Oriole Oil & Gas LTD v. Minister of National Revenue, [1985] 2 CTC 2418, 85 DTC 681

Rip, TCJ:—In computing its income from a business for 1976 the appellant, Oriole Oil & Gas Ltd, ("Oriole") deducted the sum of $1 million paid to two employees purportedly in satisfaction of loss of office and also in consideration for releases by the employees of the appellant "from all rights, claims, and demands whatsoever under or arising out of employment contracts" between the appellant and the employees; as a result of the deduction by Oriole, it incurred an income loss in 1976 which it carried forward to the 1977, 1978 and 1979 taxation years. The Minister of National Revenue, Taxation, the respondent, disallowed the deduction on the basis that the expenditure was not made or incurred for the purpose of gaining or producing income from a business within the meaning of paragraph 18(1)(a) of the Income Tax Act ("Act") and, if allowed as a deduction to Oriole, it would unduly or artificially reduce Oriole’s income for its 1976 to 1979 taxation years inclusive within the meaning of subsection 245(1) of the Act; the Minister also claimed the amount of the deduction is not reasonable in the circumstances and pursuant to section 67 of the Act should be disallowed.

Oriole was incorporated under the laws of Alberta in 1972 by Herbert C Flanagan for the purpose of acquiring mineral leases for properties having shallow gas plays, that is a formation of natural gas within 2,000 to 2,500 feet from the surface. Prior to 1972 Mr Flanagan had been employed for 16 years as a petroleum landman by two oil companies in Alberta, Midwest Oil Corporation and Pacific Petroleum Ltd. A petroleum landman was described by Mr Flanagan as one who assembles land for oil and gas development and deals and negotiates on a company's behalf. Shortly after Oriole was incorporated Mr Flanagan invited Mr L R Burroughs, a petroleum engineer whom he had known for about four years, to join him as a shareholder in the newly formed corporation; each of Mr Flanagan and Mr Burroughs owned 50 per cent of the issued shares of Oriole.

Mr Flanagan gave evidence on behalf of Oriole. He and Mr Burroughs had been involved previously in two small drilling ventures in southern Alberta. In the course of drilling those wells they extended the shallow gas plays from about Township 16 to about Township 22, and at that point Mr Flanagan invited Mr Burroughs to participate in Oriole. They then "decided to go after some big blocks of land". Oriole searched for areas of land having shallow gas plays and according to Mr Flanagan was successful in finding these reserves. Mr Flanagan testified that as the petroleum landman he looked at "hundreds and hundreds of logs” and finally blocked off "about 60 thousand acres of mineral rights" in southern Alberta. He then went to various oil companies that controlled the leases on these lands and made several drilling deals and committed Oriole to drill eight to ten earn- ing wells with options to drill wells on the remaining acreage. But Oriole did not have any drilling money and therefore sold its contracts for the drilling rights to other companies which had funds available for drilling for a net profit interest in the properties. In other words, Oriole would obtain drilling rights from companies owning the mineral leases in the property and would then sell the rights to companies that were financially able to drill; Oriole would retain a certain portion of the profits after operating expenses. Oriole had a 95 per cent success ratio in drilling wells. After completing its work in southern Alberta Oriole then made two or three smaller deals in central Alberta and then, in 1974, completed its drilling prospects. At the time Oriole had gas reserves of approximately 20 billion cubic feet.

The business carried on by Oriole did not require a large number of employees. In 1972 the only employees of Oriole were Messrs Flanagan and Burroughs and later on a secretary.

Once Oriole no longer looked for drilling prospects its activities consisted primarily of maintaining the properties, collecting rents from leases and verifying wells on stream. Leases eligible for future development had to be supervised carefully. Oriole had very little cash flow because most of its reserves were shut in gas which it anticipated would come on stream three to four years later once it obtained gas contracts. Oriole’s interest was ultimately limited by the term of the leases which ran for 10 years, but once a well produces, the life of a lease goes on until the well runs dry.

About the time Oriole terminated its activities for drilling prospects Messrs Flanagan and Burroughs decided to sell their shares in Oriole. At this time Oriole engaged the services of D & S Petroleum Consultants Ltd of Calgary to prepare a valuation of Oriole’s assets. The report was submitted to Oriole on February 8, 1974 effective March 1, 1974. By letter dated April 25, 1974 the valuation of February 8, 1974 was changed to reflect certain items, in particular the date of production from various leases and the price of gas and its escalation per year. The valuation was instigated at the behest of Mr Burroughs. As a result of the appraisal Messrs Flanagan and Burroughs were of the view they could receive approximately $4,000,000 for their shares.

