Citation: 2010 TCC 168
Date: 20100323
Dockets: 2009-1150(EI)
2009-1151(CPP)
BETWEEN:
J.R. SAINT & ASSOCIATES
INSURANCE AGENCIES LTD.,
Appellant,
and
THE MINISTER OF NATIONAL REVENUE,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
Introduction
[1]
The Appellant set up the
Employee Profit Sharing Plan (the “EPSP”) on January 1, 2006 for Nicolas
Anstis, Kevin Lundy, Shannon MacDonald and James Saint, all employees of the
Appellant (the “Employees”). Following the establishment of the EPSP, the Employees’
salary and wages were reduced to a nominal amount and the balance of their
remuneration was paid to them through distributions from the EPSP funded by the
Appellant. The Appellant admits that the purpose of the EPSP was to eliminate
the Canada Pension Plan (“CPP”) and employment insurance (“EI”)
premiums payable on salary and wages. Payments to employees from an employees
profit sharing plan are treated as trust income, and not salary and wages,
under the CPP and EI program.
[2]
The Respondent argues that
the EPSP was a sham (the “Sham Argument”) because the Appellant caused salary
and wages due and payable to the Employees to transit through the EPSP for the
purpose of misleading the Minister of National Revenue (the “Minister”) into
believing that the payments made by the EPSP to the Employees were trust
distributions. According to the Respondent, the payments were in fact salary
and wages that were due and payable to the Employees.
Issues
[3]
The issues in these
appeals are:
(a) whether the Appellant
misrepresented the circumstances surrounding the establishment and operation of
the EPSP, thus making the EPSP a sham for the purposes of the CPP and
the Employment Insurance Act (the “EIA”);
(b) if the EPSP is a sham,
whether the amounts received by the Employees thereunder are employment income
and therefore pensionable and insurable income for the purposes of the CPP
and the EIA.
[4]
At the outset of the trial,
the Respondent brought a motion to amend its Reply to the Notice of Appeal (the
“Amended Reply”) by the abandonment of its argument that the EPSP was not
properly constituted, as a consequence of which the Respondent’s case would now
be based solely on the Sham Argument. I allowed the amendment and both parties
were given the opportunity to make written submissions. Counsel availed
themselves of this opportunity.
Factual Background
[5]
Following an audit of
the Appellant’s EPSP, a referral was made for a trust account examination to be
performed on the Appellant’s books and records. On the basis of that examination,
the Minister determined that payments made to the Employees from the EPSP
during the 2006, 2007 and 2008 taxation years were pensionable income and
pensionable earnings from pensionable employment under section 12 and paragraph
6(1)(a) of the CPP and insurable income and insurable earnings from
insurable employment pursuant to section 82 and paragraph 5(1)(a) of the
EIA.
[6]
As a result of that
decision, the Minister assessed the Appellant for CPP contributions plus
related penalties and interest, as follows:
|
Year
|
Amount
|
Penalty
|
Interest
|
|
2006
|
$12,972.74
|
$1,673.89
|
$2,348.00
|
|
2007
|
$11,340.08
|
$1,563.52
|
$627.00
|
|
2008
|
$2,733.90
|
$198.64
|
$95.00
|
[7]
The Minister also
assessed the Appellant for EI premiums plus related penalties and interest, as
follows:
|
Year
|
Amount
|
Penalty
|
Interest
|
|
2006
|
$4,266.16
|
$1,673.89
|
$2,348.00
|
|
2007
|
$4,795.20
|
$1,563.52
|
$627.00
|
|
2008
|
$1,252.70
|
$198.64
|
$95.00
|
[8]
The appeals from those
assessments were heard on common evidence.
