Kocisko-Senecal & Associates LTD and Joseph Kocisko v. Minister of National Revenue, [1981] CTC 2613, 81 DTC 481

D E Taylor:—These are appeals heard on common evidence at the City of Montreal, Québec, on June 3, 1981, against income tax assessments for the year 1977 in which the Minister of National Revenue disallowed as an expense for administration salaries, an amount of $26,500 in assessing Kocisko-Senecal and Associates Ltd (the corporation) and added the same amount to the income of Joseph Kocisko (Kocisko), taxable as a benefit, and imposed a penalty on Kocisko under subsection 163(2) of the Act. At the hearing, counsel for the respondent notified the Board that the Minister agreed to the Board allowing the appeal against the penalty. Accordingly, the only dispute is that related directly to the tax treatment accorded the amount of $26,500. At an earlier date, the Board had granted an application by the Minister under section 174 of the Act, and joined Mr Pierre Senecal to the appeals of Kocisko-Senecal & Associates Ltd and Joseph Kocisko. The question in that application, for which the Minister requested a determination, was:

36 (A) Whether the amount of $26,500.00, or any part of this amount, paid by Kocisko-Senecal & Associates Ltd. to Mr. Pierre Senecal in accordance with the terms set forth in the agreement was in consideration of the shares transferred to Mr. Joseph Kocisko with the consequence that:

(i) this amount would constitute a capital payment for Mr. Pierre Senecal and would therefore be taxable as a capital gain pursuant to sections 3, 38 and 39 of the Act;

(ii) This amount would have been paid by the company for the benefit of a shareholder, namely Mr Joseph Kocisko, the deduction of which would be prohibited since this expense would not have been incurred by the company for the purpose of gaining or producing income and the deduction of this amount would therefore be prohibited pursuant to subsection 18(1 )(a) of the Act;

(iii) the amount would constitute a benefit or advantage conferred on Mr. Joseph Kocisko, shareholder of the said company and purchaser of Mr. Pierre Senecal’s shares, pursuant to subsection 15(1 )(c) and/or subsection 56(2) of the Act:

(B) Or whether this amount of $26,500.00, or any part of this amount, paid by the company to Mr. Pierre Senecal in accordance with the terms set forth in the agreement was paid on account of salary or as a bonus with respect to Mr. Pierre Sene- cal’s employment with the said company with the consequence that:

(i) this amount would constitute taxable income from employment received during the 1977 taxation year by Mr. Pierre Senecal as salary or other remuneration pursuant to section 5 of the Act;

(ii) The amount would be properly deductible by the company as an expense incurred by it during its 1977 taxation year for the purpose of gaining or producing income pursuant to subsection 18(1)(a) of the Act;

(iii) this amount would not be taxable in Mr. Kocisko’s hands for the 1977 taxation year.

The notice of appeal for the corporation sets out the basic issue and reads in part:

1. By agreement dated November 1st, 1976, Joseph Kocisko (“Kocisko”) purchased from Pierre Senecal (“Senecal”) all the shares that the latter owned in the capital stock of the Appellant for a consideration of $50.00;

2. In virtue of the same agreement, Kocisko agreed to cause the Appellant to pay to Senecal a bonus in the amount of $26,450 in three equal consecutive installments during the 1977 taxation year;

3. For the purpose of the transaction executed on November 1st, 1976, Senecal and Kocisko were dealing at arm’s length and the fair market vlaue of the shares owned by Senecal in the capital stock of the appellant was $50.00;

4. In its 1977 taxation year, the appellant paid to Senecal a bonus of $26,450. which was deducted in computing its income for the same taxation year;

Further elaboration was provided in the reply to notice of appeal:

4. In assessing the Appellant for its 1977 taxation year, the Minister of National Revenue relied, among others, on the following assumptions of facts:

(a) prior to November 1, 1976, Mr. Pierre Senecal and Joseph Kocisko were equal shareholders and employees of the Appellant;

(b) by written agreement dated November 1, 1976, Joseph Kocisko acquired the FIFTY (50) shares held by Mr Pierre Senecal: “. . .the whole for the price and consideration of FIFTY DOLLARS ($50.00) (the “purchase price”) payable in cash in the closing date and other good and valuable consideration the whole as set forth herein below.

