Martin v. M.N.R., docket 98-154-CPP

Date: 20000602

Dockets: 98-787-UI; 98-154-CPP; 98-664-UI; 98-781-UI

BETWEEN:

DAVID MARTIN, CYRIL CHISHOLM, DIETHELM von LIERES,

Appellants,

and

THE MINISTER OF NATIONAL REVENUE,

Respondent.

Reasons for Judgment

Bowman, A.C.J.

[1] These cases were heard together. They all involve the same issue: were the appellants engaged in insurable employment within the meaning of paragraphs 3(1)(a) of the Unemployment Insurance Act (the "UI ACT") or 5(1)(a) of the Employment Insurance Act (the "EI Act"), as the case may be, and, in the case of David Martin, section 6 of the Canada Pension Plan (the "CPP").

[2] The problem arises in the following way. The three appellants and one other person, Martin Palmer, who is not before the court, are skilled craftsmen. Mr. Martin is a carpenter and cabinetmaker. Mr. von Lieres is a designer. Mr. Chisholm is a drywaller and Mr. Palmer is a bricklayer. They knew each other both professionally and socially and decided to carry on business in a corporate form. In 1987 Mr. von Lieres, Mr. Martin and Mr. Palmer formed a corporation, Von Lieres Designers Ltd. In 1991 Mr. Chisholm became a shareholder and director. These four individuals are equal shareholders of the corporation.

[3] All three appellants testified, as well as Mr. Edward Chirico, an accountant who has acted for both the company and the individual shareholders since 1987.

[4] Although many assumptions were pleaded by the Minister, the one that is fundamental to the determination is the following:

(n) the Appellant and the other shareholders were four independent contractors performing services under a corporate veil but operating factually in a business form similar to a joint venture.

[5] The appellants' contention that they are employees of the corporation is relatively straightforward. The respondent's position is conceptually more complex. It raises a number of questions:

(a) if the individual shareholders are independent contractors (i.e. operating under a contract for services) vis-à-vis whom were they independent contractors: the corporation or the clients or customers for whom work was done?

(b) what does "performing services under a corporate veil" mean? Does it mean that the corporate form is a sham and may be ignored in favour of some other form of business organization that is more to the Minister's liking?

(c) what does "operating factually in a business form similar to a joint venture" mean? Are we embarking here on the treacherous waters of substance over form?

[6] I propose to approach the matter with a three-part analysis:

(a) what are the facts?

(b) in light of the facts, is the assumption in paragraph (n) quoted above correct?

(c) if it is correct as a matter of fact, does it follow as a matter of law that the relationship between the appellants and the corporation is not that of a contract of service?

[7] The concept behind the incorporation is set out in the memorandum filed on behalf of the appellants by Mr. Martin who argued the case on behalf of all the appellants. The memorandum stated in part

In 1987 we designed and incorporated a company that was to be an integrated construction service from design to finished product. We wanted the company to start small, be efficient to run, be flexible to changing dynamics and to be a pleasure to work in. A certified general accountant, Albert Le Blanc and a lawyer, Edmund W. Chaisson crafted the original structure of the company. Diethelm Von Lieres, Martin Palmer, and David Martin, in good conscience, began to work...In 1991, Cyril Chisholm, an excellent craftsman, was available and became a fellow director. We even envisioned an electrician-plumber to complete the major home building trades, but that did not materialize.

[8] Each of the shareholders was paid an hourly rate by the company based on the number of hours worked and on the going rate for the particular trade. They would discuss what projects the company would undertake. In some cases the skills of all the shareholders would be utilized. In some only one trade would be used. It is, however, important to note that all projects were treated as those of the company. The company would provide the estimate and invoice the customer and would receive payment from the customer, and the combined revenues would be deposited in the corporate bank account and used to pay the employees, whether they were the appellants or other employees hired for a particular job. The contractual relations were between the customers and the company.

[9] The appellants and counsel for the respondent all referred to the tests in Wiebe Door Services Ltd. v. M.N.R., 87 DTC 5025. The "four-in-one" test enunciated there was discussed at some length, but in the final analysis the question boils down to whether we have an employer/employee relationship between the appellants and the company, and this involves looking at the entire picture and assigning to all factors their appropriate weight.

(a) The company supplied some of the tools and the appellants supplied some. This factor does not point conclusively in either direction.

(b) The integration test is sometimes difficult to apply. Unquestionably the appellants were essential and integral to the successful operation of the company's business.

(c) The control test is equally inconclusive in a small, closely held company. To the extent that it is relevant, the appellants appear to have been prepared to surrender their independence and freedom of action to the collectivity as a whole. I discuss this point below in somewhat greater length in connection with the Lee case (infra).

