Connor v. Minister of National Revenue, [1975] C.T.C. 2132, 75 D.T.C. 85

The Chairman (orally: February 12, 1975):

1 This is an appeal by Desmond M Connor against the reassessment of the Minister of National Revenue for the 1969, 1970 and 1971 taxation years.

2 The issue in question is whether or not the earnings of D M Connor Development Services Ltd, a private company incorporated under the laws of the Province of Ontario on November 28, 1968, should be attributed to the appellant under subsection 16(1) and sections 3 and 4 of the Income Tax Act as it then applied, or whether the appellant was, as he has claimed, merely an employee of that separate legal entity drawing a fixed salary and being a one-third shareholder in the company.

3 This is a case that falls within a group of cases that has come to be known as the Sazio type. I am referring to the case of Ralph J Sazio v Minister of National Revenue, [1969] 1 Ex. C.R. 373, [1968] C.T.C. 579, 69 D.T.C. 5001, decided by Mr Justice Cattanach of the then Exchequer Court of Canada.

4 First, I should outline what the appellant's field of endeavour is, whether it be carried on as an employee of the company or as an individual. As I explained during the course of the hearing, I did not completely comprehend all of the niceties of the terms used by the appellant and his wife and by witnesses called for both the appellant and the Crown, but I feel that my knowledge is sufficient to permit me to say that the appellant's work is in the field of “people development”, social behaviour, and the advising of groups in various localities as to how they might band together to present a common front in an effort to prevent environmental damage that might adversely affect their social and economic lives. It also involves the bringing together of opposite factions so that a more cooperative approach to the existing problem might be obtained instead of having the various interested factions at loggerheads.

5 I think I can summarize best the activities of the company by referring to Exhibit A-3, which sets out in pamphlet form what D M Connor Development Services Ltd offered to the public at the time of the publication of that document which, although it is not dated, was issued somewhere around the year 1971 or shortly thereafter. It is my view, from the evidence I have heard, that its objects have not changed since the incorporation of the company or, in fact, since before the company was formed. I quote from Exhibit A-3:

BACKGROUND

Incorporated in 1968, the firm was initially based in Ottawa where a broad program of applied social research training in community development and courses in management education were developed and implemented.

A new approach to obtaining constructive citizen participation was created in 1969 and has since become the primary specialization of the firm. A dozen different applications have been made to projects from New Brunswick to British Columbia including river basin planning, highway location studies, hydro corridor location, park planning, new town design, and the siting of solid waste disposal sites.

By deliberate policy, in view of the pioneering nature of the specialty, the firm has remained small so that the direct and personal services of the principal are available to all clients.

6 The services listed are:

• Orienting seminars for senior management.

• Design of programs for specific projects.

• Management of programs as a member of a multidisciplinary consortium.

• Counsel on operational problems.

• Recruitment, selection and training of staff for programs.

• Evaluation of programs.

• Public seminars in citizen participation, team effectiveness and public meeting procedures. (Available in-house also.)

7 The publications listed are:

Handbook series: Understanding your Community;

Diagnosing Community Problems; Strategies for Development;

Citizens Participate.

Quarterly Newsletter: Constructive Citizen Participation.

Publishing is carried out through: Development Press, Box 1016, Oakville, Ont.

8 Then under the heading of “Subsidiary Interests” one reads:

While currently in a secondary position, the following areas are under constant review, are incorporated as appropriate in citizen participation services and may become major fields for the firm in the next 5 years.

CONSUMERISM: Customer participation in business as an extension of a responsive marketing philosophy; directly parallels citizen participation in planning.

ORGANIZATIONAL DEVELOPMENT: Participative management is a natural companion of citizen participation.

PERSONAL PLANNING: Principles applied by planners and managers to benefit others can readily be used to benefit themselves.

SOCIAL AUDITING: Increasingly, large organizations are being asked to demonstrate their social value as well as their economic and technical performance. This new field offers many challenges and opportunities.