(c) among other considerations set forth in the said agreement, the parties agreed to the following:

“C. The purchaser shall cause the company to pay to the vendor a bonus in the sum of TWENTY SIX THOUSAND FOUR HUNDRED AND FIFTY DOLLARS ($26,450.00) in THREE (3) equal consecutive installments on January 15, February 28 and March 21, 1977.”

Contentions

For the appellant corporation:

The bonus paid in 1977 by the Appellant to Senecal constitutes an expense incurred for the purpose of earning income and was duly deducted in computing the income of the Appellant;

For Kocisko:

The bonus paid in 1977 by the Corporation to Senecal does not constitute a benefit conferred upon the Appellant;

For the respondent:

Re: The Corporation:

Respondent submits that the amount of $26,450 paid by the Appellant was not expended by it for the purpose of gaining or producing income pursuant to section 18(1 )(a) of the Act;

Re: Kocisko:

Respondent submits that this amount of $26,450.00 was paid by the company for the Appellant’s benefit and was therefore properly included in the computation of his income for the 1977 taxation year pursuant to subsection 15(1 )(c) of the Act and/or 56(2) of the Act;

Evidence

Both the evidence and the argument were given partly in the French language and partly in English. Since the chief documentary evidence (a relevant agreement between Kocisko and Senecal) and the testimony of a major witness, the chartered accountant Mr W H J Tretiak, were both in English, this decision will be written in that language.

Mr Tretiak was the accountant for the corporation and met with the two shareholders in mid-January 1977 at their request to assist in arranging some method by which the two (Kocisko and Senecal) could part company as far as their respective interests in the corporation were concerned. He was requested to meet with the corporation’s legal adviser, and the following agreement was prepared, signed by both parties and entered as Exhibit A-2:

MEMORANDUM OF AGREEMENT OF SALE ENTERED INTO AT THE CITY OF MONTREAL, P.Q., ON NOVEMBER 1st, 1976.

BY AND BETWEEN:	PIERRE SENECAL, Insurance Broker, of the
	Town of Fabreville, District of Montreal,
	(hereinafter referred to as the “VENDOR”),
	PARTY OF THE FIRST PART
AND	JOSEPH KOCISKO, Insurance Broker, of
	the City of St. Leonard, District of Montreal,
	(hereinafter referred to as the “PUR
	CHASER”)
	PARTY OF THE SECOND PART

WHEREAS the Vendor is the record and beneficial owner of FIFTY (50) common shares of the par value of ONE DOLLAR ($1.00) each representing FIFTY PER CENT (50%) of all of the issued, allotted and outstanding shares of all classes in the capital stock of a certain corporation known as KOCISKO-SENECAL & ASSOCIATES LTD. — KOCISKO-SENECAL & ASSOCIES LTEE, a corporation duly incorporated in virtue of the Canada Corporations Act with letters patent bearing date of October 10th, 1975 and having its head office and principal place of business in the City and District of Montreal, (hereinafter referred to as the “company”), having an authorized capital of FIFTY THOUSAND DOLLARS (150,000.00) divided into TEN THOUSAND (10,000) common shares of the par value of ONE DOLLAR ($1.00) each and into FORTY THOUSAND (40.000) preferred shares of the par value of ONE DOLLAR ($1.00) each; and,

WHEREAS the Vendor desires to sell, transfer and assign all of his said common shares in the capital stock of the company to the Purchaser who desires to acquire same; and,

WHEREAS the parties hereto have agreed on all of the terms and conditions as well as the price and consideration for the said sale;

NOW, THEREFORE, THE PARTIES HERETO HAVE AGREED AS FOLLOWS:

1. THAT the preamble hereto shall form part hereof as if fully recited herein at length.

2. THAT the Vendor hereby agrees to sell, transfer, assign, convey and make over on the Closing Date unto the Purchaser hereunto accepting, a total of FIFTY (50) common shares in the capital stock of the company (“Vendor’s Stock”), the whole for the price and consideration of FIFTY DOLLARS ($50.00) (the ‘purchase price’), payable in cash on the Closing Date and other good and valuable consideration, the whole as set forth hereinbelow.

