Dermot Doyle and Martina Fennell v. Her Majesty the Queen, [1997] 1 CTC 2659 (Informal Procedure)

Margeson J.T.C.C.: — It was agreed at the outset that the two matters would be heard at the same time and the evidence would be considered in each appeal where relevant.

It was further agreed that the only year in issue was the taxation year 1992 and that the only issue was whether or not Doyle Realty Limited (the “Company”) had conferred a benefit on the Appellants as shareholders under subsection 15(1) of the Income Tax Act (the “Act”).

The Minister had assessed the Appellants on the basis that the Company had conferred a benefit of $23,582 upon each of them in the year in question. The Notice of Reassessment was dated November 21, 1994 with respect to the Appellant Dermot Doyle and November 21, 1994 in respect of the Appellant, Martina Fennell.

Agreed Facts

The Appellants’ counsel agreed with the presumptions of fact contained in paragraphs 7(a), 7(b) and 9 of the Reply to Notice of Appeal. He disagreed with the presumptions of fact contained in paragraph 7(c), (d) and (e) of the Reply.

Dermot Doyle testified that the Company was founded in 1963 by his father. He wanted to treat each of his five children equally for the purposes of inheritance and so he incorporated the Company and left 20 per cent of the shares to each of his five children including the two Appellants when he died in 1973.

After the father’s death, the Appellant Dermot Doyle attempted to find out the nature of his interest in the Company’s assets but his brother would not give him any information. Consequently, a legal action was commenced by the Appellants and another sister, Genevieve Hickey against the Company, Alfred Doyle and Leona Doyle. The Appellant Dermot Doyle said that they had tried different avenues to obtain information about the Company’s affairs and were unsuccessful.

The Appellants and their sister, Genevieve Hickey believed that their brother, Alfred Doyle was operating the Company poorly. Occupancy rates were low, maintenance was unsatisfactory, debts were not being paid off and the plaintiffs could receive no information about dividends.

The Appellant, Dermot Doyle, contacted a lawyer. He was advised that a Court action could be taken which might include a plea for accounting, winding up and a determination as to who were the proper directors.

Ultimately, the action resulted in a judgment in favour of the Appellants which included an order for costs on a solicitor/client basis against Alfred Doyle and party and party costs against the other defendants. A copy of the judgment was tendered into evidence by consent, as Exhibit A-l, for the limited purpose of establishing the result of the legal action.

After the judgment was delivered, the shareholders met and signed an agreement which effectively saw the Appellant Dermot Doyle buying out the interests of the other shareholders. The Agreement was tendered into evidence as Exhibit A-2 by consent.

By this Agreement, Alfred Doyle was relieved from paying all costs awarded against him as a result of the legal action and all of the legal costs including the costs of the Appellants were paid by the Company.

The Appellant Dermot Doyle said that when he investigated the legal action he did not do so “to enable him to take over Doyle Realty Ltd., but o exorcise the devil that was in it and allow the Company to get back to Business”.

The Appellant said that they were assessed one third each of the olicitor’s costs as a benefit from the Company even though there were six Tareholders.

In cross-examination, the Appellant Dermot Doyle said that he had initially given $1,000 as a part payment to legal counsel but he was acting for all three plaintiffs. The Company and the other two defendants also had a lawyer and they resisted the legal action commenced by the plaintiffs. The witness said that his concern with Alfred Doyle was on behalf of the Company and not personally.

The Appellant Dermot Doyle believed that Alfred Doyle was controlling the mind of his mother who held 1,000 preferred shares which were supposed to be non-voting but were being used as voting shares by Alfred Doyle to run the Company and control any shareholders’ meetings.

The plaintiffs represented 60 per cent of the common shareholders and could not appoint a member to the Board of Directors as a result of the actions of Alfred Doyle. Dermot Doyle said that he believed that the result of the legal action would be “to make the Company correct, to make it operate in a proper manner as a business and to allow the three shareholders who are the plaintiffs to direct the Company”. He said:

My concern was not for my share. I had let that go before the legal action. If it were not for my sisters I would have done nothing.

He said that there was no agreement to pay the legal costs. He was not sure if he would be responsible for his own legal costs. He was representing 60 per cent of the shareholders of the Company. He did not believe that he would lose legal action.