[9]
The Respondent stated
in paragraph 14 of the Amended Reply that it had relied on the following
assumptions of fact in making its decision:
(a) the Appellant is in the Business of providing
financial services and insurance (the “Business”);
(b) the Appellant’s fiscal year is from January 1
to December 31;
(c) the Appellant’s shareholders and their
percentages of holdings are:
2006
·
James Saint 51%
·
Saint Family Trust 49%
2007 to present
·
James Saint 100%;
(d) James Saint is the President of the Business;
(e) for the relevant period, the Workers were
employed by the Appellant under a contract of service;
(f) the Workers’ positions are as follows:
·
Shannon MacDonald Executive Assistant
·
Kevin Lundy Sales and
Administration
·
Nicolas Anstis Financial Advisor;
(g) the Appellant had five employees in 2006,
five in 2007 and four in 2008;
(h) the Appellant set up a trust (“the Trust”) on
January 1, 2006 by entering into an agreement;
(i) the Trustees of the Appellant’s “Trust” are
James Saint, James McIntyre and Daryl Phippan;
(j) James McIntyre and Daryl Phippan were not
active in the management of the funds;
(k) the realized net income is to be allocated to
the Participants prior to the end of the year via written direction from the
Board of Directors;
(l) pursuant to the Appellant’s Resolutions, the
allocations were to be as follows:
·
Resolution dated December 23, 2006, the
amount of $386,146.86 are [sic] to be paid by December 31, 2006
– Shannon MacDonald: $47,026
– Kevin Lundy: $33,369
– James Saint: $233,740
– Nicolas Anstis: $72,010
·
Resolution dated December 23, 2007, the
amount of $163,736.88 are [sic] to be paid by December 31, 2007
– Shannon MacDonald: $52,979
– Kevin Lundy: $38,646
– James Saint: $0.00
– Nicolas Anstis: $72,110
(m) the Workers received the following T4
employment income from the Appellant:
|
Name
|
2005
|
2006
|
2007
|
|
Nicolas Anstis
|
$40,499
|
$6,153
|
$64,356
|
|
Kevin Lundy
|
$34,384
|
$5,000
|
$4,500
|
|
Shannon
MacDonald
|
$46,499
|
$6,384
|
$4,500
|
|
James Saint
|
$230,000
|
$3,975
|
$294,406
|
(n) in 2006, the Workers received an annual
nominal amount between $3,975 and $6,384 on which deductions were taken through
the Appellant’s regular payroll;
(o) in 2007, the Workers received an annual
nominal amount between $1,500 and $4,500 on which deductions were taken through
the Appellant’s regular payroll;
(p) the Workers received additional income from
the Appellant as follows:
|
Name
|
2006
|
2007
|
|
Nicolas Anstis
|
$124,964
|
$72,110
|
|
Kevin Lundy
|
$33,369
|
$38,646
|
|
Shannon
MacDonald
|
$47,026
|
$52,979
|
|
James Saint
|
$280,000
|
$0.00
|
|
Total
|
$485,359
|
$163,736.88
|
(q) in 2006, the percentage of additional income
compared to T4 income was as follows:
|
Name
|
2006 T4 income
|
2006
additional income
|
Percentage
|
|
Shannon
MacDonald
|
$6,384.62
|
$47,026.50
|
726.56%
|
|
Kevin Lundy
|
$5,000
|
$33,369
|
667.38%
|
|
James Saint
|
$3,975.00
|
$280,000
|
7,044.03%
|
|
Nicolas Anstis
|
$6,153.85
|
$124,964.37
|
2,030.67%
|
(r) in 2006 2007, the percentage of additional income compared to T4
income was as follows:
|
Name
|
2006 2007 T4 income
|
2006 2007 additional income
|
Percentage
|
|
Shannon
MacDonald
|
$4,500.00
|
$52,979.75
|
1,177.33%
|
|
Kevin Lundy
|
$4,500.00
|
$38,646.25
|
858.81%
|
|
James Saint
|
$294,406.00
|
$0.00
|
0.00%
|
|
Nicolas Anstis
|
$64,356.76
|
$72,110.88
|
112.05%
|
(s) the payments referred to in paragraphs (q)
and (r) above were not based on any determined formula, and
contributions were calculated on an ad hoc basis;
(t) only Nicolas Anstis, Kevin Lundy, Shannon
MacDonald and James Saint received additional income from the Appellant in 2006
and 2007;
(u) the Appellant reported on its financial
Balance Sheet, Retained Earnings, as follows:
|
2005
|
$1,141,436
|
|
2006
|
$906,921
|
|
2007
|
$1,230,669
|
(v) the Appellant reported on its financial
Income Statement, Profit, as follows:
|
2005
|
$229,866
|
|
2006
|
$371,313
|
|
2007
|
$492,699
|
(w) the Appellant reported on its financial Income
Statements and on its corporate returns the amounts paid to the Workers as
salaries and wages;
(x) the Workers were paid all income through a
bank account number 1093656 in the name of “J.R. Saint & Associates
Insurance Agencies Ltd.” at Manulife Bank (the “J.R. Saint & Associates
Insurance Agencies Ltd. account”);
(y) the Appellant had signing authority and
managed the account of J.R. Saint & Associates Insurance Agencies Ltd.
