Patricia Robinson, George Grant, Darlene Grant v. Minister of National Revenue, [1987] 1 CTC 2055, 87 DTC 16

Tremblay, T.C.J.:—This appeal was heard on common evidence with the appeals of George Grant (84-454(IT)) and Patricia Robinson (85-441(IT)) on April 18, 1986 at the City of Saskatoon, Saskatchewan.

1. The Point at Issue

The point is whether each of the appellants, shareholders of Fashion Fur Saskatoon (1977) Ltd. (Fashion Fur), in the computation of his income for the 1979, 1980, 1981 and 1982 taxation years, is correct to deduct, pursuant to section 110.1 of the Income Tax Act, $1,000 (1979), $1,000 (1980), $1,000 (1981) and $500 (1982) received as dividends from Fashion Fur.

The respondent disallowed the deduction on the basis that the appellant and Fashion Fur did not deal at arm's length during the taxation years and that the dividends declared bear no relationship to the earnings or retained earnings of Fashion Fur.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent's reassessments are incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R. (1948), S.C.R. 486; [1948] C.T.C. 195;

3. D.T.C. 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his reassessments are also deemed to be correct. In the present case, the assumed facts are described in paragraphs 4(a) to (d) of the reply to notice of appeal.

4. In reassessing, the Respondent relied on the following facts:

(a) the facts admitted and set forth in paragraphs 2 and 4 of the Notice of Appeal; those paragraphs read as follows:

2. The Appellant was at all material times a shareholder of the corporation, Fashion Fur Saskatoon (1977) Ltd. owning 500 Class “B” Voting Shares.

4. The Appellant’s husband, George Grant, was also a shareholder of Fashion Fur Saskatoon (1977) Ltd. owning 500 Class “B” Voting Shares. The total issued and outstanding shares of Fashion Fur Saskatoon (1977) Ltd. at all material times was as follows:

	Shares Issues
	Class A	Class B
Ronsco Foods Ltd.	500
Grant Furs Ltd.	500
Ronald Robinson		500
Patricia Robinson		500
George Grant		500
Darlene Grant		500
Total Issued and
Ooustanding:	1,000	2,000

(b) the Appellant and the corporation did not deal at arm's length, during the taxation years under appeal;

(c) the dividends declared by the corporation and set out in paragraph 3 above bear no relationship to the earnings or retained earnings of the corporation; and

(d) the Appellant and Patricia Robinson, Ronald Robinson and George Grant are employees of the corporation and are all active and act in concert with respect to the operation of the business of the corporation.

3. The Facts

All the material facts alleged by the appellant in the notice of appeal are admitted by the respondent. However, they were completed by the latter and the two witnesses, George Grant and Ronald Robinson (spouse of the appellant Patricia Robinson). Using the notice of appeal and the testimonies, the facts can be summarized as follows:

3.01 The appellant at all material times resided in the city of Saskatoon, in the province of Saskatchewan. In 1977, George Grant and Ronald Robinson purchased for $130,000 the stock and the lease of a fashion furs store from a Mrs. Krolik. It was transferred to Fashion Fur after it was initiated.

3.02 The appellant was at all material times a shareholder of the corporation Fashion Fur owning 500 Class "B” Voting Shares. The said corporation was initiated on May 30, 1977 pursuant to the Certificate of Incorporation filed as Exhibit A-1.

3.03 Fashion Fur carried on the business of retail clothiers in the cities of Prince Albert and Saskatoon, both in the province of Saskatchewan.

Indeed paragraph 3(a) of the "Memorandum of Association” (Exhibit A-2) of the said corporation reads as follows:

3. The objects for which the Company is established are:

(a) To buy, sell, exchange, lease, hire or otherwise acquire and dispose of and deal in articles of clothing and other products made in whole or in part from furs or animal skins, raw or dressed and manufactured or unmanufactured furs, skins, articles of fur, hides, fur trimmings, and fur accessories, as retailers, wholesalers, manufacturers, principals or agents.

Moreover, because of the enactment of the Business Corporation Act in 1980, a "Certificate of Continuance” (Exhibit A-3) was issued in favour of Fashion Fur on December 31, 1980, pursuant to section 181 of the said Business Corporation Act.

