Date: 20001219
Docket: 98-9401-IT-I
BETWEEN:
SAMUEL ZAMECK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Archambault, J.T.C.C.
[1]
This is an appeal from an assessment made pursuant to
subsection 160(1) of theIncome Tax Act (Act)
and dated October 31, 1996. The Minister of National
Revenue (Minister) assessed an amount of $14,472.41 in
respect of transfers of property made to Mr. Zameck by
Micropath Business Systems Inc. (Micropath)[1]. The Minister assumed
that Micropath paid to Mr. Zameck a dividend of $17,000
during the taxation year ending on September 30, 1991
and a dividend of $11,300 during the taxation year ending on
September 30, 1992 (relevant taxation years).
Micropath had outstanding tax liabilities for these two taxation
years totalling $14,472.41. In assessing Mr. Zameck, the
Minister assumed that at the time of the payment of the
dividends, Micropath and Mr. Zameck were not dealing at
arm's length. The only issue raised by the parties is whether
a non-arm's-length relationship existed at that
time.
FACTS
[2]
Micropath was incorporated on November 7, 1978 and
during the relevant taxation years, it carried on the business of
providing computer services. Originally there were three
shareholders who held an equal number of shares in Micropath. One
year later, one of the three shareholders sold on a pro rata
basis his shares to the other two remaining shareholders, namely
Mr. Zameck and Mr. Seymour Ruby.
[3]
Messrs. Zameck and Ruby are not related within the meaning
of the Act. They first met and became friends while working for
the same employer prior to the incorporation of Micropath. In the
first years of operation of Micropath, both Messrs. Zameck
and Ruby had to continue their employment with another
employer because Micropath could not hire them on a
full-time basis. It only did so in 1988 when it had become
more profitable.
[4]
Sometime prior to the departure of Mr. Zameck in
April 1992, Micropath decided to acquire a 20% interest in
Megadata Inc. (Megadata). On its balance sheet for
the taxation year ending on September 30, 1991,
Micropath shows a loan of $13,333 as being receivable from
Megadata. On the balance sheet for the following taxation year,
this loan receivable figure has increased to $20,405. In
addition, there are accounts receivable of $11,770 which
apparently relate to Megadata.
[5]
Subsequent to the acquisition of the interest in Megadata, the
relationship between Messrs. Ruby and Zameck soured:
Mr. Zameck did not feel that he was part of the
decision-making process of Micropath and Megadata. On
April 30, 1992, Mr. Zameck sold his shares to
Mr. Ruby for $6,000. A resolution "effective
April 30, 1992" approves the transfer by
Mr. Zameck of all his shares in Micropath to Mr. Ruby.
By letter dated April 30, 1992, Mr. Zameck resigned as
director and as secretary-treasurer of Micropath.
[6]
During the 1991 taxation year and part of the 1992 taxation year,
Micropath had only two employees, Mr. Zameck and
Mr. Ruby. They both did essentially the same kind of work
but did not receive any salary for their services. They received
instead advances from Micropath on a monthly basis, although not
necessarily in equal payments because their amount depended on
the liquidity of Micropath. These advances were meant to allow
them to meet their domestic needs. A resolution by the two
directors of Micropath, Messrs. Zameck and Ruby, was signed
"effective September 30, 1991" declaring a
dividend of $34,000 which presumably was equal to the advances
received during Micropath's 1991 taxation year. Another
dividend of $22,600 was declared "effective
May 1, 1992" and was payable to the "sole
shareholder of record". Furthermore, the resolution to that
effect was signed by Mr. Ruby as the "sole director of
Micropath".
[7]
Although this May 1992 resolution states that the dividend is
payable only to the sole shareholder of record, a T5 issued by
Micropath to Mr. Zameck shows a dividend of $11,300 for the
1992 calendar year. This dividend amount was included in
Mr. Zameck's 1992 tax return[2].
[8]
The tax returns of Micropath for the 1991 and 1992 taxation years
were only filed with the Minister on July 15, 1994. On
October 31, 1996, the Minister issued an assessment
pursuant to subsection 160(1) of the Act.
Respondent's position
[9]
The respondent contends that Micropath and Mr. Zameck were
not dealing at arm's length at the time of the payment of the
dividends in 1991 and 1992. In support of her position, the
respondent relies on two decisions by my colleague
Judge Dussault: Fournier v. M.N.R., 91 DTC 746 and
Gosselin v. Canada, [1996] T.C.J. No. 206 (QuickLaw).
[10] In
Fournier, Judge Dussault concluded that a shareholder
who held 45% of the shares of a company was not dealing at
arm's length with that company because that shareholder, who
was also a director, had acted in concert with the other
principal shareholder and director to declare and pay dividends.
Judge Dussault describes the situation as follows (at page
748):
We have here two principal shareholders in a company who are
for all practical purposes the only real shareholders and
directors and who decide together, on the advice of the company
accountant, to withdraw profits made by the company in the form
of dividends declared at year-end.
[11] And this
is the conclusion that he arrived at page 748:
I cannot find a situation more suited to application of the
concept of a non-arm's length transaction between unrelated
persons, in that the company's two principal directors and
shareholders apparently acted in concert and with a common
economic interest to decide how they would withdraw the profits
made by the company for their personal use. Acting both as
directors of the company and its shareholders, they were in a
position where the concept of not being at arm's length in
fact as established by our courts could hardly be better applied.
