John J Daly v. Minister of National Revenue, [1974] CTC 2279

Judge K A Flanigan (orally: May 29, 1974):—This is an appeal by John J Daly against the reassessments of the Minister of National Revenue for the 1964, 1965, 1966 and 1967 taxation years.

The appeal arises out of reassessments of the Minister whereby funds received by John J Daly Enterprises Limited were held to be the income of the appellant in this case and not that of the company of which he was the major shareholder. This is a case that falls within the line of cases known as the Sazio line, culminating most recently with Holmes et al v MNR, [1974] CTC 156; 74 DTC 6143.

The appellant prior to the incorporation of his company in mid-1964 was employed by CKOY Limited, a radio station in the City of Ottawa. He had started work for this company in the sports department in the year 1951. In 1955 he became the program director and a couple of years later operations manager, finally becoming manager of the station in 1961. At the time of the incorporation of “Enterprises” he was the general manager of the station.

During the period prior to 1964 he did considerable free- lance work in television, in films, and in the narration of a series for the National Film Board. He says he did these things with the express consent of his employer and that this did not in any way interfere with his position Limited. His last active participation outside of CKOY Limited prior to the incorporation of John J Daly Enterprises Limited, was in 1964, within the taxation year of Enterprises ending in June 1965, when he worked as a colour commentator on the CBC for CFL football broadcasts. In 1964 Mr Allan Waters, president of CHUM Radio in the Toronto area, was considering the purchase of CKOY and made an inspection of the premises. Although ultimately he did not purchase the business, he mentioned to Mr Daly that sooner or later, and perhaps sooner rather than later, the station would eventually be sold. Mr Daly says that he then became concerned because of his past experiences and spoke to the owner of the controlling interest of radio station CJET in Smiths Falls with a view to purchasing that station. However, that did not develop into anything firm.

Mr Daly said that 1957 and 1961 had been difficult years in the radio field owing to what he described as the “rock music revolution”, which saw great stress placed by radio stations on the rock-and-roll type of music of interest to young people, music different from that to which he had been accustomed for programming purposes. He said that his company was considered more of a middle-of-the-road station. This. revolution, as he described it, resulted in many people who were not able to adapt to the change losing their positions with radio stations, and this gave him concern for his own future.

His concern was increased by the fact that the Board of Broadcast Governors (now the Canadian Radio-Television Commission) reduced the renewal period of radio station licences from five to two years, at the same time insisting on certain programming regulations.

About this time Mr Jack Kent Cooke, who was the owner of the Station and had sent Mr Daly to the station in the first place, decided to move to the United States and become a US citizen, whereupon the Board of Broadcast Governors insisted that he sell his station, as it was not considered in the best interest of the Canadian communications system to have a non-resident in control of a Canadian radio station.

In 1961 the renewal period was reduced to one year until the Board could determine who would be managing this radio station. The man who had been appointed by Mr Cooke as general manager left, and since Mr Daly had been with the station since 1951, this gave him some concern for his own future.

At this particular. time Mr Daly was himself in the process of raising a family; I think in 1961 he had four or five children. He talked to his friend, Mr Michael Anka, a Queen’s Counsel of this City and his personal lawyer, and Mr Anka explained the difference between a corporate entity and an individual entity. He then used the term “the immortality of a corporate entity”, and explained its use as a means of providing for the future of his family should anything happen to Mr Daly. This, he said, was to be an umbrella under which his other businesses would be protected and there would be continuity of existence notwithstanding Mr Daly’s decease.

The evidence is that from July 1, 1964 his employer CKOY Limited, acknowledged the existence of John J Daly Enterprises Limited. Obviously a verbal understanding had been reached because the records of the company and the evidence of its controller at that time indicate that Mr Daly personally was removed from the pay records and Enter- prises substituted, with a separate card for what were described as management fees, There was no change in the functions of Mr Daly. To anyone doing daily business with the company, there was no indication of any change nor any reason for them to note any change. Some of the employees may have known of the change, but it was not essential that they should have known. As far as I know the radio station has continued up to the present time making payments to Enterprises by way of management fees.

