Sam Kligman v. Minister of National Revenue, [1980] CTC 2085, 80 DTC 1088

Roland St-Onge:—The appeal of Mr Sam Kligman came before me on November 5, 1979, at the City of Montreal, Quebec. The issue is whether an amount of $8,754 received in 1972 is the appellant’s income even if it was received by a company in which he was the controlling shareholder.

The respondent contended that the money received was earned by the appellant personally and not by his company, Nugget Knit Inc for the following reasons in the reply to the notice of appeal:

6. In assessing the appellant for his 1972 taxation year, the Minister of National Revenue, respondent, relied on the following assumptions of facts:

(a) the appellant was the principal shareholder and president of the company “Nugget Knit Inc”;

(b) the company “Nugget Knit Inc” was incorporated in 1957 and until April 30, 1971, its activities were limited to the import and distribution of products completing the line of goods produced by the manufacture known under the name of “Little Nugget Inc”;

(c) prior to his 1972 taxation year, that is from January 1, 1971 to April 30, 1971, the appellant was employed by the company Canadian Children’s Wear Limited (hereinafter referred to as “CCW”) as a management director;

(d) during that same period of time, the appellant was a regular employee in the employ of “CCW”, on a trial basis, and received an amount of $7,500 as salary;

(e) on May 19, 1972, an agreement was entered into between the company “Nugget Knit Inc” and “CCW”, effective July 1, 1972, requesting “Nugget Knit Inc” to act as a consultant thus performing the same services as the appellant had accomplished up until that date;

(f) no other agreement existed between “CCW” and “Nugget Knit Inc”, prior to that one effective July 1, 1972;

(g) on May 30, 1972, an amount of $11,500 was paid by “CCW” to “Nugget Knit Inc” aS management fees for services rendered from May 1, 1971, to April 30, 1972:

(h) the said services rendered during the said period of time were performed by the appellant and not by the company which he controled (sic), “Nugget Knit Inc”;

(i) furthermore, no binding agreement was in effect between “Nugget Knit Inc” and “CCW” during that period, so [as] to justify the payment of these consulting fees to “Nugget Knit Inc”;

(j) “CCW” specifically required the services of the appellant through its agreement with the interposed company “Nugget Knit Inc”;

(k) under this agreement, “Nugget Knit Inc” had no other employee of Significance than the appellant who was in control of it;

(l) the services rendered by “Nugget Knit Inc” to “CCW” are identical to those rendered by the appellant before the said agreement came into effect;

(m) from April 1971 throughout the year 1972, “Nugget Knit Inc” had no true commercial activities;

(n) no bona fide business purpose could justify the interposition of “Nugget Knit Inc” into the relation existing between the appellant and “CCW”; and this interposition constituted a pure simulation to permit the appellant to reduce the amount of tax payable by him for his 1972 taxation year;

(o) apart from the management fees earned by the appellant, the income of “Nugget Knit Inc” was composed mainly of dividends and interest income for the year 1972;

(p) upon these facts, the respondent, by notice of reassessment dated August 6, 1976, added an amount of $8,754 to the appellant’s income for his 1972 taxation year on the basis that:

(i) this amount was income truly earned by the appellant, personally, in the said year and not by “Nugget Knit Inc” in its taxation year;

(ii) the amount was paid by “CCW” to “Nugget Knit Inc” pursuant to the appellant’s direction;

(q) this was confirmed by way of notification by the Minister dated February 7, 1977;

7. The respondent relies, inter alia, on sections 3, 5(1), 56(2), 56(4), 245(2), 251 and 251(2) of the Income Tax Act (RSC 1970-71-72, ch 63) as amended;

8. The management fees paid by “CCW” must be included in the appellant’s income for his year 1972 pursuant to section 5(1), these amounts having been personally earned by the appellant;

9. The interposition of “Nugget Knit Inc” into the relations existing between the appellant and “CCW” has no commercial or business justification and constitutes a pure simulation, thus enabling the appellant to reduce his liability for Income Tax;

10. The payment of the management fees to “Nugget Knit Inc” was made pursuant to the direction, and for the benefit of the appellant and must therefore be included in computing the appellant’s income for his 1972 taxation year;

11. The management fees received by “Nugget Knit Inc” from “CCW” must be included in the appellant’s income for his taxation year 1972, pursuant to section 56(4) since the appellant has transferred to “Nugget Knit Inc”, with whom he was not dealing at arm’s length, the right to an amount that would have been included in his income, had it not been transferred or assigned;

At the hearing the appellant testified as follows:

In 1960 he became the sole owner of two companies, Nugget Knit Inc and Little Nugget Inc. The former company was rendering services to the latter and the appellant was the main employee of Little Nugget Inc.

In the same year the appellant signed an agreement with Canadian Children’s Wear Ltd (hereinafter referred to as “CCW”). Following this agreement, the appellant could not work for any company other than Nugget Knit and Little Nugget Inc.