When the decision to sell was made a document, referred to by Mr Flanagan as an “employment contract", was brought to him by Mr Burroughs for signature. Mr Flanagan’s evidence is that this agreement “afforded us monetary protection, and if Mr Burroughs and I didn't agree on something, I can go my way and he could go his way. That was basically the idea”. The agreement was prepared on Mr Burroughs' initiative and is reproduced as follows:

AGREEMENT

This agreement has been made in the City of Calgary, Province of Alberta, effective the 1st day of May 1972 between:

HERBERT CHARLES FLANAGAN

hereinafter referred to as the “employee”

— and —

ORIOLE OIL AND GAS LTD

hereinafter referred to as the “employer”

The employer is desirous of securing the services of the employee for a minimum of fifteen years from the date hereof and the employee has entered into this agreement under the following terms:

1. The base salary for the first year shall be $25,000.00.

2. The base salary shall be increased in annual increments of $10,000.00 to a maximum of $75,000.00.

3. The employer will pay to the employee an annual salary of $75,000.00 for the life of the employee, commencing when the employee attains fifty-five years of age, or becomes totally disabled before that time, or retires on or after the employee's fifty-fifth birthday.

4. The employer will pay to the employee an annual salary of $75,000.00 for each full year of service, prior to retirement or becoming totally disabled, such payments to commence twelve months after voluntary withdrawal.

5. The employee is to receive a bonus of 7 /2% of the asset value of the employer company if the employer sells its assets, business, etc, before the employee attains 55 years of age.

Any sale of the employer's shares based on the value of the underlying assets will be treated as a sale of assets.

(illegible)	(A C Flanagan)
Witness	Employee
	ORIOLE OIL AND GAS LTD
	(A C Flanagan)
	(L R Burroughs)
Witness	Employer

There was one agreement between Oriole and Mr Burroughs and another between Oriole and Mr Flanagan; in all respects the agreements were identical. Both employees, Messrs Flanagan and Burroughs, signed the agreement and the appropriate director's resolution authorized the officers of Oriole, Messrs Flanagan and Burroughs, to execute the agreement on Oriole's behalf, which they did. The employment agreements were prepared and executed in 1974 notwithstanding that they took effect as of May 1, 1972.

In each of the years up to 1976 when Messrs Flanagan and Burroughs sold their shares in Oriole to Alberta Eastern Gas Ltd (“AEG"), each of Messrs Flanagan and Burroughs was paid a salary of $25,000, notwithstanding paragraph 2 of the agreement. Mr Flanagan testified that he and Mr Burroughs built the company “up from nothing" and since they had taken very little out of the company, the employment agreement offered them the opportunity to get something out of it in the event one of them retired from the company or in the event the company's assets or shares were sold to a third party. Mr Flanagan stated that in the event he and Mr Burroughs continued as employees of Oriole the agreement also gave them a guaranteed income.

Paragraph 5 of the agreement provides for distribution of assets in the event of a sale. Mr Flanagan testified that this provision was to ensure that each of he and Mr Burroughs would receive his share of the assets of the company in the event of the sale of the assets of Oriole, or if either of them sold his shares in Oriole.

Once the decision to sell the shares of Oriole was made an information kit was prepared describing Oriole, its contracts and various agreements; these were made available to all interested parties. There were not many potential purchasers making enquiries to purchase the shares. In Mr Flanagan's view this was perhaps because of Oriole's net profit interest and the location of its lands.

Messrs Flanagan and Burroughs were first in contact with AEG, a public company, in February 1976 and on May 6 of that year a letter of intent was forwarded by AEG to Messrs Flanagan and Burroughs to purchase all the issued and outstanding shares in Oriole; Messrs Flanagan and Burroughs accepted the offer on or about June 29, 1976. The letter of intent provided for the sale to take place for the consideration of $1,840,000 and 55,000 treasury shares of AEG; the value of one AEG share at the time was $11.25. According to the letter of intent the closing of the transaction was to be no earlier than July 1, 1976 and no later than July 31, 1976. The letter of intent acknowledged that Messrs Flanagan and Burroughs have accepted an aggregate sum of $1,100,000 as settlement for 'loss of office” and have released Oriole from all rights, claims and demands whatsoever arising out of their respective employment contracts.