In this sense, therefore, I consider that Les Évaluateurs
Fra-Mic Inc. was not at arm's length with the appellant at
the time of the property transfer made during its 1983 taxation
year, and that accordingly the respondent was right to apply
subsection 160(1) of the Act to this transaction.
Analysis
[12] The main
issue to be decided is whether Mr. Zameck was dealing at
arm's length with Micropath at the time of the payment of the
1991 and 1992 dividends. The concept of arm's length is
defined in section 251 of the Act as follows:
251. Arm's length
(1) For the purposes of this Act,
(a) related persons shall be deemed not to deal with
each other at arm's length; and
(b) it is a question of fact whether persons not
related to each other were at a particular time dealing with each
other at arm's length.
[13] When we
analyze the concept of arm's length as it is found in the
Act, it is clear that persons who are related by blood constitute
related persons for the purposes of the Act and are considered
not to be dealing with each other at arm's length. This is
not the situation here where we have two strangers, although
friends, who each own 50% of the shares of Micropath. The Act
defines "related persons" as also including a
corporation and a person who controls the corporation, that is, a
person holding more than 50% of the voting shares of the
corporation. Such is not the situation in this case as
Mr. Zameck owned only 50% of Micropath and could not elect a
majority of the directors on the board of directors. Furthermore,
he was not a member of a related group that controlled the
corporation because he was not related to Mr. Ruby, together
with whom he controlled Micropath. He was therefore not related
to Micropath.
[14] What is
surprising in the Gosselin decision (supra) is that
two shareholders each holding 50% of a company and not related to
each other were considered not to be dealing at arm's length
with that company. That decision amounts in effect to considering
a member of an unrelated group as being related to a corporation,
and therefore as not dealing at arm's length with the
corporation, contrary to subparagraph 251(2)(b)(ii) which
applies only to a member of a "related group". If
Parliament had intended to include members of an unrelated group,
it would surely have said so. Instead, it pointedly made no
mention of them.
[15]
Parliament, however, in its wisdom, saw fit to recognize that
parties may not be dealing with each other at arm's length in
a transaction even if they are unrelated. For example, it is
conceivable that one shareholder could have de facto control
of a corporation without holding more than 50% of the voting
shares. Such a case can be seen in Peter Cundill &
Associates Limited v. The Queen, 91 DTC 5543. The
circumstances there were such that Mr. Cundill was in a position
to bargain not only on behalf of the corporation that he legally
controlled but also on behalf of the corporation that he did not
legally control.
[16] It has
been held that an arm's-length relationship will exist
where a common mind directs the bargaining for both parties to a
transaction, where parties to a transaction are acting in concert
and without separate interests and where there is de facto
control. Here, it is important to recognize that we are trying to
determine whether an arm's-length relationship existed
between Mr. Zameck and Micropath. These are the relevant
parties for the purpose of applying the test referred to
above.
[17] The
transaction in question does not involve the acquisition of
property nor any other kind of bilateral contract. What we have
here is a corporation which declared a dividend to be paid to its
shareholders. That is the transaction in issue. As a shareholder,
Mr. Zameck had nothing to do except elect the directors on
the board of directors. Since he held only 50% of the shares in
Micropath, he could not by himself elect a majority of directors.
It is clear that Mr. Zameck did not have de facto
control over Micropath and that, acting alone, he was not able to
exercise his influence so as to direct Micropath to declare and
pay the dividend.
[18] The
decision to declare and pay a dividend belonged to the directors
of the corporation. It is as a director that Mr. Zameck
could have exercised an influence on Micropath. But,
Mr. Zameck was not the only director of the company when the
1991 dividend was declared; his co-shareholder
Mr. Ruby was also a director. Therefore he could not by
himself exercise influence over the corporation and decide alone
whether the corporation would declare the dividends. With respect
to the 1992 dividend, Mr. Zameck was not even one of the
directors who declared it. As a matter of fact, he was not even a
shareholder at the relevant time.
[19] Counsel
for the Respondent contends that Mr. Zameck acted in concert
with Mr. Ruby and had no separate interest. I do not accept
this argument. It is true that both Messrs. Zameck and Ruby acted
in concert to declare the 1991 dividend. As they were the only
two directors of Micropath, they had to agree in order to have
Micropath declare and pay the dividend. However, this does not
necessarily mean that they were acting in concert without any
separate interest.
[20] First, it
should be remembered that directors of a corporation have a duty
to act in the best interest of the corporation and not in the
interest of the shareholders. Second, special circumstances would
have to be present showing that the two shareholders and
directors were acting without separate interest. There is no
evidence of such circumstances here. For a more in-depth
explanation of my reasoning supporting this conclusion and of why
the approach adopted in Fournier and in Gosselin
should not be followed, reference should be made to the reasons
in Gestion Yvan Drouin
Inc., 1999-1856 (IT)G, issued concurrently
with the reasons herein.
[21] For these
reasons, the appeal of Mr. Zameck is allowed and the
assessment is vacated.
Signed at Ottawa, Canada, this 19th day of December 2000.
J.T.C.C.
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