Michael Petritz v. Minister of National Revenue, [1973] CTC 299, 73 DTC 5243

Kerr, J:—The appellant appeals from reassessments for the taxation years 1966 and 1967 whereby the respondent added $33,600 to the appellant’s income for 1966 and $24,000 for 1967.

The issue is whether these amounts are income of the appellant, as found by the respondent, or income of Petritz Enterprises Limited, a management company which the appellant caused to be incorporated, as contended by the appellant.

An appeal by the same appellant Petritz on the same issue for his 1965 taxation year was heard in the Exchequer Court of Canada together with an appeal by Alfred Campeau (No’s B-2668 and B-2640) by Mr Justice Gibson, who held in respect of the appeal by Petritz that the sum of $30,000 there in question paid by Depco Metal Products Limited (hereinafter called “Depco”) to Petritz was income of Petritz in his taxation year 1965 and not income of Petritz Enterprises (AC Campeau & M Petritz v MNR, [1970] CTC 306; 70 DTC 6223).

An order was issued in this appeal permitting the introduction of the transcript of the evidence and copies of the exhibits in the said previous appeals of Campeau and Petritz as part of the evidence in this appeal provided that all witnesses who gave evidence in those appeals be made available at this trial for cross-examination and to give further evidence for the appellant if deemed necessary and advisable.

Petritz Enterprises was incorporated on November 30, 1964. Its objects are ‘‘t manage businesses, properties and investments”. Its issued shares are owned by the appellant and his wife Jacqueline.

Prior to the incorporation of Petritz Enterprises the appellant and his two business associates, Alfred Campeau and George Evoy, were in the employ of Depco and they were also shareholders, directors and officers of that company. Petritz and Campeau were majority shareholders and Evoy was a minority shareholder. Prior also to that incorporation the appellant was president of Depco and was its principal employee. Depco’s business was the manufacture of rolled metal products consisting of auto trim and mouldings. The company has prospered and has increased its volume of business very substantially.

The shareholdings of Depco immediately prior to the incorporation of Petritz Enterprises were as follows:

By an agreement dated December 19, 1964 (No 6, Exhibit A-1), between the appellant and his wife, as vendors, and Petritz Enterprises, as purchaser, the appellant and his wife sold their Depco shares, along with other assets, to Peiritz Enterprises, the effective date of the sale to be November 1, 1964. Thereupon Petritz Enterprises held 450 common shares of Depco, and soon afterwards Evoy obtained 50 shares from Petritz Enterprises and 50 from Alco Management Limited (which is Campeau’s management company) and the shareholdings of Depco shares became

A consultant or management agreement dated November 30, 1964 (No 17, Exhibit A-1), was entered into between Depco and Petritz Enterprises. It contains, inter alia, the following terms:

1. The company shall retain the services of the Consultants and the Consultants shall make such services available to the Company on a nonexclusive basis.

2. The Consultants through the medium of one or more of its senior personnel shall devote such time and attention to the management of the business of the company as the Company may reasonably require.

3. The Company shall pay the Consultants for their services remuneration of an amount to be determined after the profits, before such remuneration, for each fiscal year end are known. During the year, if any funds are required on account of services rendered, the Company is to advance any such sums to the Consultants, to be charged to the Consultants’ account as a debt to the Company, and to be repaid within the year following the fiscal year end of the Company.

The agreement was in fact not executed until at least after July 28, 1966. In respect of that agreement Mr Justice Gibson said in his reasons in the Campeau and Petritz appeals from their assessments for 1965, in part as follows (pp 307-8 [6224-5]):

Consultant or management agreements were entered into: (1) between Depco and Petritz dated November 30, 1964, (2) between Depco and Alco dated October 22, 1964 and (3) between Hercules and Alco dated November 19, 1964. All of these agreements, however, were in fact executed in 1966. (See respectively Tabs 17, 18 and 19 of Exhibit 1.)

Although it was submitted in evidence and argument that orally in September or early October, 1964 there was complete agreement, I find the reason these so-called consultant or management agreements were not executed until the said dates, was because their respective terms in fact were not settled by the parties until at least June, 1966 and probably not until after July 28, 1966.

Some of the documentary evidence establishing this is set out in the correspondence between the appellants’ accountant and solicitors. (Both appellants had the same accountant and solicitors.) (See Tabs 8, 9, 12, 13, 14 and 15 of Exhibit 1.)

(Only when the terms of these so-called consultant or management agreements were finally settled were they approved and authorized for execution by the relevant companies and individuals.) (See for example in the case of Depco, Tab 20 of Exhibit 1.)