3.04 The appellant's husband, George Grant, was also a shareholder of Fashion Fur owning 500 Class "B” Voting Shares. The total issued and outstanding shares of Fashion Fur at all material times was as follows:

3.05 Ronsco Foods Ltd. is a body corporate, the shareholders of which are Ronald Robinson and Patricia Robinson (Exhibit A-4).

3.06 Grant Furs Ltd. is a body corporate, the shareholders of which are Darlene Grant and George Grant (Exhibit A-4).

3.07 Ronald Robinson and George Grant are not persons related by blood relationship, marriage or adoption.

3.08 Patricia Robinson and George Grant are not persons related by blood relationship, marriage or adoption.

3.09 Ronald Robinson and Darlene Grant are not persons related either by blood relationship, marriage or adoption.

3.10 Patricia Robinson and Darlene Grant are not persons related by blood relationship, marriage or adoption.

3.11 Pursuant to the financial statements of Fashion Fur in the years under appeal (Exhibit A-5), the net income, the retained earnings, the bonus and the dividends were as follows:

Each of the shareholders received a dividend of $1,000 in 1979, $1,000 in 1980, $1,000 in 1981 and $500 in 1982.

3.12 The decision to declare dividends in 1979 was made after George Grant spoke to his personal accountant. It seems that the appellant did not know that there was a dividend deduction. Each year, the decision to declare dividends was unanimously voted, despite that Ronald Robinson had already utilised his whole deduction.

3.13 In filing her tax return in the taxation year, the appellant reported the said dividend income pursuant to the provisions of section 82 of the Income Tax Act and made a deduction from her income claiming that the dividend was one eligible for the deduction set out in section 110.1 of the Income Tax Act.

3.14 By notice of reassessment, the appellant was reassessed by the Minister of National Revenue for the taxation year. The Minister of National Revenue alleged that the appellant was not dealing at arm's length with Fashion Fur at the relevant time and therefore denied the appellant deduction from her income of the dividend under the provisions of section 110.1 of the Income Tax Act, and assessed the appellant’s return accordingly.

3.15 Notices of objection were properly filed and served on the Minister of National Revenue and by notice of confirmation dated December 14, 1984, the Minister of National Revenue confirmed the reassessment.

4. Law — Cases at law — Analysis

4.01 Law

The relevant provisions of the Income Tax Act involved in the instant case are subsection 110.1(1), paragraph 110.1(5)(a), subsection 251(1), paragraphs 251(2)(a)(b) and 251 (4)(a). They read as follows:

110.1 (1) For the purpose of computing the taxable income for a taxation year of an individual ( . . . ) there may be deducted from his income for the year an amount equal to the lesser of

(a) $1,000, and

(b) the amount by which the aggregate of

(i) the amount of interest included in computing the taxpayer's income for the year,

(ii) the taxpayer's grossed-up dividends for the year, . . .

exceeds

110.1 (5) For the purposes of this section, grossed-up dividends of a taxpayer for a taxation year means the amount required by subsection 82(1) to be included in his income for the year, but does not include any such amont in respect of any dividend

(a) received by the taxpayer from a corporation with which he does not deal at arm's length, or

251(1) For the purpose 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.

251 (2) For the purpose of this Act "related persons", or persons related to each other, are

(a) individuals connected by blood relationship, marriage or adoption;

(b) a corporation and

(i) a person who controls the corporation, if it is controlled by one person,

(ii) a person who is a member of a related group that controls the corporation, or

(iii) any person related to a person described by subparagraph (i) or (ii);

251 (4)

(a) "related group" means a group of persons each member of which is related to every other member of the group; and

4.02 Cases at Law

Counsel for the parties referred the Court to the following cases at law:

1. M.N.R. v. Sheldon’s Engineering Ltd., [1955] C.T.C. 174; 55 D.T.C. 1110; (S.C.C.);

2. Pender Enterprises Ltd. v. M.N.R., [1965] C.T.C. 343; 65 D.T.C. 5202; (Exch. C.C.);

3. Gatineau Westgate Inc. v. M.N.R., 41 Tax A.B.C. 440; 66 D.T.C. 560;

4. M.N.R. v. Estate of T.R. Merritt, [1969] 2 Ex. C.R. 51; [1969] C.T.C. 207; 69 D.T.C. 5159;

5. Swiss Bank Corporation and Swiss Credit Bank v. M.N.R., [1971] C.T.C. 427; 71 D.T.C. 5235 (Exch. C.C.), [1972] C.T.C. 614; 72 D.T.C. 6470 (S.C.C.);