A further letter, dated July 27, 1976 was forwarded by AEG to Messrs Flanagan and Burroughs confirming the understanding reached between AEG and these gentlemen. Because of a defect in title in respect of properties in the Blackfoot area of Alberta the purchase price for the shares was reduced to $1,628,000 and 48,000 common shares in the capital stock of AEG. In addition the settlement for the employment contracts between Oriole and Messrs Flanagan and Burroughs was reduced to $1 million. Provision was also made in respect of additional amounts to be paid by AEG to Messrs Flanagan and Burroughs when the title defect was corrected: the purchase price would be increased by an additional $212,000 plus 7,000 shares in the capital stock of AEG and the shareholders would also receive $101,000 as a fee for settlement of the Blackfoot interest. A formal agreement of purchase and sale of the shares was executed by the vendors and purchaser on July 28, 1976, the day the transaction was closed.

By agreements dated effective May 1, 1976, which was prior to receiving the letter of intent but obviously during negotiations with AEG, each of Messrs Flanagan and Burroughs had agreed with Oriole that each would accept as final settlement from Oriole of deferred compensation in paragraph 3 of the employment agreement, a life annuity of $75,000 per annum guaranteed for a minimum period of 15 years, commencing at age 55. Mr Flanagan had no idea as to the origin of this agreement, when it was actually prepared and executed, or anything about the agreement, and in any event he testified the agreement was never acted upon.

The directors of Oriole, being Messrs Flanagan and Burroughs, passed a resolution on June 29, 1976 agreeing to terminate the employment contracts with Messrs Flanagan and Burroughs to pay each the sum of $500,000 in settlement for loss of office, the said moneys to be paid upon execution of the respective releases.

The date of closing of the transaction was July 28, 1976. By documentation dated July 28, 1976 each of Messrs Flanagan and Burroughs released Oriole from the employment contracts, their loss of office and "any pension or retirement plan or agreement or any other benefits whatsoever of employment or office” of each of them with Oriole. In addition each individual acknowledged in his release, and agreed, that "for the purposes of the Income Tax Act of Canada, the payment herein made to him by Oriole Oil and Gas Ltd shall be considered as income from employment or office with Oriole Oil & Gas Ltd (sic) and that such payment shall be considered as a deductible expense from income of Oriole Oil and Gas Ltd”. Mr Flanagan testified he did not know the reason this clause was added to the release, or at whose insistence it was included.

On the closing day, Messrs Flanagan and Burroughs resigned as officers and directors of Oriole, the various share certificates were endorsed to AEG and meetings of the new shareholders and directors were held naming the new directors and officers of Oriole. On the same date Oriole borrowed from AEG $1 million by security of a non-interest bearing promissory note payable on demand and forthwith issued a cheque in the amount of $1 million to Canada Trust Company for the benefit of Messrs Flanagan and Burroughs. The amounts were deposited in registered retirement savings plans of each of Messrs Flanagan and Burroughs, as retiring allowances.

In respect of the employment agreements Mr Flanagan acknowledged that the salary of $25,000 specified under the agreement for 1972 was also the salary for 1973, 1974, 1975 and 1976 and that the increments called for in paragraph 2 of the employment agreement were never made. Oriole did not accrue the increments for the later years in its financial statements. The maximum salary called for in the agreement in the amount of $75,000 was, in the words of Mr Flanagan, thought to be “fair” although he could not relate the $75,000 to anything in particular except that he thought $75,000 had some bearing on the value of the company. Paragraph 5 of the employment agreement, said Mr Flanagan, was not unreasonable for what he and Mr Burroughs had put into the company and he thought it fair, although he could not state with any certainty how the seven and one-half per cent bonus was determined. He was also vague in his evidence as to what the asset value consisted of, as to whether their value was book value, as shown in Oriole’s balance sheet, or fair market value. However Mr Flanagan did say that paragraph 5 attempted to place the value of the assets on what a purchaser would pay for the assets and thus it would include the fair market value of the assets, that is, the value of proven reserves. The assets had a fair market value in 1974 of approximately $6 million to $7 million. Mr Flanagan did not retain any professional advice in respect of the employment contract, but Mr Burroughs did. Mr Flanagan relied on Mr Burroughs. I conclude from Mr Flanagan’s evidence the employment contract was planned, conceived and brought to life by Mr Burroughs and that Mr Flanagan simply concurred with its contents, relying on Mr Burroughs. I did not have the advantage of hearing Mr Burroughs testify and since he was a primary actor, if not the primary actor, in the development of the employment agreements I am of the view some valuable evidence is lacking. There was no evidence or suggestion by counsel for Oriole that Mr Burroughs, who now resides in Oklahoma, was unable or unwilling to testify on its behalf.

