Monquart Hardwoods Ltd. v. R., [1999] 2 CTC 2923, 99 DTC 818

Beaubier T.C.J.:

This appeal pursuant to the General Procedure was heard at Fredericton, New Brunswick on March 19, 1999. Gregor Hargrove, who was the only officer and director at all material times of the Appellant (“MHL”), was the only witness.

For 1994 the Appellant claimed reimbursement for payroll expenses pursuant to the scientific research and experimental development provisions of the Income Tax Act. The Respondent admits that the expenses were for scientific research and experimental development, but denied the Appellant’s claim for the following reasons:

1. They were not incurred by the Appellant in its own right. Rather, they were incurred as agent for Riverbrand Hardwoods (1993) Ltd. (“Riverbrand”).

2. The Appellant and Riverbrand are not related corporations as required by subsection 37(1.1) of the Income Tax Act.

This appeal followed.

MHL was incorporated in New Brunswick in June, 1991. It manufactures and sells maple hardwood floors for basketball and similar sports and recreational activities. It has done so for the Barcelona Olympics, the Chicago Bulls’ arena and many other facilities. It obtained its maple hardwood from small wood lot operations in New Brunswick, but the supply was interrupted in the winter because the frozen maple could not be cut properly then. As a result, MHL instituted research to enable year-round sawing of hardwood maple to occur. The method developed is now in use at two mills in New Brunswick.

To resolve the winter supply problem, MHL spoke to the local wood lot association, Carlton-Victoria Wood Producers, and through it met with other New Brunswick wood producer associations. Riverbrand Hardwoods (1993) Ltd. was incorporated in August, 1993, in New Brunswick (Exhibit AR-17).

On October 1, 1993 a Purchase Agreement (Exhibit AR-24) was signed in Fredericton to close on October 12. The signatories were MHL, Riverbrand, Gregor Hargrove and Woodlot Owner Holdings Ltd. (“WOHL”). In it:

(I) MHL (the Vendor) agreed to transfer to Riverbrand its business carried on at Woodstock including its cash, land, prem- ises, machinery, inventories, receivables, unfulfilled orders, inventories, etc., prepaid expenses and good will (See paragraphs 1.05, 1.06, 2.01, 3.01 and 3.02) for 102 shares of Riverbrand plus immediate payment of $300,000 to be applied on MHL’s debts (Paragraphs 6.01, 7.02 and Mr. Hargrove’s testimony).

(2) WOHL agreed to

(a) Pay $300,000 immediately for 69 shares.

(b) Pay $130,000 forty-five days later for a further 29 shares. (This would give WOHL 98 shares, or 49% of Riverbrand).

(c) Loan $231,000 more to Riverbrand (Paragraphs 7.01, 7.02 and 7.03 and Mr. Hargrove’s testimony).

In fact only $270,000 of the first $300,000 was ever paid by WOHL to Riverbrand and WOHL did not loan any money to Riverbrand.

MHL received the $270,000 and applied it on its debts. MHL also had a $200,000 forgivable loan from the Province of New Brunswick which it tried to transfer to Riverbrand. This loan’s forgiveness was based on the number of person weeks worked and still required about 17 weeks. New Brunswick would not allow this to be assigned to Riverbrand and it was not. WOHL did not have the $231,000 to lend to MHL but it arranged a loan to Riverbrand through its bank, the Bank of Montreal. This was used to build a sawmill. The Bank of Montreal paid out some advances on this loan, but before the sawmill was complete it stopped advances, seized its security and forced Riverbrand into bankruptcy by an assignment in bankruptcy dated November 14, 1995 (Exhibit AR-33).

Mr. Hargrove testified and the Court accepts it as true that no shares were issued to WOHL by Riverbrand. MHL did receive its 102 common shares issued from Riverbrand pursuant to subparagraph 6.01 (ii). There are four reasons why this testimony of Mr. Hargrove is accepted:

1. Mr. Hargrove is credible and is believed.

2. 69 shares were to be issued to WOHL for $300,000 in lump figures (see subparagraph 7.02(i)). It only paid $270,000.

3. New Brunswick law is that only fully paid shares can be issued by a corporation (Business Corporations Act, c. B-9.1, ss. 23(5) and (6). 4. Mr. Hargrove’s testimony could have been refuted by testimony or by certified corporate registry documents from the New Brunswick Corporations Branch. It was not refuted.

Finally, although MHL and WOHL were authorized to nominate directors in the unexecuted shareholders’ agreement (which names additional proposed shareholders over and above the parties to the purchase agreement) there is no evidence that any directors other than MHL’s nominees were elected as directors of Riverbrand. Mr. Hargrove admitted that MHL elected three directors and denied that any other directors were elected. No corporate documents were exhibited to establish that any other directors were elected. WOHL had no right to elect directors under the draft shareholders’ agreement until it owned shares in Riverbrand. On the evidence, MHL was the only shareholder of Riverbrand.

Exhibit AR-32, dated November 29, 1993 is a rough unsigned draft of minutes of a purported meeting of directors of Riverbrand which Mr. Hargrove first saw on March 18, 1999. At best, his testimony established that a meeting occurred, but not that WOHL’s representatives were directors of Riverbrand.

The evidence is that Riverbrand never paid any of the employees in question in this appeal. The payroll in question was paid by MHL. MHL issued the T-4’s, the T-4 summaries and the separation slips and paid the employment insurance for the workers in question. Riverbrand reported to Revenue Canada in 1994 that it had no employees (Exhibit AR-10).

As a result, on the basis of the evidence before the Court, MHL was the employer of the employees in respect to which it claimed reimbursement and these employees conducted the scientific research and experimental development in question. MHL did not act as agent of Riverbrand. The evidence is that no reimbursement of the wages MHL expended was paid to MHL by Riverbrand or was claimed by MHL in Riverbrand’s bankruptcy.

In any event, on the evidence, MHL and Riverbrand were related corporations under the Act, with the result that MHL is entitled to claim reimbursement for payroll expenses related to scientific research and experimental development expenses incurred by Riverbrand. The determination as to whether the two corporations are related for the purposes of the Act hinges on whether MHL controlled Riverbrand. It was established in Duha Printers (Western) Ltd. v. R. (1998), 98 D.T.C. 6334 (S.C.C.) that control of a corporation refers to de jure control rather than to de facto control. MHL was the only shareholder of Riverbrand. Because the essential condition for the subscription for issuance of the first group of shares to WOHL, namely the payment of the lump sum of $300,000 was never met, those shares were never issued and the second group of shares was never paid for or issued. The unanimous shareholder’s agreement was never executed and, on the evidence, was never agreed to, so its conditions were not binding to determine de jure control. As the sole shareholder of Riverbrand, MHL elected the only three directors so that it had de jure control of Riverbrand and therefore was also related to Riverbrand. It follows that, pursuant to subsection 37(1.1) of the Income Tax Act, the Appellant is entitled to the reimbursement claimed.

The appeal is allowed. The Appellant is awarded party and party costs.

Appeal allowed.