9 The final item listed is “Resources”:

The principal has a diversified background of training and experience across Canada and overseas. (Career resumé on request.)

Specialization in citizen participation during the last 5 years follows a decade of applied research and management training.

A professional staff of up to 5 varies with projects; they usually possess Master's degrees in the applied social sciences and relevant experience.

A widespread network of associates and contacts facilitates staffing and other activities.

10 I think that that pretty well confirms the evidence given by the appellant and his wife, Etta M Connor, during the course of the hearing.

11 I shall deal first with the facts as they were presented by Mrs Connor and the other witnesses called. The first witness, Etta M Connor, the wife of the appellant, filed a career resumé, which is Exhibit A-1. She gave her evidence in the box, and I must say that I was most impressed with the manner in which she gave it. Her composure, her grasp of the questions that were put to her, her description of her personal abilities and of the abilities of those with whom her husband was associated, and the reasons for the incorporation of the company, were precise, firm and unshaken on any question. How ever, when one reads the career resumé in detail from 1956 (when she was a high-school teacher in Ontario and Nova Scotia) until the year 1974, one does not, with great respect, find substance or depth to her alleged abilities or to the contribution to this company that this witness is alleged to make.

12 I should say at this time that the comments I have made with respect to Mrs Connor in giving her evidence apply equally to the appellant during his testimony. I suppose, because of their training, they both could be expected to present in the witness box the appearance that they did of self-assurance and matter-of-factness. In giving their evidence neither the appellant nor his wife attempted to embellish his or her personal qualifications.

13 However, as I have said, in the case of Mrs Connor and her contribution to D M Connor Development Services Ltd in so far as it concerns this case, I must find that in effect she did not underplay her part in the success of the company in her viva voce evidence.

14 On the other hand, when one looks at Exhibit A-4, which is the resumé of the appellant, one finds that the appellant is a man of many talents in the “people development” field, which is a new field of sociology. In Exhibit A-4 he describes himself as a consulting sociologist specializing in the design and supervision of research and action programs for community, regional and organizational development. He has had extensive teaching experience both in universities and in-service development programs. In his evidence and that of his wife, it was indicated that he had been a training instructor for members of the Peace Corps in the United States and of CUSO in Canada, both of which organizations are basically concerned with providing the same type of service to such of the developing countries as might request it.

15 In 1951 he received a Diploma in Agriculture from the University of New Zealand; in 1954 a National Diploma in Agricultural Engineering from the Essex Institute of Agriculture in the United Kingdom; in 1957 the degree of Bachelor of Science in Agricultural Economics from the University of Toronto while attending the Ontario Agricultural College; in 1962 the degree of Master of Science in Sociology and Anthropology from Cornell University; and in the next year, 1963, the degree of Doctor of Philosophy in Rural Sociology, Cultural Anthropology and General Sociology, also from Cornell University.

16 The evidence indicates that in 1963, which is really the starting point of import in this case, he was doing research at St Francis Xavier University in Nova Scotia, and doing a minimum amount of teaching on the side. As time progressed, he did more and more research and less and less teaching. Subsequently, in or about 1967, he gained the confidence, experience and courage necessary to start out on his own as a consultant in his chosen field of sociology. He came to Ottawa and, by 1968, the consulting field, particularly in so far as he is concerned, “took off”, as the saying goes, and his business increased substantially.

17 I should say at this time that the prime utilizer of his talents is government, whether it be federal, provincial or municipal. Exhibit A-5 shows a list of contracts entered into between December 1968 and November 1973, and it can be seen that the majority of these contracts come from government agencies or institutions.