3. THAT as part of the consideration for the sale of the Vendor’s Stock, the parties hereto have agreed as follows.

A. The Purchaser shall cause the company to treat the Vendor’s advance (altered to read “from”) the company in the amount of FOUR THOUSAND DOLLARS ($4,000.00) as a salary to be paid to him by the company for services to be rendered to him to January 15th, 1977, and thereafter, the company shall not be indebted to him for any other advances or loans from directors of any nature whatsoever.

B. The Purchaser shall cause the company to pay all of the requisite payroll assessments such as Medicare, Unemployment Insurance and Pension Plan deductions in relation to the said sum of FOUR THOUSAND DOLLARS ($4,000.00) for and on behalf of the Vendor.

C. The Purchaser shall cause the company to pay to the Vendor a bonus in the sum of TWENTY-SIX THOUSAND FOUR HUNDRED AND FIFTY DOLLARS ($26,450.00) payable in THREE (3) equal, consecutive instalments on January 15th, February 28th and March 31st, 1977.

4. THAT the closing for the transactions contemplated by this Agreement shall be effective as of the close of business on the day prior to the Closing Date as hereinafter defined. The delivery of the Vendor’s Stock to the Purchaser shall be made at 10:00 o’clock in the forenoon at the offices of Messrs. Rosenhek & Machlovitch, Suite 1700 — One Westmount Square, in the City of Westmount, Province of Quebec, on March 17th, 1977, or on such earlier or later date as may be agreed upon by the Purchaser and the Vendor. The date or time of delivery of the Vendor’s Stock is herein referred to as the “Closing Date”.

5. THAT on the Closing Date:

A. The Vendor shall deliver to the Purchaser duly issued certificates for all of the Vendor’s Stock registered in the name of the Purchaser together with the previously issued share certificates representing the number of common shares herein being sold, endorsed in favour of the Purchaser for transfer.

B. The Purchaser shall deliver to the Vendor a cheque in the amount of FIFTY DOLLARS ($50.00) representing the purchase price referred to in paragraph 2. hereinabove.

6. THAT the Vendor warrants, covenants, represents and undertakes:

A. THAT the authorized, issued, allotted and outstanding shares in the capital stock of the company are as follows:

Class of	Number Number	Number Number
Shares	Authorized	Issued	Issued
Common	10,000		100
Preferred	40,000		nil

All of the said issued, allotted and outstanding common shares are validly issued, fully paid and non-assessable. No additional shares of the capital stock of the company, of any class, have been or will be issued or committed or optioned to be issued, to and including the Closing Date hereunder. There are no options, agreements or obligations outstanding for the authorization or issuance of any additional shares of any class. No dividends have been declared on any Class of shares remaining unpaid to the Closing Date.

B. THAT the Vendor is the absolute, record and beneficial owner and holder of all of the shares of the capital stock of the company herein being sold, and has full right, power and authority to sell, transfer, assign and deliver the same hereunder and such delivery will convey to the Purchaser lawful, valid, marketable and indefeasible title to the same free and clear of any liens, pledges, options, encumbrances, or restrictions of whatever nature.

THAT all of the foregoing covenants, warranties, representations and undertakings shall be true and effective as at the Closing Date, and shall survive the closing and any investigation made with respect thereto without limitation as to time or amount.

7. THAT the parties hereby delcare that they have required that this Agreement and all documentation and notices provided for herein, issued hereunder or relating directly or indirectly thereto, be in the English language.

Les parties reconnaissent avoir exigé la rédaction en anglais de la présente Convention ainsi que de tous documents et avis qui pourront être exécutés ou donnés à la suite des présentes ou ayant un rapport direct ou indirect avec la présente Convention.

8. THAT this Agreement shall be binding on the parties hereto, their heirs, executors, assigns, administrators and legal representatives, and the parties hereto agree for themselves and their respective heirs, executors, assigns, administrators and legal representatives to execute any further instruments which may be necessary or proper to carry out the purpose and intent of the foregoing.