(d) So far as chance of profit or risk of loss is concerned, the appellants were paid their hourly rate for work done regardless of whether the project yielded a profit. Of course, if there was no work they were not employed.

[10] I shall set out only a few of the other facts upon which the respondent relied.

(e) each shareholder bid on contracts chosen solely by him.

This is not in accordance with the evidence. Obviously contracts for work that lay within the expertise of the particular shareholder would be of greater interest to that person, but the evidence was that the shareholders consulted each other on new projects.

(f) each shareholder was responsible for his own work.

Skilled artisans usually so regard themselves, whether they be employees or independent contractors.

(g) each shareholder completed the work required on a successful bid to the satisfaction of the customer.

The relevance of this point to the issue here is not readily apparent.

(h) no one, on behalf of the Payor, directed or controlled the Appellant in the performance of his duties.

We are dealing here with skilled craftsmen not unskilled labourers. The fact that an employee is so skilled that no one can supervise him or her does not make that person any the less an employee or change the employer/employee relationship into something else.

(i) each shareholder determined his hours worked and submitted the hours worked to the Payor's secretary for payment without approval from the other shareholders.

The hourly rates were determined by the shareholders together. The hours worked were determined by the exigencies of the job. The four shareholders trusted each other. I do not see how the appellants' case would be enhanced if they had obtained the other shareholders' approval every time they submitted a time sheet.

[11] I turn now to the second part of this analysis: do the facts support the assumption that

(n) the Appellant and the other shareholders were four independent contractors performing services under a corporate veil but operating factually in a business form similar to a joint venture.

[12] As observed above the precise meaning of this assumption is hard to ascertain. However if it means what I suspect it does, that we have in essence a sham — a joint venture masquerading as a corporation — this is simply not so. The corporate form was respected by the appellants and it should be respected by the Minister and by the court. Let us take the example of four persons operating in a partnership. That form of carrying on business has a number of legal consequences — agency between the partners and unlimited liability to mention only two, as well as a somewhat complex tax regime under the Income Tax Act. If they decide to create a corporation and put the partnership business into that corporation the business may appear to the casual observer to be virtually indistinguishable to that carried on in partnership, but it is as a matter of law fundamentally different. The former partners become shareholders, their rights and obligations inter se and toward third parties are radically different. The tax consequences are completely different. The income of the shareholders is either in the form of salary or wages from employment or dividends. Neither the Minister nor the taxpayers could, however, be heard to say that the corporate form should be ignored and the relationship treated as if it were the original partnership.

[13] I conclude that factually and as a matter of law the assumption in paragraph (n) is not correct.

[14] The third part of the analysis is this: even if the assumption in (n) above were correct, would it lead to the conclusion that the appellants were not engaged in insurable employment, i.e. that they were not employed under a contract of service?

[15] I start from the premise that the expression "contract of service" denotes an employer/employee relationship and that there is no need for a written contract between the employer and the employee.

[16] Second, I think it is clear that the same rules apply under the CPP or the EI Act or UI Act as under the Income Tax Act, that is to say, if the taxpayer is regarded as an employee rather than an independent contractor for the purposes of the Income Tax Act, so that his income is from an office or employment rather than a business, then that person must be treated as employed under a contract of service for the purposes of the CPP or the UI Act or EI Act.

[17] Here we have a case where the income of the appellants is income from employment. It could not reasonably be suggested that the hourly rate paid to them by the company was income from a business.

[18] For the assumption in paragraph (n) to be sustainable, one of three hypotheses would need to be accepted.

[19] The first is that the employment relationship and indeed the entire corporate structure was a sham. The usual definition of sham that has been accepted by the courts in Canada is that set out by Lord Diplock in Snook v. London & West Riding Investments, Ltd., [1967] 1 All E.R. 518 at 528:

As regards the contention of the plaintiff that the transactions between himself, Auto-Finance, Ltd. and the defendants were a "sham", it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure; Stoneleigh Finance, Ltd. v. Phillips), that for acts or documents to be a "sham", with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a "shammer" affect the rights of a party whom he deceived.

[Footnotes omitted.]

[20] This definition was adopted by the Supreme Court of Canada in M.N.R. v. Cameron, 72 DTC 6325 at 6328 and in Stubart Investments Limited v. The Queen, 84 DTC 6305. In the latter case Estey, J. said at pages 6320-6321:

There has been no suggestion of backdating or buttressing the documentation after the event. The transaction and the form in which it was cast by the parties and their legal and accounting advisers cannot be said to have been so constructed as to create a false impression in the eyes of a third party, specifically the taxing authority. The appearance created by the documentation is precisely the reality. Obligations created in the documents were legal obligations in the sense that they were fully enforceable at law.

[21] The same is true here. The legal relationships created were the reality. There is obviously no sham.