18 He said that in 1968, on the advice of his lawyers and accountants, he decided that he should incorporate. He gave as one of the main reasons for the incorporation the question of personal liability, because he was becoming involved in larger contracts that did not involve himself alone but also other individuals, and because insurance, for what I suppose would be the equivalent of malpractice, was not available to him. He also said that the incorporation of a limited company lends credibility to the operation, because government agencies have had unfortunate experiences in dealing with individuals. At the time in question, there was a limited number of individuals who were qualified in this field, and they were usually employed by universities. The agencies would hire these individuals for part of a year but in September they would often return to their universities, leaving the agencies high and dry. He also said that the question of the tax situation was considered. The various advantages were pointed out to him by his accountants and he felt that if he could build up his company to the point where, by the time he wished to retire, it had substantial retained earnings and substantial goodwill, he would be able to sell the company as a retirement fund source. Either the appellant or his wife also stated that the company would be able to market his services more readily.

19 As I have said, the company was incorporated in November 1968 with three permanent shareholders, Mr and Mrs Connor and a Mr Searle. Mr Searle, apparently, had been in the consulting business for some 40 years before returning to university to work on further postgraduate degrees. He worked in conjunction with Mr Connor on various projects, although at no time was he ever paid by the company or the Connors, but was always paid directly by the client who was retaining the services of either Mr Connor or D M Connor Development Services Ltd.

20 There is some confusion in the minute book of the company and in its financial statements on the question of whether three shares or one thousand shares were issued, but I place no great significance on this point, because the evidence of both Mr and Mrs Connor was that Mr Searle was entitled to one-third of the equity in D M Connor Development Services Ltd. There was no doubt in Mr Connor's mind as to this, although Mrs Connor was not too firm on it, not necessarily because there was any doubt in her mind but because, in my view, she did not really understand the share aspect of the matter. The minute book does not record any meetings after December of 1969. It records only the organizational meetings and the transfer of the shares from the provisional directors to the permanent directors and shareholders. It is also interesting to note that nowhere in the minute book does Mr Searle sign the minutes. Since he did not give evidence, I can only assume that although a shareholder, he had little or no formal or practical connection with the operation of this company. The fact that he did not give evidence goes no further than to allow me to assume that appellant's counsel felt that his evidence would not have added anything to the appellant's case.

21 According to Exhibit A-5, from December 1968 to November 1973 the company grossed annually amounts that ranged from $46,000 to $107,000, and the net income after taxes went from $9,600 to $36,000. Throughout this period there was a verbal contract between the company and the appellant that he was to receive $1,500 a month in the years under appeal, and that his wife was to receive $250 a month. The evidence is that these amounts were paid by the company to the appellant and his wife pursuant to that verbal contract, which was never reduced to writing.

22 I should add that, throughout all the operation of his consulting services, whether as an individual or in the name of the company, the appellant kept his hand in at teaching, and he also published several pamphlets to which I shall refer later. The evidence is that in the period from 1963 to 1967 the Connors worked together as a team, and although all the income went to the appellant, it was considered as income earned by the couple as a family unit, was deposited in joint accounts, and there was no breakdown or salary allocation between the appellant and his wife, all the income having been declared by him.

23 I suppose this is not relevant to the final outcome of this case but I think it should be said, so that it will be known that I have not overlooked the fact. Had the appellant paid any income or employment fees to his wife, they would not have been allowable as deductible expenses under the provisions of the Act as it then existed, and the result would have been as it was regardless of the course they followed.

24 In 1970–71 Mr Searle went into a farming venture. Apparently he had a background, as did the appellant, in farming, or, at least in agriculture. To all intents and purposes, he removed himself from the consulting field.

25 Referring again to Exhibit A-5, I see that the last page is headed “Staff List”. Throughout the years in question, and in fact until 1973, the only full-time member of the staff was the appellant. Mrs Connor is listed as part-time for the 12-month period, and a secretary is listed as half-time to the end of 1970. In 1970–71 there is a half-time secretary—the same secretary—and a half-time community worker was employed for six months. In 1971–72 the community worker is no longer shown on the list of staff, but there is a second half-time secretary. However, the appeal concerns only the years 1969 to 1971 inclusive. (In 1972–73—which year is not before me—there is the same half- time secretary, plus five community workers on a part-time basis.) This corroborates the evidence given by Dr Connor when he indicated that this is the sort of business in which he could manage alone until the company obtained a contract, and then, through his various connections in teaching, lecturing and writing, was able to go out and fill his staff requirements for the particular contract.