account [sic];
(z) the J.R. Saint & Associates
Insurance Agencies Ltd. account reported the following:
·
debits and credits of $4,936.11 were processed
on a bi-weekly basis for 19 months from February to August 2006
·
debits of $4,936.11 and credits of $5,000 were
processed on a bi-weekly basis for 19 months from September 2006 to March
2007
·
debits of $3,196.67 and credits of $5,000 were
processed on a bi-weekly basis for 7 months from April to October 2007
·
debits of $3,196.67 and credits of $3,200 were
processed on a bi-weekly basis for 7 months from November 2007 to May 2008
·
effective January 2007, the $5,000 credits were
pre-authorized automatic transactions
·
credits were transferred from Manulife Bank
account number 1025234, the business corporate account;
(aa) during the [sic] 2006, 2007 and 2008,
the total contributions and withdrawals to the “J.R.
Saint & Associates Insurance Agencies Ltd.” bank account were as follows:
|
Years
|
Contributions
|
Withdrawals
|
|
2005 2006
|
$479,233.32
|
$482,427.18
|
|
2006 2007
|
$185,000.00
|
$161,657.63
|
|
2007 2008
|
$35,200.00
|
$35,163.37
|
(bb) none of the funds contributed to the J.R.
Saint & Associates Insurance Agencies Ltd.’s bank account were invested.
[10]
James Saint appeared as
the sole witness for the Appellant. During his testimony, he admitted that the
purpose of the EPSP was to allow the Employees to receive a substantial part of
their compensation in the form of distributions from the EPSP rather than as salary
and wages. As a result, most of the income earned by the Appellant’s Employees
in 2006, 2007 and 2008 was not subject to withholdings for EI or CPP
premiums. Mr. Saint alleged that the primary factor in determining the
total contribution to the EPSP was the desire to ensure that the Appellant did
not report net income in excess of the amount eligible for the small business
rate of taxation. The evidence shows that this was true for the contributions
made to the EPSP that were allocated to Mr. Saint. However, with respect
to Nicolas Anstis, Kevin Lundy and Shannon MacDonald, the evidence shows that
the situation was otherwise. In fact, during cross‑examination
Mr. Saint admitted that, with respect to those other employees, he looked
at what their remuneration for their services would have been for the year and divided
it by 26 to come up with the amount that was paid to them through the EPSP in
lieu of salary and wages.
[11]
Counsel for the Appellant
confirmed that this was how Mr. Saint determined the biweekly payments (the
“biweekly payments”) made by the EPSP to Nicolas Anstis, Kevin Lundy and
Shannon MacDonald:
MR. BECK: Sorry. It's not disputed that commencing in 2006, upon the
purported EPSP, that salaries that otherwise would have been – otherwise would
have been paid directly to employees were flowed through the EPSP.
I think my Mr. Saint's answer is essentially bi-weekly
amounts were determined based on what the same employees would have received
had there been no EPSP, or alternatively, based on what those employees
received in years that there was no EPSP.
Analysis
[12]
By agreement of the
parties, I can dispose of these appeals by deciding whether or not the EPSP set
up by the Appellant constitutes a sham in whole or in part. Before addressing
the Respondent’s Sham Argument, it is useful to consider the meaning of “employees
profit sharing plan”, which is defined in subsection 144(1) of the Income
Tax Act (the “ITA”) as follows:
144(1) Definitions — The definitions in this
subsection apply in this section.
“employees profit sharing plan” at a particular time means an
arrangement
(a) under which payments computed by reference to
(i) an employer’s profits from the employer’s business,
(ii) the profits from the business of a corporation with which the
employer does not deal at arm’s length, or
(iii) any combination of the amounts described in subparagraphs (i)
and (ii)
are required to be made by the employer to a trustee under the
arrangement for the benefit of employees of the employer or of a corporation
with which the employer does not deal at arm’s length; and
. . .
[13]
The following three
conditions must be met in order for an arrangement to meet the requirements of this
definition:
(a) payments must be
computed by reference to the profits of the employer’s business;
(b) those payments must be
handed over to a trustee under the arrangement; and
(c) all amounts received
by the trustee must be allocated each year by the trustee to the employees that
are beneficiaries under the arrangement.
