said as evidence, Mr DeGroote was the main driving force in all these companies that were associated with Laidlaw and, at the material time, he was the chief executive officer of Motorways as well as president of the appellant company.

The evidence is that he spent 80% to 90% of his time in the years 1968 and 1969—and I am speaking of the fiscal years of these companies—in trying to arrange this public financing. It is obvious from observing him in the witness-box, and from the manner in which he gave his evidence and the results that have been achieved, that he is very forceful and an enterprising businessman.

Much has been made by counsel for the Minister of the fact that the said DeGroote was not an employee of Motorways at the material time and that the only salary that he took in the year in question was some $9,700, I believe, from the appellant company. Mr DeGroote answered this by saying he did not need to take any salary from Motorways at the material time because, if he succeeded in this public financing, he personally would benefit to the extent of over $200,000.

I think that it is unquestionably correct that a person who is a chief executive officer can be an employee of a limited company without taking a salary in any given year. There may be many reasons why it suits a particular individual to take or not to take a salary from a particular company in any given taxation year.

As I have said, there is no doubt in my mind, and the evidence is uncontradicted that, as a result of his efforts, the public financing did succeed and a considerable, almost an unbelievable, increase in revenue occurred in the following four years.

The first question is: was there any agreement between the appellant and Motorways that a management fee or expense of any nature would be paid to them? Mr Pringle is not an entirely independent witness, because he is a member of a firm that derives part of its livelihood from this company, but I have observed him in the witness-box and have considered his association with the appellant company and I have no hesitation whatsoever in accepting his evidence completely. His evidence is that, long before the end of the 1969 fiscal year, it was clearly understood that a sum of money would be paid. to Motorways Transport as the result of the efforts of DeGroote in obtaining this financing.

Some $50,000-odd was paid to third parties as a cost of arranging the financing, and it would not seem unreasonable to assume that Motorways would be entitled to something for its efforts on behalf of the appellant company. There is no doubt in Mr Pringle’s mind that the sum arrived at is reasonable. He says it was related to what was a proper accounting entry in the books of Motorways and that he himself, as an experienced accountant, would have had no hesitation in justifying a payment of $100,000 to $125,000, but, as I said, because of accounting reasons, there was no point in taking more than the figure that was transferred on the books of the company.

So, on the evidence of Mr Pringle, as well as from assessing the evidence of Mr DeGroote, there is no doubt whatsoever in my mind that the figure of $61,000-odd was a reasonable sum to be charged as an expense by the appellant company, whether it be as management fee or as whatever else one would call it. There is also no doubt in my mind that it was expended for the purpose of earning income and did in fact result in a substantial earning of income in the appellant company.

I have had the opportunity to review a new decision of the Honourable Mr Justice Cattanach, which was received by the Board on the 11th of this month (February 1974), in which he deals with management fees and expenses, following somewhat along the lines of the Sazio line of cases, but dealing with whether or not the management fee in his case, which is that of Jack K Holmes et al v The Queen, [1974] CTC 156; 74 DTC 6143, which was decided in Calgary and which was a situation where a legal firm incorporated a management company to take over all of the non-professional aspects of its legal practice.

The situation was that they transferred everything to this new company and the company paid all disbursements, rents and so on, and received the sum of 15% of the proceeds of the operation as a management fee. The Minister argued that these expenses would have been incurred in any event and would have been paid by the law firm, as had been the case prior to the management company being incorporated, and therefore the 15% management fee for doing this on behalf of the law firm was an expense that need not have been incurred.

Mr Justice Cattanach, at page 165 [6149] stated:

I am unable to accept the contention thus put forward. It seems to me that if the expenses incurred for. the services in question are deductible there should be no impediment to the law firm paying the company a fee to arrange for, supply and pay for those services, and that Mr Power outlined sound business reasons for doing so and the law firm, in conducting its business as it did, conformed to accepted principles of commercial trading and did so in accordance with good business practice.