26 There was also called on behalf of the appellant Dr Katharine B Cooke, who at the present time is on leave from her regular governmental duties and is chairman of the federal Advisory Council on the Status of Women. She was a postgraduate student at the same time as the appellant and has personal knowledge of his capabilities. Let me say at this time that there is no question whatsoever in my mind that this appellant is perhaps one of the most qualified and active people in the field of “people development” or consulting sociology in this country, and perhaps in other countries as well. Dr Cooke indicated that she was instrumental in first obtaining the appellant's services for governmental work in the project known as ARDA—the administration of the Agricultural and Rural Development Act. It was her evidence that the government preferred to deal with a company or a university rather than an individual for reasons much the same as those set out by the appellant for the incorporation of his company. She stated unequivocally that the government would rather deal with a company than an individual. Not to detract from what I have just said about the appellant's professional capabilities, Dr Cooke also pointed out in her evidence that there were very few people in Canada who were qualified in the “people development” field.

27 Dr Cooke stated also that, in or about 1968, she was one of the main persons looking into “people development”, and had a hand, along with a Mr Bradley who was also directly concerned, in “people development” projects. It was Bradley's function to have contracts signed. She said that she suggested to the appellant that he incorporate because there would be much more business likely to come his way if he did so. She stated that the director—who I take to be Mr Bradley—also told Mr Connor that he should incorporate, and informed him that they wanted to form a team to do a pilot project through a limited company and others.

28 Mr Bradley was called as a witness on behalf of the respondent. He also is a former university professor. He came to this country in 1966 from the University of Vermont and was special adviser to the Chief of the Socio- Economic Division of the Inland Waters Directorate of the Department of the Environment. At the material time, he was head of the Developmental Services Unit of the Social Development Section in the Policy and Planning Directorate of the Department of Regional Economic Expansion. He was also directly engaged, as I have said, with ARDA, and he has known the appellant since 1966. He corroborates my assessment of the professional abilities of the appellant. He said they—“they” being the government agency—were putting together a training unit and needed program design in social science, and he said: “I selected Dr Connor for his ability.”

29 Mr Bradley was questioned about whether or not from his agency's point of view a limited company had an advantage over an individual, and his answer was that they looked to the ability of the person or persons involved, and for a contract of some $26,000, which was the amount of the ARDA contract of 1968–69, a very thorough and careful check would be made into the actual ability of the person or persons to whom the contract was to be awarded to perform the work. He denied that he ever informed, instructed or suggested to Connor that he should incorporate. He said that, in so far as Dr Cooke was concerned, she and he were peers in the Social Development Section of the Department of Regional Economic Expansion but with different responsibilities. He was just as firm in his assertion that he did not recommend incorporation as Dr Cooke had been to the contrary, because he said he was looking only at the qualifications of the appellant.

30 When I examined Mr Bradley myself the best that I was able to elicit was that, all things being equal, and if the persons who were to do the actual work were qualified to substantially the same degree, his directorate would prefer to deal with a limited company rather than an individual; but I only elicited this from him after two or three attempts.

31 So much for the general facts. What then happened after the incorporation? The only evidence put before me by the appellant by way of copies of contracts, consists of two contracts, one dated March 5, 1969, which was effective from December 1, 1968, between Her Majesty the Queen in Right of Canada, represented by the Minister of Forestry and Rural Development, thereinafter called “the Minister”, of the first part, and D M Connor Development Services Limited, of the second part. That contract specifically states that the company is “to provide the services of Dr Desmond Connor to act as a consultant to the Director of Policy and Planning in matters defined as follows ...”. There is also a prohibition against any other person engaging in the work without the written consent of the Minister. As one reads the entire contract, it is clear and unequivocal that what the Minister, by Exhibit A-6, was hiring was the expertise, knowledge and proven ability of this appellant alone.