The admissible, believable and acceptable oral evidence given at trial complements the documentary evidence establishing this and the oral evidence was given by each appellants and their accountant.

This evidence establishes that the appellants did not know what terms should be included in such agreements and relied on and waited until their accountant and solicitors had settled the terms of them and completed the same so that they personally could and did execute them. Specifically, this evidence establishes that no oral agreements incorporating their respective relevant terms existed between Depco and Petritz, between Depco and Alco and between Hercules and Alco, prior to the dates of execution of the said respective written agreements.

The series of adjusting and closing journal entries, in this case, made after the ends of their respective fiscal years in 1965 and 1966 in the books of all these companies, and the results therefrom carried into their financial statements, (see Tabs 21, 22, 23, 24, 25, 26, 28, 29, 31 and 32) recording, inter alia, loans made and repaid, commissions accrued and paid, and drawings debited and credited, do nothing to change the three matters of fact which obtain as a result of the above finding, namely, that in the calendar year 1965, (1) that there were no oral or written agreements whereby and under which the management company Alco provided any service to the operating companies Depco or Hercules, or the management company Petritz provided any service to the operating company Depco; (2) that neither management company otherwise provided any service to the Said respective operating companies; and (3) that the appellant Campeau never ceased to be employed by Depco and Hercules, and the appellant Petritz never ceased to be employed by Depco.

At the trial of this appeal additional evidence was given by David Lesonsky, a chartered accountant and auditor of Depco, who had previously testified in the Campeau and Petritz appeals; and the appellant was cross-examined again briefly by counsel for the respondent.

Lesonsky elaborated upon his previous testimony. He said that he had initiated a proposal to Campeau to incorporate a management company in the summer of 1964. At that time Campeau was interested in and working for Depco and also for another company, Hercules Tool & Die Limited, of which he was president and owner of 50% of its shares. The appellant was present at discussions concerning the proposal and asked for a like management company for himself. Essentially similar points were involved and discussed in respect of Campeau and the appellant, and in the result each of the associates, Campeau, Petritz and Evoy caused a management company to be incorporated for his own interests and purposes. Campeau’s company is Alco, Evoy’s is Evoy Production Control Limited. Lesonsky testified that he was familiar with their affairs and with income and estate tax law, and he advised them respecting financial and other advantages of having a management company, telling them that it would give them flexibility to provide their services to any company at times of their own choosing, and an opportunity to develop new products, that it would facilitate estate planning, and it could be used to accumulate an estate. He also testified as to delays encountered in getting the management agreements with Depco put into writing and executed. A letter, dated July, 28, 1966 (No 15, Exhibit A-1) from the solicitor, Mr Frost, who drew up the agreement, indicates that the management agreements between Depco and Petritz Enterprises and Alco were sent with that letter to the appellant for execution, and Lesonsky testified that within a few days thereafter he and the appellant got together and the appellant signed the Petritz Enterprises agreement (No 17, Exhibit A-1). Alco’s agreement with Depco was similar to Petritz Enterprises’ agreement. Lesonsky also said that Alco and Petritz Enterprises gave management services to other companies, Special Tool & Die, P V Trim and Kromet Handles. Kromet Handles was incorporated in the fall of 1967, the other two in 1970 and 1971. They are owned by the wives of the principals.

Lesonsky also said that he prepared draft financial statements for Depco at the end of each fiscal year, whereupon meetings were held with the principals to settle the sums to be paid by Depco to each of the management companies for services rendered during the year concerned. The method of making payments by way of advances during the year, chargeable to the management companies as a debt for the time being to Depco, is set forth in the agreements, No 17 and 18, Exhibit A-1.

I have had to consider the evidence given in this appeal along with the relevant evidence given in the previous Camp-eau and Petritz appeals heard by Mr Justice Gibson, and on the whole of the evidence I reach the same conclusion as he did, as above quoted, that no binding oral agreement existed between Petritz Enterprises and Depco prior to the execution of the written agreement between those com- anies, and I conclude that, prior to the execution of that agreement, there were no oral or written agreements whereby and under which Petritz Enterprises provided any services to Depco. While the argument of counsel for the appellant to the effect that there was a binding oral agreement between Petritz Enterprises and Depco as from September or October 1964 has some support, the reality of the situation, on my appreciation of the evidence, is that the parties intended to follow the advice given by Lesonsky but had placed the matter in the hands of the solicitor for preparation of an appropriate agreement in writing which would be submitted to the parties for their consideration for acceptance or otherwise, and that not until it was accepted and executed was it binding on the companies and effective.

