R. v. Phillips, [1975] C.T.C. 250, 75 D.T.C. 5188

Heald, J:

1 This is an appeal by the Crown from a decision of the Tax Review Board allowing the defendant's appeal from a reassess ment for the defendant's 1966 taxation year wherein the Minister of National Revenue added an amount of $22,000 as income pursuant to the provisions of subsection 8(1) of the Income Tax Act.[FN1: <ul>8. (1) Where, in a taxation year,<li><p>(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,</p></li><li><p>(b) funds or property of a corporation have been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or</p></li><li><p>(c) a benefit or advantage has been conferred on a shareholder by a corporation,</p></li>otherwise than<li><ul><li><p>(i) on the reduction of capital, the redemption of shares or the winding-up, discontinuance or reorganization of its business,</p></li><li><p>(ii) by payment of a stock dividend, or</p></li><li><p>(iii) by conferring on all holders of common shares in the capital of the corporation a right to buy additional common shares therein,</p></li></ul></li>the amount or value thereof shall be included in computing the income of the shareholder for the year.</ul>]

2 In 1961 one Donat Beaupré, now deceased, and the defendant, who were partners in a private detective agency, incorporated said business under the name of Phillips Investigation Bureau Ltd, a Quebec corporation (hereinafter referred to as the Company).

3 The defendant was president and Beaupré was vice-president of the Company until March 28, 1964. Early in 1964 personal conflicts arose between the defendant and Beaupré. Beaupré was dismissed and had to leave his employment with the Company. Beaupré and the defendant each held beneficially 50% of the issued common stock in the Company.

4 On March 28, 1964 two contracts were entered into before a notary, the first between Beaupré and the defendant and the second between Beaupré and the Company. By the first contract, Beaupré sold his common stock to the defendant for the sum of $12,000 (of which he only received $11,700, being $12,000 less $1,700 owed by Beaupré to the defendant, plus $1,400, Beaupré's share in the Superior Protective Systems, another company in which the two partners held an interest).

5 By the second contract, Beaupré was hired by the Company as a consultant for $48,000, payable in monthly amounts over a period of six years commencing April 1, 1964 (that is, $1,000 monthly for two years and $500 monthly for four years).

6 Apparently, pursuant to said contract, the $1,000 monthly payments were made for only four months and the company then stopped making them whereupon Beaupré sued the Company in the Superior Court of Quebec where he was successful. After this judgment in the Superior Court dated July 25, 1966, a settlement was worked out between Beaupré and the Company by which Beaupré settled his claim for $22,000 on October 17 or October 18, 1966.

7 The Minister of National Revenue, is reassessing the defendant for his 1966 taxation year, assumed that the $22,000 paid by the Company to Beaupré were funds of the Company that had been appropriated to or for the benefit of the defendant who was a shareholder in said Company during the said taxation year within the meaning of paragraph 8(1)(b) of the Income Tax Act (supra).

8 It is the plaintiff's further submission that said $22,000 represents part of the total consideration for the purchase of Beaupré's interest in the Company by the defendant and that said amount was agreed to and paid by the Company during the defendant's 1966 taxation year with the consequence that the Company conferred a benefit or advantage on the defendant within the meaning of paragraph 8(1)(c) of the Income Tax Act (supra).

9 On the other hand, it is the defendant's position that if, by the contracts of March 28, 1964, a benefit or advantage was conferred upon the defendant by the Company, which is denied, then such benefit or advantage was so conferred in the year 1964 and not in the year 1966. With respect to the $22,000 payment by the Company in 1966, it is the defendant's position that said payment was made to discharge the legal obligations of the Company only and that during the year 1966 no benefit or advantage was conferred on the defendant by the Company.

10 The defendant gave evidence at the trial before me. Before the Tax Review Board, no witnesses were heard. Before the Board defendant's counsel agreed that a benefit was conferred on the taxpayer but submitted that such benefit was conferred in the taxation year 1964 instead of 1966. The Tax Review Board agreed with that submission, thus allowing the defendant's appeal. In the trial before me, no such concession was made and defendant's counsel argued strenuously that no benefit or advantage was conferred upon the defendant, either in 1964 or in 1966.