32 Again, there is a contract dated June 4, 1973, which is a contract in connection with the new town of North Pickering, in which the company, D M Connor Development Services Ltd, might be classified as a subcontractor; but, after reading the contract, one can see that there is nothing in it to indicate that anyone other than Dr Desmond Connor was expected to do the work, and the evidence before me does not lead me to the conclusion that, even by 1974, there was anyone within the company qualified, competent and available to perform the work of that contract save and except the appellant.

33 It was pointed out, quite aptly I think, by counsel for the Minister, that, of all the contracts that are referred to in Exhibit A-5, only two have been produced, and only one that relates to a year under appeal herein. The excuse given by the appellant is that several moves have been made and documents have been lost. I find this to be an acceptable reason for the disappearance of documents, but I find it unusual, in such a meticulous and well trained person, who had gone to great pains to prepare himself for this work and then to incorporate D M Connor Development Services Ltd, one of the objects of incorporation admittedly having been to gain a tax advantage, not to have taken precautions to segregate and preserve any documents which might be of assistance to him in establishing a sound business purpose for the incorporation of the company.

34 There is another matter which gave me great concern and led to some confusion in the evidence. However, now it is quite clear that in 1969 and 1970 certain funds were paid directly to the appellant which should have been paid to the company if it was the contracting party. Presumably those cheques were endorsed over to the company by him—at least, I make that assumption—and deposited in the company's account. There does not appear to be any serious dispute that that is what happened and that during those years the appellant received his $18,000 a year (or $1,500 per month) which, as I earlier stated, he has been receiving since the company's incorporation.

35 There is a point in the evidence where the appellant showed signs of being something less than the self-assured witness he had appeared to be during most of his testimony. He chose on several occasions, when being questioned on cross-examination, to begin his answer with the phrase, “That is a hypothetical question”. There was nothing in any of the questions that was of any great significance or that was not obvious from what had gone on before, and it left me with the impression that perhaps this witness, with whom I had been so impressed, was applying some of his professional training in an effort to influence me.

36 In answer to questions put to him by myself as to how this company advertised and how persons seeking his expertise would know where to locate him, he indicated that a great deal of it was by word of mouth and by association with people in this limited field who would need his services. He said that he and his wife could not advertise because the office of the company was in their home in Nepean Township on the outskirts of Ottawa, where exhibition of business signs was prohibited, although apparently, if there was no outward advertising on the residential lot, no pressing objection was registered with regard to the use of facilities within the house as an office. There was no separate listing for the company in the telephone directory. Mainly, the knowledge that this company was available to render the services that I have outlined was spread throughout this and other countries by the publication of pamphlets, books—which would fit more into the category of large pamphlets—and newsletters, and these have been filed by the parties as Exhibit R-1 and Exhibit A-2. I have taken the opportunity not only to look at these documents but to read them. In none of the documents in Exhibits A-2 and R-1, that is to say, in none of these books containing 40 to 50 pages each, is there any reference to the work of anyone other than Desmond M Connor. The copyright is his. The theses—and I use that word in its lay meaning—proposed to persons with community problems are those of Desmond M Connor. They are printed by Development Press, which he said is a wholly owned subsidiary of D M Connor Development Services Ltd. All of these documents, some of which were originally published in 1968 or earlier, but have been reprinted as late as 1974 in one instance, are obvious attempts to influence interested clients in employing the services of the appellant himself.

37 The newsletters, as I refer to them, are headed “Constructive Citizen Participation”, and other than Development Press, which is a registered trade name—the evidence does not quite say that but that is an inference I am prepared to draw—the only name that appears in them that has any connection whatsoever with the limited company is that of Desmond M Connor. I am referring to the two publications dated 1973 and 1974, and bearing the words “Copyright: Desmond M Connor”. It is true that there is one sheet headed “D M Connor Development Services Ltd”, which is an invitation to citizens to participate in a constructive citizen participation seminar to be held in the city of Ottawa and, clearly, was entirely put on by the appellant, although, in this case, the registration fee is requested to be sent to D M Connor Development Services Ltd. In the description given therein of the workshop leader, he is said to be a consulting sociologist and president of D M Connor Development Services Ltd of Ottawa. The description then goes on to list some of the leader's degrees and some of his work. One can only be led to believe or infer from those documents that the only person involved was this appellant.