In the result the said sum of $33,600 paid by Depco to Petritz Enterprises was income of the appellant in his taxation year 1966 and was not income of Petritz Enterprises, and the appellant’s appeal from the assessment for that year is dismissed.

There remains for consideration whether after the execution of the agreement between Petritz Enterprises and Depco the services that the appellant was giving to Depco were being given not as an employee of Depco but for and on behalf of Petritz Enterprises under the said agreement.

Petritz Enterprises has a legal corporate existence separate from the appellant and the company had power under its charter to provide management services to Depco in the period concerned, and there was in fact the said executed agreement between the company and Depco to render management services to Depco.

The agreement was signed on behalf of Depco by Petritz and Evoy, and on behalf of Petritz Enterprises by Petritz only. A by-law of Petritz Enterprises (Exhibit A-7) provides that contracts of the company may be signed by the president and secretary or by the president and treasurer. However, if by that signing the parties intended that the agreement would be in force and if it was otherwise bona fide and accepted by them, I would find that the fact that it was signed by only one of the signing officers of Petritz Enterprises rendered it ineffective.

But in making the assessments in issue the respondent assumed, as set forth in paragraph 7 of his reply to the notice of appeal, that:

(a) the said sums of $33,600.00 and $24,000.00 alleged to have been received by and income of Petritz Enterprises Limited in the 1966 and 1967 taxation years were in fact earned by and income of the Appellant and constituted remuneration for services which the Appellant rendered to Depco Metal Products Limited and that the said sums were income of the Appellant for his 1966 and 1967 taxation years respectively and not of Petritz Enterprises Limited;

(b) no valid bona fide agreement existed between Depco Metal Products Limited and Petritz Enterprises Limited as alleged and that Petritz Enterprises Limited performed no services for Depco Metal Products Limited and that the alleged arrangement involving Petritz Enterprises Limited was part of a scheme to reduce artifically, the Appellant’s income.

The evidence is extensive, it includes financial statements, and income tax returns and documents, and relates to the activities of the several companies and principals, accounting and bookkeeping, payments made by Depco, the method of determining the amount of the management fees payable by Depco and the manner of payment and subsequent treatment thereof by the appellant and Petritz Enterprises respectively. It would encumber these reasons very considerably to give many of the details, and a summary of them might very well be inadequate, consequently I shall limit references to details and not attempt to summarize the evidence as a whole.

There is evidence that tends to support the assumptions made by the respondent, including the fact that the appellant did substantially the same things at Depco after the incorporation of Petritz Enterprises as he did before its incorporation, there was no obvious change in the management of Depco’s business, some cheques were paid directly by Depco to the appellant and were cashed by him personally, moneys were remitted to the Receiver General of Canada by Depco on behalf of the appellant, fees paid by Depco were not fixed on any predetermined scale or basis, no management reports were submitted by Petritz Enterprises, and there was little, if any, management activities car- ried on by Petritz Enterprises in the taxation years concerned in respect of any other company.

However, the principals were friends and business associates of long standing, with various business interests, experience, capabilities and prospects, and I think that the idea of management companies advanced by their auditor Lesonsky was attractive to them and they felt that the arrangements they would have to make would be worked out to their mutual satisfaction as occasion required. There was some resulting looseness and irregularities and breaches of a technical nature in some of the things done, such as payments by Depco to the appellant personally, which were countenanced by the parties, and at this trial Lesonsky gave plausible explanations in that respect.

In my consideration of the case, including the evidence from the appeals heard by Mr Justice Gibson and the evidence given before me by Lesonsky, I have at times regarded the arrangements for management services by Petritz Enterprises to Depco as suspect, but overall I have come to the conclusion that the main reason for the incorporation of Petritz Enterprises was, on the advice of Lesonsky, to have a management company to provide the appellant’s services to Depco and to other companies and ventures as opportunities might present themselves, that the company was not a mere cloak for the appellant or a sham, that it could legitimately carry on the objects for which it was incorporated, that the agreement for the company to provide management services to Depco was bona fide and not a sham, that such services were provided pursuant to the agreement, and that the $24,000 added by the respondent to the appellant’s income for 1967 was income of Petritz Enterprises and not income of the appellant.

Consequently, the appeal from the assessment for the appellant’s taxation year 1967, whereby $24,000 was added to the appellant’s income for that year, is allowed and the assessment is referred back to the respondent for reassessment on the basis that the said sum was not income of the appellant.

As success on the appeal has been divided, on the same evidence, there will be no order for payment of costs.