Mr Flanagan also testified that once the defect in title in the Blackfoot properties was remedied he and Mr Burroughs received $400,000 cash and no shares and not the mix of shares and cash called for under the letter of July 27 and agreement of July 28, 1976. Under an agreement made as of February 16, 1978 the $400,000 was paid “as consideration for services rendered”; the services rendered were for the correction of the deficiency in title of the Blackfoot lands.

The amounts of $500,000 paid to each of Messrs Flanagan and Burroughs for the termination of their employment contract were amounts negotiated between Messrs Flanagan and Burroughs and AEG. Counsel for the respondent thought it strange that the prospective purchaser was involved in these negotiations. This, in my view, is not unusual. It is not uncommon for a prospective purchaser of shares to negotiate with the principals involved not only as to the purchase price of the shares being purchased but also for the cancellation of any contracts between the target company and these individuals, and in most cases nothing sinister should be read into this. Here Oriole and AEG appear to agree that the purchase price for the shares would be approximately $3,500,000 of which $1 million would be allocated to the employment agreements and the balance to the shares themselves. In fact, $1 million was allocated towards the termination of the employment agreements, $2,100,000 for the shares and subsequently $400,000 was paid for services rendered in respect of the correction of the deficiency of title of the Blackfoot lands.

Under cross-examination by Mr Reynolds, Mr Flanagan admitted when he and Mr Burroughs were negotiating for the sale of the shares they had a figure in mind and they were not concerned how the transaction was structured, so long as they would obtain the amount they agreed on, that is, $4 million. The transaction could be structured as a combination of shares, employment contracts “or whatever”. Mr Flanagan also acknowledged that as far as Oriole was concerned he and Mr Burroughs were satisfactory employees fulfilling their proper functions.

To structure a transaction to yield maximum benefits to both vendor and purchaser to the prejudice of the fisc is not improper; however one must ensure the parts of the structure are bona fide and the value, if any, allocated to each is reasonable.

Oriole also called Mr Francis G Vetsch, president of AEG at the time of the transaction, as a witness. Mr Vetsch is presently president of Tripet Resources Ltd, a general oil and gas exploration and production company which is not related to Oriole or AEG.

Mr Vetsch testified that prior to the transaction taking place AEG did an internal valuation of the assets of Oriole and determined that the value of the company was $4,800,000, discounted at 20 per cent. Based on the valuation of the assets of Oriole he then recommended to his directors that he negotiate for the purchase of the shares and employment contract “payoff” all in the order of $3 million to $4 million. He testified that he believed the employment contract to be a “‘bona fide” contract between Oriole and Messrs Flanagan and Burroughs. He says he took the agreement on its face value and did what he thought had to be done in respect of completing the purchase. He stated that AEG did not wish to retain. either Messrs Flanagan or Burroughs once it had acquired Oriole since AEG was fully staffed and did not require executives of their calibre. Mr Vetsch testified that his company, AEG, made a sincere effort to value the employment contracts and make certain that Oriole’s liability under contracts would be reflected in the purchase of the shares. In his view clause 3 of the agreement had a time problem but clauses 4 and 5 were straightforward. Originally in negotiating the sale and purchase of the shares the employment contracts were valued at $550,000 each. An internal calculation by employees of AEG had valued the contracts at $800,000 to $900,000 per contract, that is $1,600,000 for both contracts. There was no evidence as to how this calculation was done. However in preparing the letter of intent AEG felt the employment contracts were generous and tried to “make them more reasonable”. There was also a deficiency problem in respect of the Blackfoot property which reduced the value of the assets by $400,000; as a result all the items in the transaction — the shares, employment contract and money payments — were renegotiated and all, including the employment contract, were reduced on a pro rata basis. I infer from Mr Vetsch's evidence that in his view all the items in the transaction were part and parcel of a single transaction, the acquisition of Oriole shares.