The lawyers for the plaintiffs took instructions from them and they contracted to pay him. The amount assessed to each plaintiff was one third of the amount that Revenue Canada had decided was the proper amount to allot to legal costs and this was agreed to by the Appellants on the advice of their accountant.

The witness said, “I gave Mr. Watters (the lawyer) no more money for the legal action except for the $1,000 or a little more. Any other money given to the lawyer was for other personal work.”

Immediately after the legal action had been successful, the Appellant, Dermot Doyle, instructed their lawyer to satisfy the judgment and to collect the legal fees against the defendants. It was agreed that the Company would pay the shortfall.

He admitted that if the Company could not pay, he would have been personally responsible for the legal costs together with the other Appellants. This collection action was terminated after the parties reached an accord.

The Respondent called Jane Mah who was an auditor with Revenue Canada. She was familiar with this matter. She reviewed this file, the working papers, talked to the auditor on the file and to the Appellants or their representatives.

The Company was denied the expenses that they had claimed and the Appellants were assessed benefit for the years 1991, 1992 and 1993. Objections were filed and the assessments for 1991 and 1993 were vacated.

The 1992 taxation year had the largest claim for expenses and it was agreed by the Appellants’ accountant that the figure of $70,746 was the proper amount to be considered as the amount of legal fees paid to legal counsel as a result of the action in question.

At first the figure was allotted among all six shareholders but then it was considered to be an expense of the three plaintiffs only and the benefit was allotted among them.

In cross-examination the witness said that she had concluded that the legal liability for the debt was that of the three plaintiffs only. She did not know if any one other than the three shareholders had benefited from the legal action but she concluded that that was not an issue.

Argument of the Appellants

Counsel agreed that the amount of $70,746 was the amount agreed upon as the legal fees of counsel for the plaintiffs in the civil action and that this was the amount that was paid by the Company.

His position was that any benefit that resulted was that of Alfred Doyle and not that of the Appellants or at least was a benefit to all of the shareholders since they benefited from the legal action and not just the plaintiffs.

Counsel asked: What is a benefit under subsection 15(1) of the Act? He said that the amount paid here was an amount paid by the corporation in the “reorganization of the business of the corporation” and is therefore exempt under the provisions of paragraph 15(1 )(a) of the Act.

His position was that under the provisions of section 339(1 )(b)(ii) of the Corporations Act, S.N. 1986, Ch. 12, as a result of the legal action the trial judge ordered a winding up of the business of the Company. This was not done as the parties reached an agreement so what in effect was left was a reorganization. The costs were incurred for the purpose of “winding up”. There need not be a winding up in order for the provisions of paragraph 15( 1 )(a) of the Act to apply.

The nature of the action in the Supreme Court of Newfoundland was an application to wind up the Company under section 339(1 )(b)(ii) of the Newfoundland Statute. It was not an action to promote the interest of the plaintiffs but of the Company.

Counsel referred to an excerpt from a text, “The Fundamentals of Canadian Income Tax”, Second Edition, Vern Krishna, in support of this proposition. Counsel referred to the case of Assaly v. Minister of National Revenue, [1978] C.T.C. 2082, 78 D.T.C. 1086 and said that essentially the same action took place in that case as in the case at bar. There, the argument advanced by the taxpayer shareholders was that they received no benefit from the legal action which they took to resolve an impasse be- tween the directors of two companies which had brought the businesses of the companies to an impasse. The taxpayer shareholders took action to have the companies wound up and the deadlock was resolved.

Counsel argued that this appeal should be allowed and that the assessments vacated with costs to the Appellants.

If the Court should find that there was a benefit conferred upon the shareholders, it should be allotted among all six shareholders and not just the three shareholders of the Company.

Argument of the Respondent

Counsel for the Respondent took the position that the issue in the present case is under subsection 15(1) of the Act. The section is very broad. There is no definition of “benefit” because the legislators did not want to limit its meaning.

The exceptions referred to in paragraph 15(l)(a) do not apply to the present case.

The provisions of the Act dealing with winding up are covered in section 88 of the Act. This was not a winding up situation.

There was no distribution of assets that could be considered to be the deemed benefit. The amounts in question here resulted from a legal bill owing by the Appellants which was paid for by the Company.

There was no action in the Company until after the judgment was delivered in the civil action. This could not have been a reorganization since nothing happened until after the judgment was delivered.