6. Sayers v. M.N.R., [1981] C.T.C. 2871; 81 D.T.C. 790; (T.R.B.);

7. Schuss et al. v. M.N.R., [1983] C.T.C. 2411; 83 D.T.C. 350 (T.R.B.);

8. Buckerfield's Ltd. et al. v. M.N.R., [1964] C.T.C. 504; 64 D.T.C. 5301; (Exch. C.C.);

9. M.N.R. v. Dworkin Furs (Pembroke) Ltd., [1967] C.T.C. 50; 67 D.T.C. 5035; (S.C.C.);

10. Oakfield Developments (Toronto) Ltd. v. M.N.R., [1971] C.T.C. 283; 71 D.T.C. 5175; (S.C.C.);

11. The Queen v. Imperial General Properties Ltd., [1985] 2 C.T.C. 299; 85 D.T.C. 5500; (S.C.C.);

12. Special Risks Holdings Inc. v. The Queen, [1986] 1 C.T.C. 201; 86 D.T.C. 6035 (F.C.A.);

13. M.N.R. v. Kirby Maurice Co. Ltd., [1958] C.T.C. 41; 58 D.T.C. 1033; (Exch. C.C.);

14. Robson Leather Co. Ltd. v. M.N.R., [1977] C.T.C. 132; 77 D.T.C. 5106; (F.C.C.);

15. Chamberlain et al v. M.N.R., [1982] C.T.C. 2772; 82 D.T.C. 1781; (T.R.B.).

4.03 Analysis

4.03.1 Pursuant to the Act, there are two different tests that can be applied in determining whether parties deal at arm's length or not. They are set out in paragraphs 251 (1 )(a) and 251 (1)(b) quoted above.

4.03.2 Concerning the first test, the Court was informed at the beginning of the submissions that the parties are both in agreement that the shareholders of Fashion Fur and the companies Ronsco Foods Ltd. and Grant Furs Ltd. are not related persons. The Court agrees.

Applying the Buckerfield's test indeed none of the shareholders control Fashion Fur per subparagraph 251(2)(b)(i) because the Grants and their holding company (Grant Furs Ltd.) own 50 per cent of the shares and the Robinsons and their holding company (Ronsco Foods Ltd.) own 50 per cent of the shares.

Since the two related groups did not control Fashion Fur and since the Robinsons and the Grants are not related by blood relationship, marriage or adoption (para. 251 (2)(a)), none of the shareholders is related to the corporation per subparagraph 251 (2)(b)(ii). Neither are they related to Fashion Fur pursuant to subparagraph 251 (2)(b)(iii).

Consequently, a non-arm's length relationship cannot be established between any shareholder and Fashion Fur.

4.03.3 The factual test provided in paragraph 251 (1)(b) is the second test to determine whether or not the shareholders of Fashion Fur deal at arm's length with the said corporation.

The term “arm’s length” originates in reference to transactions between principal and agent, solicitor and client, guardian and ward, etc.

Mr. R.S.W. Fordham, Q.C., Member of the then Tax Appeal Board, in No. 60 v. M.N.R., 6 Tax A.B.C. 412 at 417; 52 D.T.C. 268 at 271, referred to The Pocket Law Lexicon and other sources to find the ordinary meaning of “at arm’s length".

In The Pocket Law Lexicon, 8th Ed. (1951), edited by A.W. Motion, at p. 39, “‘at arms length” is thus defined:

One who has an advantage over another by virtue of holding a position of trust, is bound, on a proposal for a contract between them, to divest himself entirely of that authority, influence, or advantage which he possesses, so as to place himself on an equality, and to let the negotiation proceed as between two independent persons. This is called putting at arms length. It is most frequently applicable to transactions between solicitor and client, trustee and cestui que trust, guardian and ward, &c.