The appellant became half owner of the two companies and CCW, half owner of Little Nugget Inc. Between 1960 and 1972, he sold his shares to Nugget Knit Inc. On March 1, 1976, the appellant signed two agreements, giving effect to an agreement existing since July 1, 1972: one between the appellant and Nugget Knit Inc and the other one between the appellant and CCW.

According to those documents, the appellant, as of 1972, became the employee of Nugget Knit Inc and, as such, he rendered services to CCW.

He testified that in 1972 he also worked for Little Nugget Inc.

The appellant went on to say that in February of the same year he received a telephone call from Mr Louis Bloom, the owner of CCW, and was asked to become his manager. Mr Bloom was partly retired and had problems with his employees. The appellant took sick the same day but was hired on a temporary basis. After seven months, he became a permanent employee of CCW. In 1972 he received a salary from Little Nugget Inc, Nugget Knit Inc and CCW. Before July 1, 1972, the appellant received personally $7,500 from CCW but thereafter the salary was received by Nugget Knit Inc.

Upon cross-examination, the appellant explained that he started to work with Mr Bloom when he was 27 years old and that they bought a company together; that Little Nugget Inc was incorporated in 1949 and Nugget Knit Inc in 1954; that both companies had the same objectives, the same telephone number and operated from the same premises; that before 1972, he was the main employee of Little Nugget Inc and received a full salary therefrom; that besides him, Nugget Knit Inc had other employees, namely his wife, his two boys and two girls; that according to a statement dated April 1973, three of the appellant’s children were students and received very little from the company: Paula—$750, Harris—$750 and the appellant himself—$3,500. Altogether, the income from services rendered was only some $12,000.

The appellant testified that when he became permanent, he received the $11,500 as management fees; there was no written agreement like those signed in March 1976.

Mr Bloom testified that from 1928 to 1972, CCW was his company; that the appellant worked for him some years and thereafter decided to have his own company; that the appellant could not get along with his partners and decided to come back to CCW. He also explained that, because of problems with his employees in 1972, he approached the appellant and offered him the position of general manager. At first, the appellant was on a temporary basis because of illness; he later became permanent.

Mr Bloom also stated that he was a 50% partner in Little Nugget Inc but because CCW had a much more important business than Little Nugget Inc,

he needed the appellant and, to use his own words: “I needed him more in my business”.

Counsel for appellant argued that the salary was never received by the individual who rendered the services but by the company Nugget Knit Inc and he referred the Board, among other cases, to MNR v A Thomas Leon et al, [1976] CTC 532; 76 DTC 6299, that there was a bona fide purpose in incorporating Nugget Knit Inc that was still active around 1972 although there was a decline in business; that the said company was the proper vehicle to render the services because:

(1) the appellant had, as an employee, acted for CCW which had a huge internal problem and

(2) Mr Bloom approached Mr Kligman to become his manager.

Counsel for appellant argued that from February to October 1971, the appellant was paid $7,500 and, thereafter, he was asked by CCW to continue his services on a permanent basis; that Nugget Knit Inc was not a sham because it had existed since 1954 and, following the 1972 agreement, the Said company was to receive the salary.

Counsel for respondent admitted that Nugget Knit Inc was a valid company and not a sham but also argued that there was a bona fide purpose for the interposition of Nugget Knit Inc between the appellant and CCW for the following reasons:

(1) Although Nugget Knit Inc existed, two witnesses admitted that the services were rendered by the appellant personally;

(2) In 1971/1972, Mr Bloom did not ask for the services of Nugget Knit Inc;

(3) Mr Bloom knew the appellant very well and was in constant business relation with him;

(4) The appellant had control of Nugget Knit Inc and the family was to benefit therefrom;

(5) Nugget Knit Inc was not very active since it had no employees and did not pay any salary but was in existence only to receive benefits from Little Nugget Inc.

(6) The appellant worked for Little Nugget Inc as a key employee but the children did not work on a regular basis.

Counsel for respondent terminated her argument by saying that the appellant, who was always working for Little Nugget Inc, could not work for Nugget Knit Inc; that the cases cited by the appellant, namely,

Ralph J Sazio v MNR, [1968] CTC 579; 69 DTC 5001;

MNR v James A Cameron, [1922] CTC 380; 72 DTC 6325, and

Bernard Feinstein v The Queen, [1979] CTC 329; 79 DTC 5236,

had no application in the present appeal because Nugget Knit Inc was not a bona fide business to render services to others and was used in the case at bar to minimize the appellant’s income tax for his 1972 taxation year.

As may be seen, the evidence adduced is too farfetched to really convince the Board that the interposition of Nugget Knit Inc into the relation between the appellant and CCW had any commercial or business justification; that there is not a tittle of evidence to show that Nugget Knit Inc in 1971/1972 was rendering the services required by Mr Bloom. The said company had no employees, no organization to render such services and no business activities.

It is crystal clear that the services were rendered by the appellant personally and the two agreements signed in March 1976 cannot change the Situation. Furthermore, the appellant had the onus to show that Nugget Knit Inc did in fact render the services to CCW, but he failed to do so to the Satisfaction of this Board.

Consequently, the appeal is dismissed.

Appeal dismissed.