I should go back one step and point out that in 1962 Mr Daly had entered into what has been referred to as an employment contract, setting his remuneration at a fixed sum per year plus 12% by way of bonus for every dollar of profit over $100,000 befores taxes. The contract, page 1 of appellant’s Exhibit 1, contains a provision whereby a portion of the bonus up to, I think, 100 shares of common stock per year could be taken in this fashion, and the consent of the Board of Broadcast Governors was obtained for the bulk group of 500 shares which were taken up eventually by Mr Daly in his personal capacity.

It is this contract that was allegedly assigned to Enterprises, and the only change was that Mr Daly personally retained the privilege of buying the shares of the company. From July 1, 1964 the same salary. was paid for the same general manager in the same location, only the payments were made to a corporate entity rather than to an individual.

Page 62 of the appellant’s corporate Exhibit 1 is a renewal of the contract for payment of the same amount, and is an identical arrangement which is addressed again to Mr Daly rather than to the corporation as it then existed in 1967.

On December 16 of 1968, I think it was, Mr Anka, as solicitor for either Mr Daly or the company, wrote to the Gowling, McTavish firm: of solicitors in this City requesting of Mr Gordon F Henderson, QC, who was then president of CKOY Limited and had been vice-president in 1962, that the understanding that had been in existence since 1964 be brought into some sort of formality by way of a written contract between CKOY Limited and John J Daly Enterprises Limited. This was effected by Exhibit A-2, which was prepared after the notices of reassessment under appeal. In my view, this document simply sets out what had been going on since 1964.

The memorandum of agreement dated July 1, 1971 refers to the oral agreements reached in July of 1964 and simply sets out once again the contents of page 1 and page 62 of Exhibit 1, save and except that this time it is alleged in the agreement that the company is entitled to buy the shares, which on Mr Daly’s evidence was quite clearly not the case. So this is just another error in the documentation that has occurred throughout the course of his dealings since 1964.

If one looks at the reasons given for the incorporation other than the ones I have just referred to, and considers reasons other than the survival of the company after the demise of Mr Daly, then one finds very little. The sum of $1,000 out of a gross sum of about $34,000 in fees was received in 1965, the first fiscal year of Enterprises, the rest coming from CKOY. The second fiscal year showed income of $53,420 by way of fees, all from CKOY, and $202 interest from another source, to which I will refer and from which I shall draw some inferences in a moment. In 1967 there were fees totalling $47,400, all from CKOY, with $1,700 interest; and in 1968 there was about $47,000 in fees, again all from CKOY, interest of $2,250 and a dividend of $22.50.

Mr Daly says that he had intended to undertake within the corporate entity publication of a parliamentary guide which had been in existence for some time, and also to get into the travel agency business. Plans for these endeavours did not come to fruition in the years under appeal, and the only other activity that did produce other income was an association with Ottawa Cablevision after 1965 whereby Enterprises became a shareholder and debenture holder in Ottawa Cablevision. It is from this source that some of the interest and possibly the dividend stem.

In addition, according to the evidence of Mr Anka, Enterprises engaged in the lending of money under three mortgages which have just recently been paid off. So presumably some of the interest was also received from that source.

So far as the actions of Mr Daly himself are concerned, he really undertook nothing of substance other than his operation of radio station CKOY. It is true that, according to the evidence, the appellant investigated a couple of properties but turned them down as investments for various reasons—failure to make title in one case; unsatisfactory type of buildings in another instance, and so on. Eventually the company did enter the travel business, and is now engaged in that business to the extent that it operates what has been described as a wholesale branch of the travel agency business known as Vista Cruises, or some such offshoot, which infers to me some sort of charter arrangement.

One document that has caused considerable consternation is entitled “Assignment of Contract”, which is at page 29 of appellant’s Exhibit 1. Paragraph 1 is unintelligible, but in his evidence Mr Anka said it was clearly a misnomer to have labelled the document as assignment of contract and that this was probably done mechanically by someone in his office from information received from Mr Parrott, the auditor of the company. He said it was in fact a contract of employment and is covered in the initial minutes of the directors and shareholders of Enterprises.

l will leave this point for the moment because I think I can decide this case without making any determination in that regard. However, I shall refer to it again later.