Mr Vetsch said that AEG's preference would have been to acquire assets outright because of the beneficial tax treatment that would accrue to the purchaser, but that Messrs Flanagan and Burroughs insisted that all they would sell were shares and therefore AEG had to modify its offer to make it more equal to an asset sale.

In cross-examination, Mr Vetsch acknowledged that Oriole made available to AEG the D & S Petroleum Consultants Ltd report and this was reviewed by officials of AEG. The present worth of the assets of Oriole as of 1974, in the view of AEG, was $2,980,000, discounted at 20 per cent. He affirmed that AEG's internal valuation in 1976 of Oriole’s assets gave a value to Oriole's assets in the amount of $4,800,000 which was not necessarily a real value. Mr Vetsch stated that a company president would look at a value of a company differently than petroleum engineers since he has to consider risk factors.

Mr Vetsch also testified that AEG was active in the same area of Alberta as Oriole and was of the view Oriole’s properties were good properties. AEG was a pioneer in the area and it had the confidence in the ability of Oriole’s properties to produce. Mr Vetsch stated that there were some risks in the assets valued by his staff in 1976 but these risks were not substantial; nevertheless he stated that he would not pay $4,800,000 for the assets.

Mr Vetsch admitted that he knew the employment contracts had to be settled with Messrs Flanagan and Burroughs if the sale of shares was to take place; AEG looked at this as a package. Mr Vetsch testified that Oriole was faced with the situation of settling the employment contracts if they wanted to purchase the shares.

Mr Penner, a chartered accountant practising as a partner with Thorne & Riddell in Calgary, was also called as a witness by the appellant. Mr Penner's evidence was that based on the amounts contained in the employment agreements, in particular clauses 3, 4 and 5, he would have made an actuarial calculation that the values of the contracts in 1976 were not less than $500,000 each.

Counsel for Oriole submitted that the payment of $1 million by Oriole to Messrs Flanagan and Burroughs was a payment to get rid of onerous contracts of employees and is therefore a deductible expense, and not a payment of capital. Counsel argues that the employment contracts were entered into in 1974 to give comfort to two employees and were treated as

‘“ bona fide” and enforceable by AEG during negotiations for the sale of the shares. While Oriole was cash poor in 1976 it was asset rich, argues counsel, its assets having a value in excess of $4 million, which would have been sufficient to purchase the employment contracts of Messrs Flanagan and Burroughs.

In support of his position Oriole's counsel referred the Court to several well-known and often cited authorities, including B W Noble, Limited v Mitchell (1927), 11 TC 372, Anglo-Persian Oil Co Ltd v Dale (1931), 16 TC 253, Automatic Toll Systems Ltd v MNR, [1974] CTC 30; 74 DTC 6060 and Dy mo of Canada Ltd v MNR, [1973] CTC 205; 73 DTC 5171.

The issue in these cases was whether a payment by a taxpayer to rid himself of an onerous contract was a payment on capital account, and therefore not deductible in computing income, or on account of revenue, and therefore deductible in computing income. I do not believe this is the issue in the case at bar. In the present appeal the issue, in my view, is whether Oriole made the payment of $1 million as an outlay or expense made or incurred by Oriole for the purpose of gaining or producing income from its business.

To determine whether the payment in question was made or incurred for the purpose of gaining or producing income from Oriole’s business I must determine the reason for the payment. In the appellant’s view the payment was made pursuant to the employment agreements which, he says, were bona fide and were acted upon by the parties. The Minister argues to the contrary. Thus the dispute between the litigants comes down to whether the employment agreements were valid enforceable agreements intended to be acted upon by the parties or whether they were documents prepared for negotiating purposes only in contemplation of the sale of shares and the parties never intended to enforce any legal obligations created by the agreements.

