Frank H Galway v. Minister of National Revenue, [1972] CTC 580, 72 DTC 6493

Cattanach, J:—This is an appeal from a judgment of the Tax Appeal Board dismissing an appeal of the appellant herein from assessment to income tax for his 1961 taxation year. The merits of the appeal were not argued before the Tax Appeal Board. The appellant adduced no evidence and it followed as a matter of course that the appeal was dismissed by the Board. In reality, therefore, the present appeal is an appeal from the assessment of the appellant by the Minister to income tax for his 1961 taxation year, as is the case even when the matter has been heard on its merits by the Board bearing in mind that an appeal to this Court is a hearing de novo.

in assessing the appellant as he did the Minister added to the appellant’s income an amount of $200,500 on the assumption that the amount was received by the appellant as a commission for services rendered by him in the course of carrying on his business of a business broker from which it follows that the amount so received would be income and properly taxable as such.

As against this assumption the appellant contends that he received no commission but rather that he was acting in his own self-interest in building or adding to a capital asset already held by him or that the amount was paid to him gratuitously or given to him as a gift, in either of which events it was a windfall to him.

It is not disputed that the appellant received the amount of $200,500. The dispute revolves about the character of that sum in the appellant’s hands which in turn determines the taxability thereof.

The facts are novel.

The appellant, now retired, had been associated with a real estate brokerage company known as H B Sussman Associates Limited. In that employment the appellant does not appear to have concerned himself with real property transactions as such but rather devoted himself to that phase of the business dealing with the sale and purchase of businesses as going concerns and as such he acted on behalf of either the vendor or the purchaser. He described himself as a business broker and apparently he did not limit himself to his association with the Sussman company but operated other businesses acquired by him both in Canada and in the United Kingdom.

some time in 1960 the appellant found the opportunity to buy MidWest Produce Company, Limited (hereinafter called Mid-West) with head office in Winnipeg, Manitoba, which company with its subsidiaries, conducted a produce business throughout the prairie provinces.

The plan conceived by the appellant to acquire Mid-West was complex. The appellant caused to be incorporated a company called Frank Galway Holdings Limited (hereinafter called Holdings) with a capital stock consisting of preference and common shares. The gist of the plan was that Holdings would acquire the shares of Mid-West in conjunction with some other company which would buy the assets of Mid-West then lease those assets back to Mid-West which would continue to operate the business under the direction of Holdings.

The appellant would acquire 50% of the common shares of Holdings, and the leaseback company would also buy 50% of the common shares of Holdings.

The money to enable Holdings to purchase the shares of Mid-West would be generated by the leaseback company subscribing for 200,000 preference shares of the par value of $1 each and the purchase price of the assets of Mid-West in the approximate amount of one million dollars which would be advanced by way of a loan by the leaseback company to Holdings.

Having conceived this plan the appellant approached Traders Finance Company, Limited to participate in the manner as generally indicated above. The appellant had no previous dealings with Traders Finance Company, Limited. He unfolded his plan to Mr M A Monteith, a vice- president of Traders Leasing Limited. Mr Monteith was receptive to the plan. He put it to his board of directors who agreed to participate. At this point I would interject that the acquisition of the shares in Mid-West was effected by Holdings in 1961 in conjunction with Traders Finance Company Limited through its subsidiary and related companies, Traders Leasing Limited, Canadian General Securities Limited and Cox Insurance Agencies Limited. For the purposes of this matter it is convenient to refer to these companies as the Traders Group which was, in effect, the participant in the transaction without attempting to follow and outline the inter-company transactions and relationships.

The appellant purchased 50% of the common shares in Holdings for a consideration of $500 and the Traders Group purchased the remaining 50% of the common shares for an equal consideration.

Traders Group subscribed for 200,000 preference shares of Holdings for a consideration of $200,000. The appellant held no preference shares. Traders Group also provided interim financing. The Traders Group and Holdings Limited each acquired 50% of common shares of Mid-West but since Traders Group had provided interim financing by way of advances, and Holdings was indebted to Traders Group, the shares owned by Holdings in Mid-West were pledged to Traders Group as security for that indebtedness.

Holdings then negotiated the purchase of the shares of Mid-West. The assets of Mid-West were sold by Holdings to Traders Group and Traders Group promptly leased those assets back to Mid-West.

Traders Group was not interested primarily in its equity position but looked to its profit from the leasing arrangement. The lease of the assets back to Mid-West was for a period of ten years which yielded to Traders Group an annual return at the rate of 15% on its outlay.

The benefit of this transaction to Traders Group lay first in its profitable leaseback arrangement in addition to its holding of 200,000 preference shares and 500 common shares of Holdings.

