Lawrence Shapiro v. Minister of National Revenue, [1983] CTC 2618, 83 DTC 563

Bonner, TCJ:—The appellant appeals from assessments of income tax for the 1972 to 1977 taxation years. The appeals were heard by the assistant chairman of the Tax Review Board. He died before giving judgment. The parties then agreed that another member of the Board give judgment on the basis of consideration of the record and transcript of the evidence and argument. The Board was continued as the Tax Court of Canada by virtue of section 3 of the Tax Court of Canada Act.

The Minister assessed tax for the years in question on the basis that certain so-called management fees paid by United News (Wholesalers) Ltd (hereinafter “United”) to La Quinta Management Ltd (hereinafter “La Quinta’) were the income of the appellant. The issue is whether the Minister was right or whether the fees were, as alleged by the appellant, the income of La Quinta.

United was formed in 1957. It carried on the business of a wholesale distributor of reading materials. The appellant started to work for the company at that time as assistant sales manager. By July of 1970 the appellant was sales manager of United. United then had two shareholders, the appellant’s father and Joseph Busheikin, each of whom held fifty percent.

La Quinta is a company which the appellant caused to be incorporated in 1968. It would appear that at all material times the appellant controlled the company. On July 1, 1970, La Quinta entered into an agreement with United. That agreement (hereinafter called the “management contract”) provided in part as follows:

1. The Company (United) shall engage the services of the Consultant (La Quinta) as an independent consultant providing sales managerial staff and attending to all problems with regard to sales of the Company provided that the Company shall be entitled to the services of its employee Lawrence C Shapiro during the term of this Agreement.

2. The Company shall pay the Consultant the sum of TWENTY THOUSAND FOUR HUNDRED ($20,400.00) DOLLARS per annum by equal monthly instalments during the term hereof together with such bonuses, as may be from time to time mutually agreed upon.

7. The Consultant will at all times hold available to the Company its employee Lawrence C Shapiro for the use of the Company during the term hereof to apply his experience and skill to the problems and duties which shall be presented to him from time to time by the Company and he shall give his personal attention to the matters for which the Consultant has been retained under this Agreement and shall in the performance of such services use his best skill and ability.” [1]

Following formation of the management contract there was virtually no outward sign of any change in the relationship between the appellant and United. The change in the relationship was brought to the attention of upper level personnel at United because they had to know for legal, financial and payroll purposes. Lower level staff members were not told. Customer of United were not told. The appellant resigned verbally and then simply performed the duties of sales manager much as he had done before.

The appellant’s father was general manager of United up to the time of his death in 1971. The appellant then became general manager. That event gave rise to an amendment to the management contract as follows:

This wt+l confirm that the Agreement entered into between us July 1st, 1970 is to be forthwith amended by deleting the word “sales” in the second line in section 1 and substituting the word “general” therefor; and by deleting the word “sales” in the third line of such section 1 and substituting the words “general management”.

Throughout the relevant period invoices for the management fees in question and disbursements were sent by La Quinta to United. Amendments to the compensation provisions of the management contract were made from time to time. Most if not all of them were provided for by amending agreements in writing duly executed by both parties.

There were some slight slip-ups. An attempt was made to make a contribution to a deferred profit sharing plan in respect of the appellant as employee of United. La Quinta employees, including the appellant, were treated as part of a group of employees of United for purposes of medical insurance.

The provision of the appellant’s services under the management contract was only one of the activities carried on by La Quinta. Immediately after La Quinta was formed in 1968 the company commenced to carry on the business of a retail merchant. It also held shares in other companies, both of the small private and large public variety.

Counsel for the Minister argued that “. . . there was no business purpose for the interposition of La Quinta between United and Mr Shapiro . . .” and that, consequently, . . the income earned by La Quinta is . . . taxable in Mr Shapiro’s hands . . . ”. The evidence indicates that the principal if not exclusive reason for the formation of the management contract was the reduction of income tax. When asked what led La Quinta into the management contract the appellant testified that in 1970 he was reading in the newspaper about Mr Ralph Sazio who, as he said, had set up a management company for his employer, the Hamilton football team. The appellant explained further that Mr Sazio “.. . had been successful in having this arrangement accepted by the Department of Revenue”. The appellant concluded that he . . felt this would be an opportunity to do the same thing”.

The management contract cannot be treated as a sham or as in some other way ineffective simply because a tax reduction motive led to its formation. The submission made by counsel for the Minister in this regard rested on the definition of “sham” adopted by the Federal Court of Appeal in Norman Leon v MNR, [1976] CTC 541; 76 DTC 6303. The Federal Court-Trial Division had occasion to consider that definition recently in Frederick G Vivian v The Queen, [1983] CTC 107; 83 DTC 5144. Mahoney, J, stated at 118 (5147):

The definition of “sham” in the context of the Income Tax Act was, however, considerably broadened by the Federal Court of Appeal in MNR v Leon, where it was held:

If the agreement or transaction lacks a bona fide business purpose, it is a sham . . . In the case at bar, thee is no bona fide business reason for the agreements and the sole purpose of the agreements is the savings in income tax.

By that definition, the interposition of the management companies was a sham.

The Court, however, refrained from finding sham on the basis of an analysis of decisions of the Federal Court of Appeal made subsequent to that in Leon. Vivian cannot be distinguished in principle and I am therefore bound to reach the same result. Accordingly I find that the interposition of the management contract was not a sham. This branch of the Minister’s argument therefore fails.

The second argument advanced by counsel for the Minister was that Mr Shapiro remained an employee of United after July 1970 because there was no change in his duties as a result of the management contract. I must confess that I can see absolutely no force in this argument. The position is this: At the outset the appellant was an employee, but he resigned. By that act the employment contract was brought to an end. The slip-ups previously referred to did not serve to reconstitute the master-servant relationship. Following the resignation there was no privity of contract between the appellant and United. This was the situation recognized by all persons concerned, the appellant, United and La Quinta. The relevant persons treated the resignation as effective and the provisions of the management contract as the rules which governed their relationships. The mere fact that the appellant was the individual who performed the tasks which in the aggregate made up the duties of sales manager (and later general manager) does not in some way entitle him to look to United for payment or otherwise restore the privity of contract which existed prior to the resignation. Nothing in the Income Tax Act justifies the imposition of taxation on the basis that a masterservant relationship once formed becomes immutable. There is no authority for the proposition that the mere absence of the outward appearance of change is sufficent to nullify the management contract and the consequences which flow from it. The income in question is that of La Quinta.

The appeals will therefore be allowed and the assessments in issue referred back to the Minister for reconsideration and reassessment on the basis that the payments made by United to La Quinta pursuant to the management contract formed no part of the appellant’s income.

Appeal allowed.