11 The defendant's evidence before me was to the effect that he purchased Beaupré's 250 shares of $12,000. In describing the relationship between the two contracts executed on March 28, 1964, he said it was his intention to “tie Beaupré down”. He said that if he had paid Beaupré off immediately and completely, he feared that he might open up in opposition and thus do harm to the Company. He said that his fears were justified because some four months after the agreements of March 28, 1964 Beaupré did, in fact, open up his own detective and security agency. The defendant says that that is the point at which the Company ceased paying Beaupré the $1,000 monthly payments. He said further, that as a result of Beaupré commencing his own agency, in competition with the Company, the Company lost its contract for security services with Steinberg's which represented gross income to the Company of approximately $115,000 annually. According to the defendant, the Company also lost some smaller contracts to Beaupré's agency.

12 Under cross-examination, the defendant admitted knowledge of the Income Tax Act to the extent that any moneys payable by way of consultant fees might be considered as deductible for tax purposes whereas any moneys paid for shares in the capital stock of a company, in these circumstances, was clearly a capital expenditure and, therefore, not deductible for taxation purposes. He also conceded that after March 28, 1964 Beaupré never rendered any services of any kind of the Company. He said that, within six weeks of March 28, 1964, he made requests of Beaupré by mail requesting that he take on two different assignments and that he was not able to contact Beaupré. He said that Beaupré was more or less incommunicado after March 28, at least so far as he, the defendant, and his Company were concerned. He also conceded that, according to the Company's balance sheet as of November 30, 1963, the book value of the Company's shares was established at $99.98 per share and said that he had no reason to dispute this value. He also said that he sold all of the shares in the Company for $139,000 in 1968. The defendant also conceded that the so-called consultant agreement did not contain a “non-competition covenant” on the part of Beaupré. The defendant's only explanation for this was that he depended on his accountant and the notary who drew the contracts to protect him and that he thought the contract protected him against competition by Beaupré. The consultant agreement also contained two other clauses to which I attach some significance. The first such clause reads as follows.

That the Company may not, for any reason, terminates this agreement or dismiss Mr. Beaupré for any reason whatsoever.

That if Mr. Beaupré dies before the expiration of this agreement, the Company hereby undertakes to pay the legal or testamentary heirs of the said Mr. Beaupré the balance that may be owing, at the time of his death, on the said sum of forty-eight thousand dollars ($48,000), payable in the above- described manner by way of annuity, until the expiration of this contract;

• (a) he purchased Beaupré's one-half interest in the Company for $12,000; and

• (b) that the second contract for $48,000 was, in fact, what it purported to be—i.e., a contract for Beaupré's services:

14 1. Several months before March 28, 1964, the book value of the Company was established at approximately $50,000. It seems extremely unlikely that a one-half interest therein could be purchased for $12,000 since the indications were that the Company was increasing rather than decreasing in value as time went on.

15 2. The defendant sold the Company in 1968 for $139,000.

16 3. The so-called contract for services could not be terminated nor could Mr Beaupré be dismissed for any reason whatsoever. This is, to say the very least, a most unusual provision in a contract for services. The contract also provided that if Mr Beaupré died before the agreement was completed, the balance of the $48,000 still owing would continue to be paid to his estate. This clause is further confirmation of the view that the payment of the $48,000 was not related to or dependent upon the provision of services by Beaupré.

17 4. The admission by the defendant that he was aware of the taxation advantages in endeavouring to show a substantial portion of the consideration for the shares as payment for services, which, if accepted, would be a deductible item.

18 5. Beaupré never rendered any services of any kind to the Company after March 28, 1964. The defendant tried to give him two different assignments within six weeks of March 28 but could not locate him. In spite of this, the defendant continued to make the $1,000 monthly payments for another two or three months (until Beaupré opened up his own business). This is further confirmation of the fact that the payment of the $48,000 to Beaupré was in no way related to or dependent upon the provision of services by Beaupré.

19 6. The absence in the contract of a non-competition clause. I did not find the defendant's explanation in this regard to be persuasive. He said that he was relying on his accountant and the notary to protect his interests; that he was a policeman essentially and not a lawyer and could not be expected to understand the legalities and technicalities of the situation. In my view, a non-competition clause was not inserted because it was not considered necessary, either by the defendant or by those acting on his behalf. In my view, Beaupré was to receive $60,000 for his one-half interest in the Company and that the two contracts instead of one were made in an attempt to lessen the incidence of income tax liability.

20 For the above reasons, I have concluded, on all of the facts here present, that a benefit or advantage was conferred on the defendant, being a shareholder of the Company, by the Company.

21 This conclusion does not however dispose of the appeal. The remaining question for decision is whether said benefit was conferred in 1964 when the two agreements in question were entered into or in 1966, when the Company paid the $22,000 to Beaupré.