In looking at the minutes of the company for the years in which the income or management fees were received from CKOY Limited, it is clear that the sum contracted for by Mr Daly with CKOY Limited for his services was reduced by almost 50% on each of the years. In addition, sums were paid to his wife, ranging from $3,000 in one year to a high of $4,500 in the final year with which I am concerned. There is no question that she did render some services to the company. She acted as s bookkeeper, secretary, did some monitoring of CKOY and other radio stations. She had previously been employed as a bookkeeper, and I am sure that so far as the company was concerned the payments were justified. However, this is not a matter that falls to be determined.

Many cases have been cited to me in argument. The case of Sazio v MNR, [1968] CTC 579; 69 DTC 5001, 'is, of course, the leading case from which all the others of this type stem. It is interesting to note that the reassessments in this case were probably made before the Sazio case was heard. I believe the reply of the Minister in this case was prepared by the same counsel who appeared in the Sazio case, and indeed is almost identical.

However, there is a vast difference between the facts in this case and the facts in the Sazio case. In Sazio there were at least four or five existing business reasons for the incorporation. There was the fact that Ralph J Sazio, coach of the Hamilton Tiger Cats, was concerned, just as Mr Daly was, about his future once his playing days were over and had engaged in one or two general insurance businesses. The company had taken over the management of an apartment building. It produced radio and television commentaries and ran schools for football, all of which the company was competent to do.

In that case there was an avowed intention to achieve a degree of business diversification that would justify the existence of the company and the fulfilment of the wishes of its principal shareholder. However, I am also aware of the other cases cited to me, particularly in the case of MNR v James A Cameron, [1972] CTC 380; 72 DTC 6325, which was decided in the Supreme Court of Canada, and Holmes et al v MNR (supra).

In the Cameron case the court found that the agreement was not a sham and that there was a sound business reason for the existence of the intermediary company, which was to allow Mr Cameron gradually to divest himself of his interest in the company which had built up a substantial reputation.

In the Holmes case, in my respectful view, the learned trial judge, who also decided the Sazio case, has gone about as far as he could possibly go in finding justification for a management company for a firm of lawyers. In that case he finds as the business reason for the existence of the company the leasing of the premises, the transfer of certain duties of the lawyers to the company, thus relieving them of duties in certain fields and freeing them for more productive roles as well as relieving them of their obligation with regard to the covenant in the lease. The learned judge found this was sufficient reason to allow the management fees paid by the legal firm to the company in question (whose shareholders consisted of the wives of the married members of the legal firm plus one unmarried partner), to be deducted as an expense under paragraph 12(1)(a) of the Act.

The situation in that case is somewhat different, I think, from the case before me. I can see no sound business reason for the procedure that was adopted in July of 1964 between CKOY and John J Daly. Nor can I see where there was any sound business reason for the incorporation of his company at that time. If I accept—and I do accept

—the evidence of Mr Anka that it was for the future protection of the heirs of Mr Daly, then I am at a loss to understand why he would reserve unto himself the shares in CKOY Limited, which he was entitled to purchase by way of bonus, rather than putting them into the company that was allegedly incorporated for the future well-being of his family.

I think this is clearly a case of the agreement being an agreement penned in one sense, to be read in another, which is really a paraphrasing of the classical definition of “sham” in the Snook v London & West Riding Investments Ltd, [1967] 1 All ER 518 at 528.

I now return to page 29 of appellant’s Exhibit 1 and can dispose of it in one of two ways. Either the construction of that document is that it is a contract of employment and the reference therein to an assignment is a misnomer—in which case I find it difficult to perceive in the agreement any provision for the payment of John J Daly for whose benefit the contract was allegedly entered into—or, on the other hand, I can take the connotation given it by Mr Daly as the general manager referred to in paragraph 2, namely, that it refers to an “individual”, in which he was entitled, or should receive from CKOY before the incorporation of Enterprises. Therefore, there would be no justification whatsoever for paying Enterprises less than the amount specified in the 1962-1967 agreement. So, either way, I find no assistance in this document for the appellant in this case.

On all of the evidence I cannot find that this case falls within the ambit of the Sazio case, or even within the very wide ambit of the Holmes case. I am satisfied that the Minister’s assessments were correct both in law and in fact, and the appeal must therefore be dismissed.

Appeal dismissed.