Exactly the same definition appears in the 4th Edition (1904), edited by J.E. Morris, at p. 36. The phrase is thus at least forty-eight years old, but the Board has never been referred to a reported case in which the three words were dealt with judicially.

In Mozley and Whitely’s Law Dictionary, 6th Ed. (1950), at p. 29, the phrase is defined as follows:

AT ARM’S LENGTH. When a person is not, or having been, ceases to be, under the influence or control of another, he is said to be “at arm’s length” with him, e.g., cestui que trust and trustee.

The courts however refused to adopt this meaning for the purpose of the Income Tax Act.

There have been a number of cases at law that considered the factual test of arm's length. The cases indicate some factors relevant in determining the arm’s length relationship under the factual test but stress that the facts of each case are important.

The relevant time for determining the existence of an arm's length relationship or not is the time of the transaction in question. In the instant case, it is the time the dividend was paid.

4.03.4 Respondent's argument

The reassessments are mainly based on the respondent's contention that the appellants, all employees of Fashion Fur, acted in concert with respect to the operation of its business, including the declaration of dividends and that the said dividends bear no relationship to the earnings or retained earnings of Fashion Fur.

Counsel for the respondent contends that there is a lack of independent judgment between the shareholders and Fashion Fur “that is the existence of a common mind which directs the bargaining for both of the parties.” She referred to the Gatineau Westgate case (para. 4.02(3)).

In that case, Mr. Maurice Boisvert, Q.C., Member of the then Tax Appeal Board, held that the purchase of land by a corporation from its two equal shareholders who were unrelated, but who were partners in a real estate business was not an arms’ length situation.

Mr. Boisvert said at page 459 (D.T.C. 564):

The form that Théoret and Philips wished to give to the deed of sale is of little importance, they are partners united by a common interest in a property, who sold that property to themselves by the instrumentality of a company which they may get to do anything they want. There is no arm's length between the vendors and the purchaser for each of the partners exercised a determinative influence on the other without which the sale could not have taken place, and the purchaser, the appellant, could not become owner without the mutual influence of both its shareholders.

In the Gatineau Westgate decision, counsel also referred at page 461 (D.T.C. 565):

. . . Therefore, as purchaser, the appellant was dependent upon, and under the thumb of, the vendors. Clearly a company is distinct from the person of its shareholders; but when a company may not exercise its powers without recourse to the person of its shareholders as a group, it is in fact tied in respect of the exercise of its powers to the will of its shareholders . . .

Ms. Deydey also referred to the Pender decision (para. 4.02(2)) at 359:

It is, in my view, a fair inference from the foregoing that in the dealings between Sung and Pender Enterprises Ltd., the parties were not acting independently but as highly interdependent parties and Sung, at the time of the transaction and throughout the period under review, was in a constant position of advantage or interest with regard to the appellant corporation to a point where in fact the parties involved here cannot be considered as dealing at arm's length.

Ms. Deydey said that the thrusts of the Pender decision and the Gatineau Westgate decision were summarized by Mr. Justice Cattanach in the Estate of Thomas Rodman Merritt case (para. 4.02(4)) at page 217 (D.T.C. 5165-66):

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties are dealing at arm's length. In other words where the evidence reveals that the same person was “dictating" the “terms of the bargain”’ on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.

Ms. Deydey contends that Cattanach, J. in the above passage confirms the position that in an arm's length situation, there should be two separate minds and that he contemplates this even in a shareholder-corporation type of situation. So in spite of the fact, in the present case, that each shareholder has a 25 per cent shareholding, they all acted in concert to dictate the actions of Fashion Fur with respect to the dividends. Then they became in a non-arm's length situation in that respect with Fashion Fur.

She is surprised that only $1,000 of dividend was declared per shareholder when pursuant to the financial statements (net income and retained earnings), it was possible to declare more than that (para. 3.11). Also the fact that the decision to declare dividends was only made after George Grant spoke to his personal accountant because it is only then they realized that there was a dividend deduction (para. 3.12).

She submitted that the decision to declare dividends was only motivated by the fact that three of the four shareholders could use and could benefit from this deduction. It was this instance that caused the company to declare the dividends in the amounts it did declare.