I put the question to Mr DeGroote to the effect that, in his mind, was it necessary to take the course that was taken in 1968 and 1969 for sound business reasons, and he clearly stated that it was, and this, as I have pointed out earlier, has been borne out by the results that are shown in appellant’s Exhibit A-2.

The ratio of the decision dealing with paragraph 12(1)(a) in Mr Justice Cattanach’s reasons is at page 165 [6150], where he states:

In my view the 15% management fee was an expense incurred for the purpose of earning income and it was a reasonable amount to be paid for the benefits which enured to the law firm.

He then goes on to say that he is confirmed in his conclusions by the remarks by Mr Justice Ritchie in Shulman v MNR, [1961] Ex CR 410; [1961] CTC 385; 61 DTC 1213, which he quotes, as follows:

Because the management fee was paid to a corporaeion of which the appellant and his wife are the only shareholders and, so far as the record discloses, the management agreement was negotiated between the appellant in his personal capacity and the appellant in his capacity as the agent of Shultup does not, per se, preclude the management fee from being a legitimate operating expense of the law practice.

Again, he goes on, in referring to pages 423 and 424 [398, 1220] of the Shulman judgment:

In view of the uncontradicted evidence of Mr Shulman, I am not prepared to find the provisions of Section 12(1)(a) demand the dismissal of the appeal. According to Mr Shulman’s testimony the duties he performed as the agent of Shultup had a direct relation to increasing the income of the office and his own professional income. In such circumstances I am unable to find payment of the management fee, standing by itself, was not an outlay or expense that can be justified on the ground of having been made in accordance with the ordinary principles of commercial trading or accepted business practice.

There also he refers to a case of Mr Justice Gibson, which was a management company case involving doctors in Toronto, and in that case (Grotell v MNR, [1972] CTC 480; 72 DTC 1641), Mr Justice Gibson also held that, where there was a real intention and no sham involved, the payment of a management fee was a deductible expense properly incurred for the purpose of earning income.

On the evidence that I have heard, I have no hesitation in finding as a fact that the efforts of Motorways, through the personage of Mr DeGroote, resulted in increased revenues to the appellant and the expense that was charged off by the accountants was one clearly incurred for the purpose of earning income and deductible under paragraph 12(1 )(a).

The second contention, which is not as seriously dealt with in this case as in some other cases, is the question of the artificiality of the payment and whether or not it would unduly reduce the income of the company. I quote again from page 168 [6151] of Mr Justice Catta- nach’s decision:

In my view the propriety of the deduction of the management fee falls to be decided upon a determination of the question whether genuine business reasons existed for the payment of the management fee under this contract.

In concluding that the payment of the fee was an expense incurred for the purpose of gaining or producing income from the plaintiffs’ business, I found that true business motivation existed with consequent business advantages.

That being the case it follows that payment of a management fee is a legitimate expense commensurate with the commercial and business advantages which flowed from the performance of those services and that the payment of the management fee did not result in an artificial reduction of the plaintiffs’ income.

In this case I have found the payment to be reasonable, to have been expended in the course of earning income, and therefore I adopt the words of Mr Justice Cattanach in dealing with the subsection 137(1) aspect of the case, because I find also in this case that true business motivation was the sole reason for the actions that were taken by Motorways on behalf of the appellant company in this case and as required by the appellant company.

The respondent has cited several cases to me which I do not propose to go through in detail but, as has so often been said in such cases, they all depend on their particular set of facts and I cannot quarrel with the cases that have been cited to me with respect to the principles that they enunciate, but their facts do not correspond to the facts of this case, and it seems to me that the only thing that there is for me to determine is, as I have determined, that the payment was reasonable, that it was made for the purposes of gaining income, that there was no artificiality connected with the transaction in any way, and that I am not going contrary to the principles of law as laid down in any of the cases cited to me.

Therefore, on all the evidence, the appeal will be allowed and will be referred back to the Minister for reassessment accordingly.

Appeal allowed.