The profits generated by Mid-West were used to discharge its obligation to Traders Group under the leaseback arrangement. Then the earnings would be applied to meet the dividend requirements on tne preference shares of Holdings. If surplus was available in Holdings it would be used to redeem the preference shares held by Traders Group.

The benefit to the appellant was that he became the owner of 50% of the common shares in Holdings for the modest investment of $500 and he had an employment arrangement. He managed Holdings and Mid-West. When the indebtedness of Holdings to Traders Group was discharged and when the preference shares held by Traders Group in Holdings had been redeemed then the appellant would own one-half of the common shares in Holdings which was the parent of a wholly owned subsidiary, Mid-West.

Shortly after the completion of the acquisition of Mid-West by Holdings the appellant had authority to negotiate the sale of the shares of Frankel Steel Construction (hereinafter called Frankel) for a commission pursuant to an agreement with Egmont Frankel, the principal shareholder. The price for the shares acceptable to Mr Frankel was $3,700,000 subject to his approval of the prospective purchaser. The commission was to be $180,000 which was to be shared three ways, $60,000 to the appellant, $60,000 to H P Sussman Associates Limited and $60,000 to Alan Frankel, the son of Egmont Frankel, who was also employed by the Sussman brokerage firm and who naturally acted in close liaison with his father in the matter.

The appellant arranged the sale of the Frankel shares to German interests but the purchaser was not acceptable to Egmont Frankel and this sale was not completed.

The appellant conceived a plan for the acquisition of the Frankel shares very closely paralleling the plan used to acquire the shares of Mid-West.

Again the gist of this plan was that Traders Group would put up the $3,700,000 required to purchase the shares of Frankel. in return for this Traders Group would obtain a 50% interest in Frankel and the appellant would also obtain a 50% interest. As in the acquisition of Mid-West it was the appellant’s plan that Holdings (or another company to be incorporated) would purchase the shares of Frankel with funds advanced to Holdings in exchange for preference shares. The distribution in the common shares of Holdings would remain the same, that is, 50% to Traders Group and 50% to the appellant but Traders Group, by agreement, would exercise 100% of the voting control. In short Traders Group would put up the money for which it would receive a 50% interest in Frankel through the interposition of Holdings and the appellant would also receive a 50% interest in Frankel in consideration of him having put the package deal together, but the appellant would advance no money towards the furtherance of the acquisition of Frankel.

Before approaching Traders Group with this plan the appellant first ascertained from Egmont Frankel that he would have no objection to the appellant acquiring an interest in the shares. The appellant did this in purported compliance with what he conceived to be his obligation under section 49 of The Real Estate and Business Brokers Act, RSO 1960, c 344. Section 49 requires that a broker or salesman shall not make an offer to purchase for himself either directly or indirectly any property listed with him for sale or any interest therein until he has disclosed to the owner complete details of his negotiations with any other person.

Having so cleared his proposed acquisition of an interest in Frankel shares, the appellant laid this proposition before Mr Monteith of the Traders Group. It was essentially the same proposition as that involving Mid-West. In effect the appellant said to the Traders Group “you put up the money and I put up the deal. For that you, Traders Group, get a 50% interest in Frankel and I also get a 50% interest. The shares of Frankel will be acquired by Holdings. Traders Group will buy further preference shares in Holdings”. The physical assets would be sold by Holdings to Traders Group and Traders Group would then lease back those assets to Frankel, then a subsidiary of Holdings.

Again Mr Monteith was receptive to the pian. Mr Monteith placed the plan before the Advisory Committee of Traders Group which approved the plan in principle. Mr Monteith so informed the appellant who formed the opinion from this advice that the deal had been concluded. The appellant then left for England for about two weeks to look after his interests there.

In the meantime, because of the large amount of money involved, the matter was referred to the full board of directors of Traders Group. The outside directors were not in favour of giving the appellant such a large interest. They considered a 50% interest to the appellant as excessive for his minimal contribution and accordingly reduced that interest to 25%.

Further, Traders Group had become disenchanted with the Mid-West deal to which it was a party and decided that it should get out of that deal. There was an investigation of that deal by the Department [of National Revenue] directed to the possibility of a dividend strip, which investigation accounts for the delay in bringing the present appeal to trial.

Traders Group consulted its legal and accountancy advisors who oointed out possible tax consequences if the deal went through as proposed by the appellant.

These three factors led to a revision of the thinking by Traders Group. First, Traders Group was not prepared to permit the participation of the appellant to be 50% but reduced it to 25%. Second, it decided to get out of the Mid-West deal and third, it was decided by Traders Group to acquire the shares of Frankel by direct purchase.

When the appellant returned from England he was informed of this change in the attitude of the Traders Group by Mr Monteith.