[14]
At this point, it
should be noted that the Appellant also relies on an election that was made
under subsection 144(10) of the ITA. That provision provides relief from
the condition that payments into an EPSP must be computed by reference to
profits, and reads as follows:
144(10) Payments out of profits — Where
the terms of an arrangement under which an employer makes payments to a trustee
specifically provide that the payments shall be made “out of profits”,
the arrangement shall, if the employer so elects in prescribed manner, be
deemed, for the purpose of subsection (1), to be an arrangement under which
payments computed by reference to the employer’s profits are required.
[Emphasis added.]
[15]
A valid subsection
144(10) election has the effect of the “computed by reference to . . .
profits” requirement being deemed to be satisfied if the terms of the plan
provide, for example, for fixed payments to be made into the plan out of the
profits of the employer. There is in that case no need for the payment into the
plan to be determined by means of a formula-based calculation.
[16]
This brings us to a consideration
of the concept of sham in Canadian tax law. One of the leading cases on the
subject is the decision of the Federal Court of Appeal (the “FCA”) in 2529-1915
Québec Inc. v. Canada.
In that case, the FCA distinguishes the concept of sham from the notion of
abuse. The notion of abuse is relevant for the purpose of the general
anti-avoidance rule found in section 245 of the ITA, which is not
applicable in the present case. The FCA concludes that a transaction can be set
aside under the concept of sham if the evidence shows the existence of the
requisite element of deceit:
59 It follows from the above definitions that the existence
of a sham under Canadian law requires an element of deceit which generally
manifests itself by a misrepresentation by the parties of the actual
transaction taking place between them. When confronted with this situation,
courts will consider the real transaction and disregard the one that was
represented as being the real one.
[17]
The Appellant argues
that the onus of proof as it pertains to the concept of sham rests with the
Respondent. It is not open to the Respondent to rely on the assumptions of fact
contained in paragraph 14 of the Amended Reply to support its position. The
Respondent must establish the factual underpinnings of a sham in the case at bar
on the basis of the evidence. I agree with the Appellant on this point only
with respect to paragraph 14.1, which was added in the Respondent’s Amended
Reply. The Respondent can rely on the assumptions of fact pleaded in paragraph
14 of the Respondent’s Reply and carried over into the Amended Reply. That
paragraph was amended to correct clerical errors only. In fact, some of those
assumptions of fact are germane to the Respondent’s Sham Argument.
[18]
I believe that the
Trust Indenture executed to establish the EPSP contains a number of
misrepresentations of fact. Section 1 of the preamble to the Trust Indenture
provides the following:
The Company desires to establish an Employee Profit Sharing Plan
pursuant to Section 144 of the Income Tax Act (the “Plan”) for the benefit of
the Eligible Beneficiaries in order to permit the Eligible Beneficiaries to share
in the profits of the Company;
[Emphasis added.]
[19]
Similarly, article 2 of
the Trust Indenture defines the purpose of the EPSP as follows:
The Company contributes the Trust Assets to the Trustees for the
benefit of the Participating Beneficiaries identified in this Trust Indenture.
[20]
Paragraph (j) of
article 1 of the Trust Indenture defines “profits” as follows:
“Profits” means the net income of the Company arrived
at by following generally accepted accounting practices as determined from the
financial statements of the Company for the fiscal period in question.
[Emphasis added.]
[21]
From the Trust
Indenture, it can be seen that the salient features of the EPSP are the following:
(a) The purpose of the
EPSP is to allow eligible employees to participate in the Appellant’s profits.
(b) The Appellant has
absolute discretion to determine the amount of its contribution to the EPSP
subject to a minimum contribution equal to 1% of profits.
(c) Contributions to the
EPSP must be made out of the Appellant’s accumulated profits as defined in the
EPSP.