4.03.5 Counsel for the appellant contends that even if it was available for Fashion Fur to declare more than $1,000 dividend per shareholder because of the financial situation (para. 3.11), this does not mean that it was obliged to do so. In fact, many reasons may force a company not to declare as dividends all the available earnings and retained earnings. It is even the normal policy of an enterprise to keep a generous cash-flow to provide the day-to-day expenses and any eventualities.

If the shareholders would have declared such dividends only to benefit from the dividend deduction of $1,000, they would have voted only $666. It is indeed the grossed-up dividend which is deducted in the computation of the taxable income and not necessarily the actual dividend as provided in subparagraph 110.1 (1 )(b)(ii).

4.03.6 In all the cases referred to by counsel for the appellant, it is always a transaction of sale or purchase and not an administrative decision as it is in the instant case, that the arm's length concept is involved.

In the Gatineau Westgate case, the appellant, a real estate company, purchased properties from the two directors of the company, each one owning 50 of the 101 shares.

In the Pender case, it is the purchase of a business by the appellant company. The vendor was the employer of the two shareholders, his employees, and was related to him as cousin and brother-in-law.

In the judgment at page 358 (D.T.C. 5210-11) more details are given:

Furthermore, the onus clearly lies on the appellant to show error on the part of the Minister in his assessment in holding that the transaction herein was not at arm's length and this onus, in my view, has not been satisfied by the appellant here. This, indeed, appears from the various relationships of the individuals and companies involved herein which I have already described and particularly from the following: Lee and Wong, the shareholders of the appellant, were in the employ of Sung and had been employed by him for a long time prior to the transaction involved herein and they still are; Wong negotiated the lease herein for Sung. In the first years of operation and afterwards, Pender Enterprises Ltd. paid substantial sums to Sung’s Companies, Columbia Caterers Ltd. and Sung Management Ltd.; the deal was set up and the price of sale as well as the leasehold was determined by Sung's accountant and financial adviser, Mr. Rathie. Sung, through his management companies, received statements from Pender Enterprises Ltd. every year, which enabled him to keep a tab on the appellant and raise the rent when desirable. The above alone might have been sufficient to establish that the deal was not of an independent nature and, therefore, not at arm's length. There is, however, more and this, in my view, confirms the non-arm’s length nature of this transaction, in that in the course of the operation of the restaurant business, whatever lease Pender Enterprises Ltd. had, was never respected and although in 1954 the increase of the rent might have been justified by the increase of the size of the premises, there is no such reason for the subsequent increases in rent which took place particularly in 1957and 1958, at a time of course when Sung was the owner of the landlord, Tourists' Services Ltd.

In the Merritt case, the problem was the value of debentures issued by the appellant company formed to invest assets of an old age person who had become increasingly prodigal with his assets. On the death of the said person, the Minister added to the estate, the face value of the debenture ($207,000) plus interest on the basis that the deceased and the corporation were not dealing at arm’s length.

4.03.7 In declaring dividends, it seems to me that the independence of a corporation cannot be affected when the quantum of dividends is involved in the circumstances such as in the instant case. One cannot reproach the company not to have declared a larger amount of dividends because earnings and retained earnings were available.

I would agree if there were not enough availability of earnings and retained earnings to pay dividends. Then, indeed, the concert of the director- shareholder which, in fact, is most of the time involved in the decision in a private company to declare dividend, can be reproached to the directors. It is against the interest of the company. This is not the point in the instant case.

But one may contend that nevertheless this favours the shareholders. A company, despite it is a legal different person from the shareholders, is not per se against the shareholders. When a decision is in the limits of the reasonableness, in the limits of general principle of accounting, in the limits of the general principles of administration and business, it seems to me that the lack of independence cannot be found in such a decision because it favours the shareholders.

Directors, whether it is a public company or not, are aware that there are tax savings in declaring dividends. They are inherent in the system.

In the instant case, directors declared more than they needed for the deduction. Ronald Robinson had even already utilised the whole deduction. The vote was unanimous (para. 3.12).

5. Conclusion

For these reasons, the appeal is allowed with costs and the matter referred back to the respondent for reconsideration and reassessment.

Appeal allowed.