IN WITNESS WHEREOF the parties hereto have signed at the time and place first hereinabove mentioned.

AND WE HAVE SIGNED:

(Signature)

PARTY OF THE FIRST PART

“VENDOR”

(Sgd. J. Kocisko)

PARTY OF THE SECOND PART

PURCHASER

Mr Tretiak had little in the way of direct instructions from the two shareholders, but clearly understood that Senecal wanted $26,500 to leave the company. Tretiak was to make the arrangements for payment to Senecal in the best manner to accomplish the transfer of stock. He was not certain whether the $26,500 had been described as for sale of the stock, or in what precise manner — it was, however, the amount that Senecal would accept. He did not recall pointing out that it would be done by way of salary, but that method could have been raised at the meeting. Senecal was aware that the total par value of the 50 shares of stock he held was $50. The draft financial information as at October 31, 1976 had been available to both parties and discussed at the meeting. The retained earnings position stood at $57,701 as of that date. Provision was made in the agreement for payment to Senecal of the $26,450 in three separate cheques, and this was done. Copies of the cheques were presented as exhibits and these were in the net amounts of $5,505.23 (dated 18.01.77), $5,505.23 (28.02.77) and $5,505.24 (31.03.77), and various deductions including an amount of 16,660.16 from each one for income tax had been made. The cheques were signed by Kocisko only and endorsed by Senecal only. Accordingly, Senecal received a net of $16,515.70 and a total of $5,280.48 income tax had been deducted. The T4 1977 wage slip prepared by the corporation for Senecal included appropriate indication of the above amounts. To Tretiak’s knowledge, there had been no objection raised by Senecal to the cheques, the deductions, or to the T4 wage report.

Mr Kocisko explained the history of the break-up between himself and Senecal. He (Kocisko) felt he was contributing more to the profits than Senecal and while Senecal had offered to buy him out, he concluded that Senecal could not have raised the necessary funds, so he agreed to buy out Senecal. He stated that Senecal had been a good, loyal and steady shareholder and employee of the company.

Mr Senecal was in general agreement with the testimony of both Tretiak and Kocisko on the history of the corporation and his reasons for leaving it, except that he made it clear that he had not agreed payment should be by way of salary. He could not be certain that the specific manner of payment had been discussed or explained in detail — but he had agreed to accept the total of $26,500. In his view, the entire amount was for the sale of his stock, and any gain should be on capital account — it should not be taxed as income. The par value of his 50 shares of stock had been $50, and therefore the amount at issue in any event was $26,450, not $26,500. He gave no satisfactory explanation for his acceptance of the salary cheques or the T4 wage slip under cross-examination. He agreed a separate bonus had been set up and paid to him for the fiscal year 1976. He had not worked at all in the interest of the corporation after he had signed the agreement Exhibit A-2 sometime in mid-January 1977, nor had he given any commitment to do so after that date.

Argument

Counsel for the appellants essentially limited his argument to the fact that there was no prohibition to the corporation paying Senecal a bonus, it had done so and simply deducted it as a proper expense, following all the proper procedures of remitting income tax deductions and preparation of a T4 wage slip. The agreement (Exhibit A-2) spoke for itself, and since it was at arm’s length, required acceptance.

Counsel for Senecal gave a detailed argument, emphasizing that his client’s share of the capital stock had a value at October 31, 1976 of about $28,850 (one half of $57,701) and that the agreement was dated as of the very next day (November 1, 1976). Senecal had agreed to accept a total of $26,500 (no one disputed that) and certainly he would not have accepted $50 for his stock. While the agreement called the $26,450 a “bonus”, the Board should look at precisely what did happen and the only conclusion was that the amount in question had no relation to salary, but was purely for the sale of the stock. Income tax should not have been deducted, but it could not be considered critical to the determination of this appeal. Among the case law cited were the following:

MNR v Estate of Donat Beaupré, [1973] CTC 316; 73 DTC 5255;

In re William Spira, James Randell, Julius Salamon, and Ferro Structural Steel (Toronto) Limited v MNR, [1975] CTC 2158; 75 DTC 83;

Gunter Gahrns v The Queen, [1978] CTC 651; 78 DTC 6436.