The appellant considered that he had no legal right to a 50% interest in Frankel because he said that there had been no written agreement with respect thereto.

On the other hand Traders Group felt that it was under an obligation to the appellant to the extent of a 25% interest in Frankel. That right may have been a. legal enforceable right or merely a moral right. Traders Group considered it to be their moral obligation to compensate the appellant for the appellant’s foregoing whatever right he may have had.

Accordingly Traders Group did a calculation to rationalize the difference between a 25% interest in Frankel and a 50% interest in MidWest (Exhibit 15). This calculation of the aforesaid difference worked out to $200,500.

Bearing mind that Traders Group would buy the shares of Frankel itself and that it wanted to withdraw from all participation in Mid-West and to compensate the appellant for his forebearance in attempting to enforce what right he may have had to participate in the Frankel deal to the extent of the difference between a 25% interest in Frankel and a 50% interest in Mid-West the following proposals were made by Traders Group to the appellant.

The appellant would buy the 500 common shares held by Traders Group in Holdings for $500 and the 200,000 preference shares of the par value of $1.00 each held by Traders Group in Holdings for $200,000. On its part Traders Group would pay the appellant $200,500 for his interest in 25% of the common shares of Frankel.

This arrangement was reduced to writing in the form of an agreement between Traders Group and the appellant (Exhibit 9) and presented to the appellant for his acceptance.

The appellant testified that, in his opinion, he had no choice in the matter because he had no legally enforceable right against Traders Group and he was heavily indebted to it. Accordingly he signed the agreement on the philosophy that half a loaf was better than none.

Traders Group then issued its cheque to the appellant for $200,500. The appellant, in his turn, issued his cheque in the amount of $200,500 in exchange for which Traders Group transferred 500 common and 200,000 preference shares held by it in Holdings to the appellant.

It was explained in evidence that the exchange of cheques was effected for bookkeeping convenience.

I would add that throughout those transactions Traders Group considered that it was dealing with the appellant personally rather than with Frank Galway Holdings Limited, the corporate entity referred to as Holdings.

I would also add that in the agreement between Traders Group and the appellant (Exhibit 9) the appellant is described in the second recital as ‘the beneficial owner of 25% of the issued and outstanding common shares in the capital stock of Frankel Steel Construction Limited and in paragraph 3 of the agreement Traders Group covenants to purchase “the common shares of Frankel Steel Construction Limited (being 25% of the outstanding common shares) held” by the appellant for $200,000 in cash.

In fact the appellant never became the registered holder of the common shares in Frankel.

It was also accepted that the appellant was not an employee of Traders Group.

In the result Traders Group purchased the shares of Frankel for $3,700,000. A commission was paid in the amount of $180,000 by Egmont Frankel. That commission was divided equally between the appellant, Alan Frankel and H B Sussman Associates Limited. The appellant declared the commission of $60,000 which he received as income.

In addition the appellant also received all shares held by Traders Group in Holdings so that he became the sole owner of all shares in Holdings. Those shares had the value of $200,500. This figure is not disputed.

The Minister added that value of $200,500 to the appellant’s income and levied tax accordingly.

The basic issue is whether the receipt of $200,500 by the appellant in the circumstances outlined constitutes income to the appellant in that it was remuneration for services rendered by him to the Traders Group for putting together a package deal for Traders and in bringing that deal to Traders and is therefore taxable, as is contended by the Minister or, as contended by the appellant, the amount received by him was not a fee, commission or remuneration for services rendered by him for the Traders Group but rather that the appellant was a co-investor with Traders Group in that his efforts in putting the deal together, which efforts had a value which could be translated into monetary terms, and that the appellant’s efforts were directed to an enhancement in the value of his holdings in Holdings and therefore constituted a capital outlay by him which would not be taxable. It was further contended by the appellant that since there was no legal obligation on Traders Group to compensate the appellant the fact that it did so constituted that compensation a windfall or gift and therefore it was not income.

The crux of the appellant’s contention that the money equivalent for the shares in Holdings that were transferred to him by Traders Group which is admitted to be $200,500 could not be remuneration for services to Traders Group is predicated upon the appellant’s belief that he was precluded from receiving a commission or fee from both the vendor, Egmont Frankel, and the purchaser, Traders Group, by The Real Estate and Business Brokers Act.

My attention was directed to sections 40, 49 and subsection 52(2) of that statute.

Section 40 provides that no action shall be brought for the payment of a commission on the sale or purchase of real estate, which by definition includes a business, unless,

(1) there was an agreement in writing signed by the party to be charged or

(2) the broker obtained an offer in writing that is accepted, or

(3) the broker, having been authorized to list the property shows the property to the purchaser or introduces the vendor to the purchaser.

section 49, to which I have previously referred, precludes a broker from making the purchase or any interest therein, unless he discloses to the listing vendor complete details of this negotiation with any other person.