[22]
The evidence shows that
these principles were not adhered to with respect to the contributions made to
fund the biweekly payments made by the EPSP to Nicolas Anstis, Kevin Lundy and
Shannon MacDonald (the “Non-shareholder Employees”). Prior to the creation of
the EPSP, the Appellant was obliged to pay the Non-shareholder Employees’ salary
and wages on a biweekly basis. Shannon MacDonald and Kevin Lundy’s salaries were
a fixed amount plus a small bonus. Nicolas Anstis provided investment advice to
clients and his remuneration was based on a formula that took into account his
contribution to the Appellant’s earnings. Following the creation of the EPSP,
the Appellant offered the Non‑shareholder Employees the opportunity to
receive a substantial portion of their compensation through biweekly payments
from the EPSP. The Non-shareholder Employees accepted this arrangement and
received from the EPSP biweekly payments which were characterized by the
Appellant in its tax filings as trust distributions. The sum of these biweekly
payments and the nominal annual salary amount constituted the employees’
remuneration for their employment services for the relevant period. While none
of the Non-shareholder Employees were called as witnesses by the Appellant,
Mr. Saint and his counsel admitted that part of the Non-shareholder
Employees’ normal employment compensation was paid through the EPSP. There is other
evidence which corroborates this fact. The unaudited financial statements of
the Appellant for the periods under review characterize the contributions paid
out of the EPSP as salaries and benefits deductible in the calculation of the
Appellant’s net income for financial statement purposes. Exhibit A-5 appears to
be an Excel spreadsheet that tracks the payments made to the Employees from the
EPSP. The title on the spreadsheet describes the payment summary as the “EPSP
Payroll”. At trial, I asked Mr. Saint whether Mr. Anstis would be
entitled to claim the amounts accrued to his account but not yet payable in the
event that he was terminated without cause. Mr. Saint confirmed that he
would be entitled to claim all such amounts. I surmise that the other Non‑shareholder
Employees would be entitled to similar treatment. In other words, their
vacation pay and severance claims would be based on the sum of the amount shown
to be their nominal salary and the amount of all the biweekly payments received
from the EPSP. As regards these payments, there was nothing discretionary about
the Appellant’s contribution to the EPSP. The evidence shows that the payments
were required in order for the Appellant to fulfill its obligations towards its
employees. The Appellant was in a position to call the Non‑shareholder
Employees to testify concerning their understanding of the character of the
payments made to them under the EPSP. I draw a negative inference from the fact
that they were not called to testify on this point. As salary, the biweekly payments
could not form part of the Appellant’s accumulated profits as defined in the
Trust Indenture. The amounts of those payments were deductible in the
calculation of the Appellant’s profits, as shown in the Appellant’s unaudited
financial statements. Profit is the amount that remains after the deduction of
all expenses incurred to earn revenue.
[23]
Counsel for the
Appellant argues that my colleague Porter D.J. considered a similar EPSP
arrangement in Allan A. Greber Professional Corporation v. M.N.R., 2004
TCC 78, and arrived at a conclusion different than my own. In Greber,
the Minister agreed that the EPSP was a valid and properly constituted plan.
The Minister did not advance the “Sham Argument” in that case. In the present
case, the Minister argues that misrepresentations of fact were made by the
Appellant in the Trust Indenture for the purpose of causing the Minister to
believe that the EPSP distributions were trust distributions whereas there was
an agreement that these payments were owed for services rendered.
[24]
I agree with the
Minister’s interpretation of the evidence as it concerns the biweekly payments made
out of the EPSP. The same analysis, however, cannot be applied either to lump‑sum
payments, if any, made to the Non-shareholder Employees, or to the amounts paid
to Mr. Saint in 2006 out of the EPSP. Mr. Saint, as the controlling
shareholder of the Appellant, can, unlike the Non‑shareholder Employees, cause
the corporation to pay him dividends on the shares he owns, or he can draw
remuneration in the form of salary and bonuses. He alone can determine the
quantum of each type of distribution. As the controlling shareholder and
managing director of the corporation, Mr. Saint does not require a formal
employment agreement to define his entitlement as an employee of the
corporation. All accumulated and undistributed profits accrue indirectly to
Mr. Saint’s account as the sole shareholder of the corporation.
[25]
The evidence shows that
Mr. Saint received two separate large payments from the EPSP in fiscal
year 2006. This evidence does not support the Respondent’s allegation that
salary and wages otherwise owing to Mr. Saint were simply routed through
the EPSP. The form of payment is more consistent with the fact that profits of
the Appellant were shared with Mr. Saint through contributions made to the
EPSP by the Appellant.
Conclusion
[26]
For all of these
reasons, the assessments are referred back to the Minister for reconsideration
and reassessment on the basis that only the biweekly payments received by
Nicolas Anstis, Kevin Lundy and Shannon MacDonald from the EPSP for the 2006,
2007 and 2008 taxation years were insurable income and insurable earnings from
insurable employment pursuant to section 82 and paragraph 5(1)(a) of the
EIA and pensionable income and pensionable earnings from pensionable
employment under section 12 and paragraph 6(1)(a) of the CPP.
Signed at Ottawa, Canada, this
23rd day of March 2010.
"Robert J. Hogan"
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