The second part of paragraph 15(l)(a) does not stand alone, that is the reference to the reorganization. This portion of the paragraph must be read in relation to the first part, the reduction of capital.

Counsel took the position that the civil action in question here was commenced by the Appellants because Dermot Doyle was dissatisfied with the way that the Company was being managed. It was a dispute among shareholders to remove Alfred Doyle. Only the plaintiffs gave their lawyer instructions. They believed that they would be successful. The action was on behalf of the three shareholders only. It makes no difference that the ultimate result may have been an indirect benefit to the Company or to anyone else. The question to be asked is: Whose legal bill was it and who was liable to pay it? The answer to this question does not come from asking a further question, who benefited from it? In support of this proposition, he referred to the cases of William F. Koch Laboratories v. Minister of National Revenue (1956), 16 Tax A.B.C. 39, 56 D.T.C. 489; D.J. MacDonald Sales Ltd. v. Minister of National Revenue (1962), 29 Tax A.B.C. 94, 62 D.T.C 208; and 412237 Ontario Ltd. v. R. (sub nom. 412237 Ontario Ltd. v Canada), [1994] 1 C.T.C. 2177, 94 D.T.C. 1022 (T.C.C.). To say that the amounts were not allowed as expenses to the Company does not mean that they were not benefits to the Appellants.

Counsel also cited Border Fertilizer (1972) Ltd. v. Minister of National Revenue, (sub nom. Border Chemical Co. v. R.), [1987] 2 C.T.C. 183, 87 D.T.C. 5391 (F.C.T.D.); Ben Matthews & Associates Ltd. v. Minister of National Revenue, [1988] 1 C.T.C. 2372, 88 D.T.C. 1262 (T.C.C.) and Rigmil Ltd. v. Minister of National Revenue (1964), 36 Tax A.B.C. 321, 64 D.T.C. 652, in support of his arguments. (These cases involved the claiming of expenses by the corporations, whether or not they were deductible by the corporations or whether they were capital in nature or expended for the purpose of earning income. They did not involve the issue of “benefit”.)

Counsel also referred to Croteau v. Minister of National Revenue (1964), 36 Tax A.B.C. 299, 64 D.T.C. 643 which appears to confront headlong the issues involved in the case at bar.

Counsel argued that the case of Mary Assaly et al., supra, is distinguishable from the case at bar. It dealt with a very specific set of facts unlike those in the present case. This case has not been referred to in any other decisions. Further, the shareholders in that case brought the action as directors and were duty bound to do so. There was no impasse in the Company operations in the case at bar. The legal fees were only paid after the Appellant Dermot Doyle became a director following the successful conclusion of the legal action.

Rebuttal

In rebuttal, counsel for the Appellant argued that not all of the parties in the legal action in Mary Assaly et al., supra, were directors as counsel for the Respondent implied.

In that case, the same legislative provisions applied as under section 339(1) of the Corporations Act of Newfoundland. It has to be a shareholder.

As in Mary Assaly et al., supra, there was no distribution of capital and this is the same situation in the case at bar.

Counsel argued that the amount in question in this case was a dividend.

Sur Rebuttal

Counsel for the Respondent advised the Court that in the event that the appeals were allowed, he wished to speak to the matter of costs.

Analysis and Decision

The Court has firstly to deal with the question of what constitutes a benefit. There is no definition in the Act of this term. Subsection 15(1) does not attempt in any way to limit the ordinary or common meaning of the word. In Webster’s Ninth New Collegiate Dictionary, Thomas Allen & Son Limited, the word “benefit” includes the word “advantage”.

Counsel for the Appellant took the view that there was no benefit under the section but if there was it was a benefit conferred on Alfred Doyle since he was the person who was ordered by the Supreme Court of Newfoundland to pay the plaintiffs solicitor/client costs. These are the very costs which compose the amounts in issue.

It is true that since the Company ultimately paid the costs, as the result of an agreement reached between the parties to the litigation after the judgment was handed down, Alfred Doyle may have gained a benefit, but that does not necessarily mean that the Appellants did not likewise receive a benefit.

The tax implications on Alfred Doyle are not before this Court.

The payment by the Company, in accordance with the agreement reached, satisfied the legal liability of Alfred Doyle to pay the legal costs of the Appellants as between solicitor and client but it also removed the liability of the Appellants to pay their lawyers’ bill which they otherwise would have been responsible for paying.