38 Therefore, I must now decide whether or not there is any sound business basis for the incorporation of this company that would give this appellant the relief that was permitted in the case of Ralph J Sazio v. MNR previously cited. I quote from the reasons for judgment of Mr Justice Cattanach on pages 587–8 [5006–7]:

Here the appellant and his Company are two separate entities. In my view this is not a matter of form but rather a matter of substance and reality. Both the appellant and the Company could sue and be sued in its own right and indeed there is nothing to prevent the one from suing the other if need arose.

Ever since the Salomon case, [1897] AC 22, it has been a well settled principle, which has been jealously maintained, that a company is an entirely different entity from its shareholders. Its assets are not their assets, and its debts are not their debts. It is only upon evidence forbidding any other conclusion can it be held that acts done in the name of the company are not its acts or that profits shown in its accounts do not belong to it. The fact that a company may have been formed to serve the interests of a particular person is not sufficient to establish the relationship of principal and agent between that person and the company. In order to hold otherwise it must be found that the company is a “mere sham, simulacrum or cloak”.

It is my view that the evidence in the present appeals is conclusive that such is not the case. It must also be borne in mind that the Company engaged in a variety of activities other than supplying the football coaching services of the appellant and I can see no logical reason for segregating the football coaching services from those other activities.

39 In the Sazio case, on the facts that were before the learned trial judge, the company carried on many operations other than the foot ball coaching services referred to. As I recall it, there were one or two insurance agencies being managed, a radio or television program, spring football clinics, and other activities in which the company was involved and from which it derived income. In this case nothing is being offered but the professional ability of Desmond M Connor. In my view there is no evidence to support the argument or assertion that his wife was an integral part of the project team that was available through D M Connor Development Services Ltd. There is nothing in the evidence to indicate any serious participation on her part in the activities of the company, and certainly not in the activities of her husband in the performance of contracts in which he was specifically designated as the person to do the work. However, there is evidence that she has achieved some degree of success in her own right. I think she stated at one time in her evidence that she had now received a contract at a fee of some $150 a day for her own specialty as a psychologist. There is no suggestion in any of the evidence, or in any of the documents, that her participation was a requisite for the obtaining or the carrying out of the work. There is no staff in the office in their home, except herself and a part time secretary.

40 I am not certain in my own mind that it is even necessary to come to the conclusion, as the learned trial judge did in the Sazio case, that in order to dismiss an appeal such as this one must find that the company or transaction is a sham, simulacrum or cloak. There is no doubt whatsoever that the company was properly incorporated and was a separate legal entity as established by the Salomon case referred to in the Sazio decision. There is no reason why a company once incorporated as a separate legal entity cannot carry on a successful separate business as was found to be done in the Sazio case. It seems to me that the real test is: what does the main driving force behind the company use the company for? In my view, there was nothing more than an assignment or a diversion to a limited company of funds that would otherwise have been directly paid to the appellant, and the only possible business reason that might be found for so doing, or upon which an argument for incorporation might be based, lies in the fact that the appellant did enjoy a certain degree of limited liability. But if his avowed intention was to take this small salary in order to build up the assets of the company, then it seems to me that he stood to lose just as much, whether the company was sued or he was sued, if a judgment was awarded against the company. His whole assets, save and except what was a very modest salary for a man of his qualifications, were locked into this company and would have been lost to him had the company become a judgment debtor for any amount in excess of its assets.

41 On all of the evidence, including any inferences that can be drawn from the exhibits filed, I cannot find that there was any sound business reason for the incorporation of this company in the light of the activities and actions of this appellant in the years subsequent to the incorporation. Accordingly, the appeal must fail, and will be dismissed.