Subsection 52(2) provides that the commission or other remuneration payable to the broker shall be in the agreed amount or a percentage of the sale price.

I would assume that the appellant’s belief that he was precluded from accepting a dual commission or remuneration was predicated upon his belief that the purpose of the Act was to prevent a conflict of interest in a broker or salesman acting for both parties.

However the provisions above referred to do not appear to specifically preclude a broker or salesman from exacting commission or remuneration from both parties to a transaction. Those sections prevent a broker from suing for payment of remuneration unless he has complied with the requirements of section 40. If he has done that with both parties to a transaction then it seems to follow that the broker could sue both or either of the parties.

My recollection of the appellant’s testimony was that in some instances he had acted for both parties to a transaction and exacted a commission or remuneration from both parties.

In my view it is not necessary for me to decide the question whether a broker is precluded by the statute from receiving a commission or remuneration from both parties to a transaction.

Assuming that the appellant was so precluded that does not prevent the commission or remuneration that he may have received from a party to a transaction for which he was prevented by the statute from suing for from being income. It is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses are subject to tax (see MNR v Eldridge, [1965] 1 Ex CR 758 at 766: [1964] CTC 545; 64 DTC 5338).

Therefore the question which remains for determination is whether the appellant performed services for Traders Group and was the amount of $200,500, which ultimately became the Traders Group shares in Holdings which were transferred to the appellant, remuneration for those services to Traders Group, if performed by the appellant.

There is no question whatsoever that the appellant received a commission from Egmont Frankel upon the eventual sale of the shares of Frankel to Traders Group.

However the appellant foresaw a still greater advantage to himself. First he advised Egmont Frankel as vendor that he personally con- templated the purchase of an interest in those shares. From that the logical inference is that the appellant would be co-purchaser. This inference is further confirmed by an affidavit filed by Alan Frankel, the son of Egmont Frankel, in which he swore that appellant and one of the companies in Traders Group would be buying the shares in Frankel but that he was not familiar with the manner in which the appellant would participate as principal nor was he aware of the proportions in the proposed purchase.

At one stage in his testimony the appellant did say that he contemplated the personal purchase of part of the Frankel shares for cash if he could borrow the money to do so. This did not happen.

The plan put forward by the appellant to Traders Group for the acquisition of the Frankel shares was that Traders Group would put up the full purchase price which was $3,600,000. The appellant would put up no cash whatsoever. His contribution was he had conceived the idea and put the deal together. This is a contribution upon which a money value may be placed. The appellant, in his proposal to Traders Group, placed a value on his services at a 50% interest in the Frankel shares which would be $1,800,000.

When the proposal was first considered by the Advisory Committee of Traders Group it was approved in principle. It is debatable if this constituted a binding or enforceable agreement but again this is a question I do not consider that I must decide. By accepting the appellant’s proposal in principle Traders Group must be taken to have accepted the appellant’s appraisal of the value of his efforts in putting the deal together and presenting it to Traders Group.

The question which follows is on whose behalf were those services performed. Obviously the appellant is going to be compensated and in that sense the efforts were on his own behalf. But that compensation to the appellant would come from the Traders Group. This is what the appellant expected. It was Traders Group that would put up the entire purchase price. it was Traders Group that would compensate the appellant for putting the deal together by making available to him 50% of the Frankel shares. In my view Traders Group would not compensate the appellant unless it was receiving something of value. Because Traders Group was to receive something of value, for which it was willing to pay, it follows that the services for which Traders Group was willing to pay were performed on its behalf.

When the matter came before the board of directors for ratification the board concluded that the compensation to the appellant was too high and accordingly reduced it to 25%. This to me is a negotiation of the value to be placed upon the appellant’s services. The fact that Traders Group had greater bargaining power than the appellant does alter the fact that there was a negotiation of the compensation for the appellant’s services.

Both the appellant and Mr Monteith in their testimony were consistent in their protestations that the interest received by the appellant in the shares of Frankel was not a commission, a finders fee, or a gift. If it was not a gift then it must have been payment for value received. In my view it is not necessary to apply any precise terminology to what was received by the appellant. For the reasons I have expressed it was, in my opinion, remuneration received by the appellant for services he performed in his capacity as a business broker on behalf of Traders Group. it therefore follows that the amount so received is income to the appellant and as such is properly exigible to tax.

The exchange of that compensation from cash into shares of Holdings which were transferred to the appellant by Traders Group as has been described was merely the method of payment to the appellant and does not detract from the payment in kind being income to the appellant.

The appeal is, therefore, dismissed with costs.