The position of counsel for the Minister was relatively passive, but supported the position of Senecal with certain additional jurisprudence:

Gabriel Maioni v MNR, [1980] CTC 2722; 80 DTC 1626;

Hugh Knox Limited v MNR, [1973] CTC 2053; 73 DTC 50;

MNR v Estate of Donat Beaupré, [1973] CTC 316; 73 DTC 5255;

The Queen v William G Phillips, [1975] CTC 250; 75 DTC 5188; [1976] CTC 126; 76 DTC 6093;

Beloeil Mercury Vente et Service Ltée v MNR, [1979] CTC 2368; 79 DTC 194;

William Richard Kay v MNR, [1971] Tax ABC 363; 71 DTC 285;

William Spira, James Randell, Julius Salamon & Ferro Structural Steel (Toronto) Limited v MNR, [1975] CTC 2158; 75 DTC 83;

John T Burnett v MNR, [1975] CTC 2222; 75 DTC 83;

MNR v Gordon W Pannell, [1973] CTC 81; 73 DTC 5038;

Ralph Pickard Bell v MNR, (No 661 v MNR), [1962] CTC 253; 62 DTC 1155.

Findings

The position of counsel for Mr Senecal is a rational one — that Senecal simply would not have accepted $50 for stock worth some $28,850 — and counsel made a convincing case for the acceptance of his position. However, his argument presupposes that clause 3(c) of the agreement is coincident with or consequential to clause 2 of the agreement. In simple terms, counsel for Senecal interprets the agreement to say: “I agree to sell you my stock for $50, after you have paid me a bonus of $26,450 for selling you my stock at that price”. However, that is not the only interpretation that can be placed on the agreement and, at best, Senecal could only say that he agreed to sell the stock for $50 and a promise from Kocisko to do certain other things including those mentioned in clause 3(c). In my view, clauses 5(A) and (B) make it clear that Senecal did not receive the $50 until “closing date”, and did not deliver the stock until then. All in all, the agreement (Exhibit A-1) is ambiguous and conflicting. The date “on November 1st, 1976” means nothing other than whatever happened, did occur after the end of the 1976 fiscal year end, and can only be applicable in and to the 1977 fiscal year of the corporation. The “good and valuable consideration” referred to in clause 2 of the agreement represents only promises (“shall cause the company”) on the part of Kocisko to do certain things. In fact, Kocisko could not have done any of these things without the agreement of Senecal before he (Kocisko) was the owner of all the stock, and there is no indication the transfer occurred before March 7, 1977 at least, and more probably March 31, 1977, the date of the last payment to Senecal. There is no indication that in the interim a “trustee” or “escrow” relationship between the parties had been established for the control of the stock.

As I read the agreement, the payment of the “bonus” of $26,450 required the consent of Senecal as a shareholder to the same degree it needed the agreement of Kocisko. It is fundamental to the argument of Senecal that the “bonus” was a bonus for selling his stock (an amount over par, represented by his one-half interest in the retained earnings). It is fundamental to the argument of the appellants that it was a salary bonus. That leads me to the conclusion that it can only be interpreted in the light of what did happen subsequent to and in implementation of the agreement. From that perception, the acceptance of the salary cheques and the T4 by Senecal without question is critical, and can only be interpreted, as far as Senecal is concerned, that the agreement referred to a “salary bonus”. There is nothing in the agreement or in its implementation to support Senecal’s contention that he was unaware that “bonus” meant salary. Whatever else may arise from an examination of this matter, his claim to a capital gain is unfounded — the $26,450 at issue was not for the sale of his stock — it is salary income to Senecal in the year 1977.