[22] The second proposition implied by the assumption in paragraph (n) is that the Minister of National Revenue is entitled to apply in CPP or UI or EI matters some form of ill-defined concept of "substance over form" — that is to say if a taxpayer chooses a particular form of business organization or structure the taxing authorities can, if it suits them, drive a coach-and-four through the legal relations created and say, in effect, you might have done things differently and therefore we will treat you as if you had. That notion is no more acceptable under the UI Act and the EI Act and the CPP than it is under the Income Tax Act. In Continental Bank of Canada et al. v. The Queen, 94 DTC 1858, aff'd 98 DTC 6505 (S.C.C.), the concept of substance over form was discussed at some length. At page 1871 the following summary of the concept appears.

The principle to be deduced from these authorities is simply this: the essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not the nomenclature that governs. The Minister, conversely, may not say to the taxpayer "You used one legal structure but you achieved the same economic result as that which you would have had if you used a different one. Therefore I shall ignore the structure you used and teat you as if you had used the other one".

[23] Here there is no basis for ignoring the corporate structure chosen by the appellants simply because the Minister happens to think that the manner in which they have chosen to structure their affairs may look superficially a bit like a joint venture.

[24] The third hypothesis upon which the respondent may be seeking to ignore the formal structure is that in a closely held corporation there can never be an employer-employee relationship between the corporation and the controlling shareholder or the small group of controlling shareholders on the theory that the requisite degree of control cannot exist. The proposition is wrong as a matter of law. It was conclusively laid to rest in Lee v. Lee's Air Farming Ltd, [1961] A.C. 12 (Privy Council). In that case it was contended that the controlling shareholder and sole managing director of a company could not be a "worker" for the purposes of the New Zealand Workers' Compensation Act, 1922, because he could not be a servant of the company.

[25] At pages 26-27 Lord Morris of Borth-y-Gest said

Nor in their Lordships' view were any contractual obligations invalidated by the circumstance that the deceased was sole governing director in whom was vested the full government and control of the company. Always assuming that the company was not a sham then the capacity of the company to make a contract with the deceased could not be impugned merely because the deceased was the agent of the company in its negotiation. The deceased might have made a firm contract to serve the company for a fixed period of years. If within such period he had retired form the office of governing director and other directors had been appointed his contract would not have been affected. The circumstance that in his capacity as a shareholder he could control the course of events would not in itself affect the validity of his contractual relationship with the company. When, therefore, it is said that "one of his first acts was to appoint himself the "only pilot of the company," it must be recognised that the appointment was made by the company, and that it was none the less a valid appointment because it was the deceased himself who acted as the agent of the company in arranging it. In their Lordships' view it is a logical consequence of the decision in Salomon's case that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the company. If this stage is reached then their lordships see no reason why the range of possible contractual relationships should not include a contract for services, and if the deceased as agent for the company could negotiate a contract for services as between the company and himself there is no reason why a contract of service could not also be negotiated. It is said that therein lies the difficulty, because it is said that the deceased could not both be under the duty of giving orders and also be under the duty of obeying them. But this approach does not give effect to the circumstance that it would be the company and not the deceased that would be giving the orders. Control would remain with the company whoever might be the agent of the company to exercise it. The fact that so long as the deceased continued to be governing director, with amplitude of powers, it would be for him to act as the agent of the company to give the orders does not alter the fact that the company and the deceased were two separate and distinct legal persons. If the deceased had a contract of service with the company then the company had a right of control. The manner of its exercise would not affect or diminish the right to its exercise. But the existence of a right to control cannot be denied if once the reality of the legal existence of the company is recognised. Just as the company and the deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the deceased.

[26] The Privy Council followed Salomon v. Salomon & Co., [1897] A.C. 22, and Inland Revenue Commissioners v. Sansom, [1921] 2 K.B. 492 (C.A.).

[27] The decision in Lee was followed by Christie, A.C.J. in Coulter v. M.N.R., 86 DTC 1048 at pages 1049 to 1050 and in Boychuk v. M.N.R., 92 DTC 1300.

[28] It comes to this. There is simply no basis upon which the formal and legally binding relations between the appellants, their company and the company's customers can be ignored or set aside in favour of some nebulous and equivocal arrangement conjured up by the Minister of National Revenue (but not articulated with any degree of precision) for the purpose of denying to the appellants unemployment insurance benefits or, in the case of Mr. Martin, CPP benefits.

[29] The appeals are allowed and the determinations or decisions that the appellants were not employed in insurable employment in the relevant periods for the purpose of the UI Act, the EI Act and the CPP are varied on the basis that the appellants were engaged in insurable employment by Von Lieres Designers Ltd. during the periods in question.

Signed at Ottawa, Canada, this 2nd day of June 2000.

"D.G.H. Bowman"

A.C.J.