There can be no doubt that the Appellants retained their own counsel, they instructed him, not as counsel for the Company but as their personal counsel. The Company had its own counsel and indeed was a defendant in the action.

Until the Court judgment ordered the defendant Alfred Doyle to pay the plaintiffs costs on a solicitor/client basis, that defendant had no legal liability to pay those costs. Likewise the granting of the order against Alfred Doyle did not remove the legal liability of the Appellants to pay their lawyer. Indeed if the agreement had not been reached and the defendant Alfred Doyle had been unable to pay that part of the Appellant’s legal bill which constituted the solicitor/client costs, the Appellants would still have been required to pay that bill.

Those facts would appear to bring this case in line with the cases of Kenora Miner and News Ltd. v. Minister of National Revenue, [1970] Tax A.B.C. 337, 70 D.T.C. 1228 and Croteau, supra.

Even if the Court was to conclude that the Company or Alfred Doyle had also received a benefit that would not preclude the finding that the Appellants had received a benefit under the Act.

Counsel for the Appellants argued that the action taken had as its purpose the benefit of its shareholders and the Company. Even if the Court accepted that proposition that would not preclude a finding that the Appellants had also received a benefit as a result of the action.

The above referred to cases would appear to be at variance with the results in Mary Assaly et al., supra. The factual situation there was very similar to the facts in the case at bar. In the Assaly case, supra, the Ta> Review Board concluded that since the action by the taxpayers was tc break an impasse between the directors which prevented the carrying out o the normal profit-making activities of the Company, the expenses wer« incurred for the purposes of producing income and the taxpayers receive no benefit.

In the case at bar there was no dispute between the directors as none of the Appellants were directors but that would hardly be a sufficient basis for distinguishing the case at bar from the Assaly case, supra.

The Tax Review Board concluded that: “The taxpayers did not receive any benefits per se from the fact that the companies paid the legal expenses”. This Court has difficulty in accepting that proposition and to the extent that the two cases cannot be distinguished this Court believes that the results reached in Kenora Miner et al., supra, and Harold E. Croteau, supra, should be followed.

It is to be noted that the Assaly case, supra, did not attempt to define or even consider with any specificity what constituted a benefit.

On the basis of the facts established in this case, the Court is satisfied that the Appellants received a benefit as a result of the payment of the legal costs of their solicitor by the Company within the contemplation of subsection 15(1) of the Act.

The Appellants may escape liability for the receipt of the benefit conferred upon them by the Company if they can bring themselves within the exceptions found in paragraph 15(1 )(a) of the Act.

Counsel for the Appellants took the position that the legal action was in the nature of an application for winding up under the appropriate Statute of Newfoundland and since the winding up did not take place because of the agreement, the result was a reorganization.

But even if the Court were to conclude that there was a reorganization of the Company it would still have to find that the benefit conferred had come about on the winding up, discontinuance or reorganization of the business but the benefit conferred in the case at bar came about on the payment of the legal bill of the Appellants for the Company. The Court is satisfied that the type of benefit conferred in the case at bar is not the type of benefit contemplated by paragraph 15(l)(a) of the Act.

Likewise the Court is satisfied that what occurred in the case at bar was ot in the nature of an “appropriation” of capital property to the benefit of h—ra shareholder creating a taxable dividend as referred to in sections 18 and 19 of the Textbook, “The Fundamentals of Canadian Income Tax Act’, econd Edition by Vern Krishna, Carswell 1986.

The types of benefit contemplated by section 15 and in the above eferred to textbook are in the nature of benefits received as a result of the -^distribution of assets after winding up, bankruptcy, reorganization, dis- ontinuance, reduction of the paid up capital, the redemption, cancellation

—r acquisition by the corporation of shares of its capital. This section does ot contemplate excepting a benefit such as was conferred in this case.

With respect to the argument that if there was a benefit, it was one sixth the amount rather than one third since there were six shareholders, the Court rejects that argument.

The subject matter of the conferred benefit was the payment of the legal bill of the Appellants alone. The other shareholders were not legally bound to pay those legal fees because they did not retain the counsel who charged them. Any benefit that those shareholders, other than the Appellants, received did not come about as a result of the retention of the Appellants’ legal counsel.

The appeals are dismissed and the Minister’s assessments are confirmed.

Appeals dismissed.