Although the terms of the employment are confusing, the employment agreements did create legal obligations between the employees and Oriole for a base salary in the first year of the agreements, annual increments, a pension, and a lump sum payment on sale of Oriole’s assets or the employees' shares. However it is also clear from the evidence that up to July 28, 1976, the date of the sale of shares to AEG, only the first clause of each employment agreement had been enforced by Messrs Flanagan and Burroughs. Each agreement was effective May 1, 1972 and the base salary actually paid to Messrs Flanagan and Burroughs in 1972 was $25,000. The second clause of the agreement was never enforced and indeed there is no reference in the books of account of Oriole for any annual increments for 1973, 1974, 1975 or 1976 in accordance with the agreement; the salaries for the years after 1972 remained at $25,000; the annual increments were not accrued by Oriole either for accounting or tax purposes.

The third clause of each agreement is not clear in my view. The payment of $75,000 per year is not a salary: the sum is to be paid even if the employee is totally disabled or is retired and is no longer an employee of Oriole. I would therefore assume the payment is some sort of a pension. Also, the payment is to be made "when the employee attains fifty-five years of age . . ., or retires on or after the employee's fifty-fifth birthday". Is the employee to receive this payment once he reaches 55 years of age but is not yet retired? Or must he first retire? In any event by agreements effective May 1, 1976 — when negotiations with AEG were active — Messrs Flanagan and Burroughs accepted “as final settlement from the employer of the entire claim to deferred compensation in clause 3 of the Employment Agreement entered into between the parties May 1, 1972 a life annuity of $75,000 per annum guaranteed for a minimum period of 15 years, commencing at age fifty-five . . .”. But these agreements too were not enforced by the parties and were never acted upon.

The fourth clause of each employment agreement appears to provide for a pension of $75,000 per year for as many years as the employee was employed by Oriole. When Mr Penner valued the employment agreement on an actuarial basis as at June 30, 1976 he accorded four years' service to each of Messrs Flanagan and Burroughs without regard to the reasonableness of this amount.

The fifth clause of the employment agreements also troubles me. The clause calls for a salary bonus of seven and one-half per cent of the asset value of Oriole if Oriole's assets are sold before the employee reaches age

55. What the words "asset value’’ mean are vague. Do they mean the value of the assets as recorded on the books of Oriole, or the value of the assets, including proven reserves? Mr Flanagan thought the latter. But what about Oriole’s liabilities? Is the asset value to be reduced by the liabilities of the company? Also, the employee is entitled to a similar bonus on any sale of his shares based on the “underlying” assets of Oriole. Here, too, terms are not clear as one would expect in an agreement of this type if the agreement was one which the parties intended to govern their relationship.

Mr Flanagan testified that the employment agreement was brought to him by Mr Burroughs “on or about the time we decided to sell the company”. He had no input into the decision as to how age 55 was arrived at as the time at which certain payments would start. He testified the sum of $75,000 in clause 2 was fair “for what we had done” and that the value of $4 million he and Mr Burroughs put on Oriole had a bearing on determining the salary of $75,000 per year.

When the purchase price for the shares had to be reduced on closing because of the title defect in the Blackfoot lands, which reduced the value of the assets by $400,000, Mr Vetsch testified that each of the factors in the “overall deal”, the money payments, the shares of AEG “and the settlement of the employee contracts were reduced more or less pro rata.

I infer from the course of conduct of Messrs Flanagan and Burroughs and Oriole, which prior to June 28, 1976 was controlled by Messrs Flanagan and Burroughs, the timing of the agreements, the execution of the agreements of May 1, 1976 but not enforcing the agreements, the level of salaries paid by Oriole to Messrs Flanagan and Burroughs in 1973, 1974, 1975 and 1976 notwithstanding the employment agreements, the non-accruing of the increments by Oriole, that the employment agreements were never intended to be enforced or to be acted upon. Clause 1 simply reflected what had taken place four years prior to the time the employment agreements were prepared and executed and is a confirmation of what had transpired earlier. The claim by Mr Flanagan that he and Mr Burroughs entered into the employment agreements for “monetary protection” rings hollow: Oriole had ceased its drilling program and its activities consisted of collecting rents, looking after some wells at Drumheller and general maintenance; some leased land was also eligible for further drilling. The aggressive part of the business was over. I cannot accept Mr Flanagan’s statement that if he and Mr Burroughs did not agree on something the employment agreements permitted each to go his separate way. No clause in either agreement provides for such an eventuality.