22 In my view, the judgment of the Federal Court of Appeal in the case of James F Kennedy v Minister of National Revenue, [1973] F.C. 839, [1973] C.T.C. 437, 73 D.T.C. 5359, when applied to the facts here present, supports the submission of the defendant that the benefit here conferred was conferred in 1964 and not in 1966.

23 In that case, in 1965, an automobile sales company, all of whose shares belonged to appellant, acquired an old building for its business at a cost of $344,000. The company then sold the building to appellant for $259,000, giving him a promissory note for $53,000, in the difference between the sale price and the amount of a mortgage on the building, which was assumed by appellant. In 1965 the appellant was assessed income tax under subsection 8(1) (supra), on the assumption that in 1965 the company transferred to him a property worth $344,000 for $259,000. On these facts, the Court held that the creation of a debt by a company in favour of a shareholder for no consideration confers a benefit on the shareholder within the meaning of subsection 8(1) and that, accordingly, the promissory note given appellant in 1965 by the company must be taken into account for the purposes of subsection 8(1) in 1965 and not, as contended by appellant, in the year when the note was paid. At pages 842 and 843 [440, 5361] of the judgment, Jackett CJ clearly restates the distinction made in other cases between “income” and a “benefit” as contemplated in subsection 8(1) as follows:

... In the case of “income”, it is assumed, in the absence of special provision, that Parliament intends the tax to attach when the amount is paid and not when the liability is created. (The courts naturally react against taxation before the income amount is in the taxpayer's possession.) Here, the question is when a “benefit” has been “conferred” within the meaning of those words in section 8(1). In my view, when a debt is created from a company to a shareholder for no consideration or inadequate consideration, a benefit is conferred. (The amount of the benefit may be a question for valuation depending on the nature of the company.) On the other hand, when a debt is paid, assuming it was well secured, no benefit is conferred because the creditor has merely received that to which he is entitled. I am, therefore, of the opinion that the $53,000 promissory note must be taken into account for the purposes of section 8(1) in the year in which it created an indebtedness from the company to the appellant, namely, 1965.

The question of benefit or no benefit in the 1965 taxation year is, in my view, primarily a question of fact in connection with which the onus of proof was on the appellant. ...

24 The principles above stated established by the Kennedy case (supra) were followed by my brother Addy, J in the case of The Queen v Frank Leslie, [1975] C.T.C. 155, 75 D.T.C. 5086. At page 159 [5089] of that judgment, Mr Justice Addy said:

Generally speaking, when a legally enforceable obligation to pay has been entered into, in one taxation year, and this obligation is met and paid in a subsequent taxation year, it is when the legally enforceable benefit is created and not when the taxpayer actually receives payment that the amount should be taken into account.

25 In the Leslie case (supra), Addy, J departed from the general rule above stated on the facts peculiar to that case (ie, in the Leslie case (supra), while the legal obligation was created in 1959, it was clear that there were insufficient assets to meet the legal obligation imposed, whereas, in 1969, when the payment was made, the assets had accumulated sufficiently to allow the obligation to mature into a real benefit). In the case at bar, the Company was a solvent going concern in 1964 when the legal obligation was created, the book value of its assets being in excess of $50,000 and the market value being, in all likelihood, considerably higher. The Company was sold a few years later for $139,000. I have no doubt, on the evidence, of the Company's ability to comply with the obligations assumed under the contract of March 28, 1964 at that time and at all relevant times thereafter.

26 Applying paragraph 8(1)(c), it was in 1964 that the defendant purchased the Company shares for $12,000, which, on the evidence, was for considerably less than their real value. The agreement for the sale of the shares dated March 28, 1964 conferred complete and absolute title in the shares in the name of the defendant. Accordingly, this “benefit or advantage” was conferred on the defendant, a shareholder, by the Company, in 1964.

27 In my view, paragraph 8(1)(b) does not apply to the facts of this case because the $22,000 in funds paid by the Company in 1966 were not “appropriated” for the “benefit of a shareholder”. The $22,000 was paid by the Company to Beaupré to relieve the Company of its obligations under the contract of services of March 28, 1964 between the Company and Beaupré (italics are mine).

28 The defendant was not a party to that contract. He had no obligations thereunder. Therefore, any moneys paid under that contract or to cancel that contract or to satisfy a court judgment pursuant to that contract were paid for the benefit of the Company and not for the benefit of the defendant.

29 For the foregoing reasons, plaintiff's appeal is dismissed with costs.