I can think of nothing which would prevent the corporation paying Senecal a bonus out of the 1977 fiscal year, even up to mid-January 1977, and that is critical to an understanding of this issue. There is no reason to conclude that the corporation was to pay Senecal a second and separate bonus related to the 1976 operation. The bonus at issue here had no relevance to the 1976 fiscal year, and the fact that Senecal made no commitments to continue to work for the company after signing the agreement does not appear significant to me. Whatever may be the determination of the Board relative to the sale of the capital stock for $50, the bonus of $26,450 was a legitimate deductible expense for the corporation for the year 1977, separate and distinct from the sale of the stock.

Dealing with the position of the appellant Kiocisko, it was not disputed by any of the parties that the book value of Senecal’s stock as at October 31, 1976 was approximately one half of the retained earnings of the corporation

— some $28,850 — an amount not materially different than that at issue in the appeal. Neither was it disputed that as a basis for the agreement (Exhibit A-2), Senecal had agreed to accept, and Kocisko had agreed to pay, a total of $26,500 in order to accomplish the transfer of the stock and the departure of Senecal. Further, it was common ground that Senecal had left the details of the arrangements up to Mr Tretiak. It is not clear that Senecal had understood (and it is denied by him that he agreed) that the amount at issue of $26,450 would be regarded not only as fulfillment of the agreement but also as salary to him. The essence of the proposition put to the Board by Kocisko is that by the corporation paying Senecal a salary of $26,450 out of the 1977 operations, the corporation somehow reduced its net earnings as at October 31, 1976 by that amount, and the stock he acquired was worth only $50, no benefit accruing to him.

There is no reason for the Board to conclude that the $26,450 was not paid out of current 1977 earnings, and indeed the retained earnings at October 31, 1977 (according to other evidence provided by Tretiak) had increased, notwithstanding the payment to Senecal, to some $106,490. Only by showing that there had been an operating loss in the corporation during the period November 1, 1976 to March, 1977 (or perhaps even to January 1977) could Kocisko show that the value of Senecal’s stock had been reduced at all — and only the demonstration of a very substantial operating loss in that period would reduce its value to $50. Accordingly, the value of the stock acquired by Kocisko from Senecal for $50 (some time in March 1977) retained a value of at least an amount of $28,850. In this part of the transaction, the appellant Kocisko and the third party Senecal bought and sold stock, and the corporation was not party to the transaction. In that sale, it could be argued that a benefit was conferred upon Kocisko by Senecal, a situation not unlike that referenced in subsection 245(2) of the Income Tax Act. However, the Minister has supported the assessment against Kocisko under “paragraph 15(1 )(c) of the Act and/or subsection 56(2) of the Act”. In my view neither the evidence nor the testimony support a conclusion that the corporation conferred a benefit on Kocisko (paragraph ¥5(1)(c)). Indeed, I have found that the corporation was not party to thé sale of stock between Senecal and Kocisko. With respect to subsection 56(2) of the Act, the “taxpayer” in that section must be Kocisko in order tomake it relevant at all. I do not see how the bonus to Senecal paid by the corporation could be construed to be “for the benefit” of Kocisko; nor do I see how it could be a “benefit” conferred on Senecal, in that it has been found already to have been salary.

Returning therefore to the questions posed by the Minister in the application under section 174 of the Act, the Board determines as follows:

36(A)

(i) An amount of $50 represents a capital payment, but there was no capital gain to Senecal.

(ii) The above $50 is a benefit to Kocisko.

(iii) —The above $50 is a benefit to Kocisko.

36(B)

(i) $26,450 represents taxable salary income to Senecal.

(ii) $26.450 is deductible to the corporation.

(iii) $26,450 is not taxable to Kocisko as assessed and contended by the Minister.

Decision

The appeal of Joseph Kocisko for the year 1977 is allowed in order that the penalty assessed be withdrawn, and the amount of $26,450 is not to be taxed according to the provisions of subsections 15(1) or 56(2) of the Income Tax Act.

The appeal of Kiocisko-Senecal & Associates Ltd is allowed in order to permit the amount of $26,450 to be deducted from income forthe year 1977.

In all other respects the appeals are dismissed.

The entire matter is referred back to the respondent for reconsideration and reassessment in accordance with the above reasons for decision.

Appeals allowed in part.