There is no evidence that it was in the best interest of Oriole that Messrs Flanagan and Burroughs retire; in fact the evidence is that Messrs Flanagan and Burroughs were valued employees of Oriole and resigned because this was the wish of the prospective purchaser of their shares. Oriole led no evidence that the employment contracts were onerous to it, although the reasonableness of the payments was questioned by the Minister. There was no business reason causing Messrs Flanagan and Burroughs to resign as employees of Oriole; they resigned because they ceased to be shareholders in Oriole and they agreed with the prospective purchaser during negotiations for their shares that they would resign and release Oriole from the employment contracts for a sum of $1 million. The aggregate of $1 million, and the other amounts received by Messrs Flanagan and Burroughs from Oriole, approximated the amounts they expected to receive for the shares. I conclude that even in Mr Flanagan’s mind the payment for termination of the employment agreement was a means of obtaining part of the purchase price for the shares. I also cannot accept either Mr Flanagan’s position that the salaries called for in the employment agreements were prepared to permit him and Mr Burroughs to take out of Oriole the value of the growth of the company that was due to them. Shareholders normally receive profit from a company by way of dividends, or if the shareholders sell their shares, by the purchase price of the shares which reflects the value of the company. Employees receive salary for services performed and salary may at times be dependent on the income of the Company. The employment agreement was simply a device to be used by Messrs Flanagan and Burroughs if necessary and to the extent necessary as events unfolded during any negotiations for sale of their shares. This was the substance of the matter. The contract, while enforceable, was not enforced or acted upon by either employee. I doubt whether Messrs Flanagan or Burroughs ever had the intention of enforcing the contract. While Mr Vetsch may have thought during negotiations the employment agreements were valid and enforceable there is no evidence he knew, or ought to have known, the parties had no intention of enforcing the employment agreements.

This was not the situation in Noble. In the Noble case the appellant corporation claimed as a deduction from its profits for tax purposes the sum of £19,200 payable to a retiring director in the following circumstances. The original directors were appointed for life so long as they held a qualifying number of shares, subject to dismissal forthwith for neglect or misconduct towards the Company. A director so dismissed was only entitled to receive his salary then due and could be required to sell his shares to the other directors at par. He would also have to surrender for cancellation certain notes issued by the Company entitling him to participate in surplus profits. Circumstances arose in 1920 and 1921 in which the Company might possibly have been justified in dismissing one of the directors, but, to avoid publicity injurious to the Company’s reputation, it entered into negotiation with him for his retirement. He claimed £50,000 compensation, but a compromise was arrived at and embodied in an agreement by which he agreed to retire from the Company, to transfer his 300 one pound shares to the other directors at par value, although they were worth considerably more, and to surrender his participating notes. The Company agreed to pay him £19,200 and the directors to pay him £300 (expressed to be consideration for his shares), making together £19,500 which he agreed to accept in full satisfaction of all claims against the Company and the directors.

In the King’s Bench Division, Mr Justice Rowlatt gave judgment in favour of the Company. He found a payment to get rid of a servant in the interests of the trade is a proper deduction” (page 413). Rowlatt, J stated the Company made the payment to the directors “because it was essential in their opinion to get rid of him for the sake of the good name of the Company and they did not want any litigation or publicity or any scandal or anthing of that kind, so they paid it for business reasons”; the sum was paid to get rid of the director (page 414). Mr Justice Rowlatt found the payment to be a business expense since what the company did was no more than to get rid of a servant in the course of its business (page 415). The Court of Appeal dismissed the appeal.

Accordingly I cannot find that the $1 million paid by Oriole to Messrs Flanagan and Burroughs was for the purpose of gaining or producing income from the business. The purpose for the payment of the money for the benefit of Messrs Flanagan and Burroughs had no relationship to the business being carried on by Oriole and was not made in the course of its business. The payment was part and parcel consideration for the shares. As I indicated earlier it is conceivable and proper on the sale of shares of a corporation by a shareholder who is also an employee of the corporation for him, qua employee, to receive payments from the corporation as a retiring allowance, termination payment and as damages on the cancellation of an employment contract; however the payments are to be determined without regard to the sale of his shares and on the basis that all contracts are enforceable and have governed the relationship of the employer and employee. This was not the case here.

The deduction of the $1 million by Oriole is prohibited by paragraph 18(1 )(a) of the Act.

The appeal is therefore dismissed.

Appeal dismissed.