Mary Assaly, Thomas C Assaly, Ernest Assaly, Louis C Assaly, Laureen Assaly, Trendsetter Developments Limited, Assaly Construction Limited and Gloria Assaly v. Minister of National Revenue, [1978] CTC 2082, 78 DTC 1086

A W Prociuk:—The above appeals came on for hearing at a special sittings of the Board in Ottawa. The parties agreed that all appeals be heard on common evidence relating to legal and liquidator’s fees. In the case of Louis C Assaly v MNR, being appeal no 76-1189, a request by counsel for the appellant, and consented to by counsel for the respondent, that the issue of the shareholders’ loan be adjourned to the next regular sittings in Ottawa, was granted.

The appellant Assaly Construction Limited was incorporated some years prior to the material time herein, under the laws of the Province of Ontario and has its head office in the City of Ottawa. It shall be referred to hereinafter as “ACL”. Its shareholders, officers and directors were at the material time: Ernest Assaly, Thomas Assaly and Louis Assaly, the individual appellants herein. ACL was in the business of residential and commercial construction.

The appellant Trendsetter Developments Limited (hereinafter called “TDL”) was similarly incorporated prior to the material time herein. pursuant to the laws of the Province of Ontario, with its head office in Ottawa. Its shareholders, officers and directors during the material time were: Mary Assaly and Gloria Assaly. Laureen Assaly was a Shareholder but evidence does not indicate that she ever was a director and/or officer of TDL at any time. TDL was in the business of acquiring and developing raw land and the sale of residential and commercial accommodations.

Thomas and Gloria Assaly, Ernest and Mary Assaly, Louis and Laureen Assaly are husband and wife.

The taxation years under appeal are 1972, 1973 and 1974.

Prior to 1972, ACL built dwellings on land owned by TDL in the Ottawa area, pursuant to a contract between the two companies. TDL would pay ACL for its construction work as money became available to TDL from the sales of completed housing units.

In 1971 a serious disagreement arose between the two appellant companies as to further construction and as to the turning to account of certain TDL inventory. ACL had billed TDL for its work and in 1971 the amount owing and unpaid was substantial. Also, there arose a serious disagreement among the management of TDL, principally between Gloria Assaly as secretary-treasurer and director, and Mary Assaly as president and director. In both companies it was not possible to call a directors’ meeting. TDL was more seriously affected in that its day-to-day operations and decisions to carry on the business ground to a halt. The same situation obtained in ACL at a later stage. It soon became obvious to each group, that is TDL and ACL, that legal assistance and advice were necessary to resolve the various impasses that came about.

Gloria Assaly consulted and retained Messrs Gowling and Henderson. Mary Assaly consulted and retained Messrs Hughes, Laishley, Mullen, Touchey and Sigouin (hereinafter called “Hughes, Laishley’’).

Thomas Assaly then consulted and retained Messrs Gowling and Henderson. Ernest Assaly consulted and retained Messrs Hughes, Laishley.

Numerous court actions were commenced and certain appeals instituted for certain court orders. The Clarkson Company Limited was appointed as liquidator or manager of TDL (and this is in issue) but the company was not wound up.

The legal and liquidation manager’s fees incurred in the said years and paid by each appellant company were substantial and are as follows:

Each company, in computing its income for the said years, claimed as a deduction the fees paid by it. In each case the respondent disallowed the deductions on the ground that same have not been shown to have been outlays or expenses incurred for the purpose of gaining or producing income within the meaning of paragraph 18(1 )(a) of the Income Tax Act, SC 1970-71-72, c 63.

Further, the respondent assessed each individual appellant herein on the basis that legal expenses were incurred by each one qua shareholder and when same were paid by the company a benefit was conferred on the individual appellant and the benefit (being a pro rata of the legal fees paid by the company) was added to her or his declared income in accordance with the provisions of subsection 15(1) of the Income Tax Act. The addition to their respective incomes are as follows:

ACL appeals on the grounds that (a) the legal fees were incurred by it solely in order to resolve the impasses within itself and between itself and TDL; (b) the initiation by it of involuntary winding-up of itself and TDL was the only effective remedy to keep both in existence and operating; and (c) that fees were incurred for the purpose of gaining or producing income as it once again became a viable commercial enterprise and accordingly the said legal fees are properly deductible from its income by virtue of paragraph 18(1)(a) of the Income Tax Act which reads as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property:

TDL appeals on similar grounds, adding thereto the ground that the fees paid to The Clarkson Company Limited are deductible from its income because Clarkson was not a true liquidator but an interim manager-operator during the period of impasse and as a result this appellant once again became a viable commercial entity.

The individual appellants appeal from the reassessments of their respective incomes on the ground that none of them had any benefit conferred by the company of which they were shareholders when the company paid the legal fees incurred. In each case it is claimed that each consulted and retained a law firm in their capacities as directors and officers of their respective companies on behalf of the said companies for the purpose of resolving the impasses, which eventually happened; that the fees paid by each company were proper company expenses and not personally incurred expenses which the company paid. Subsection 15(1) of the Act reads as follows:

15. (1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction.

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been 'Conferred on a shareholder by a corporation

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 84, 88 or Part II applies.

(e) by the payment of a dividend, or

(f) by conferring on all holders of common shares of the capital stock of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

Thomas C Assaly and Ernest W Assaly testified at the hearing of these appeals. It was agreed, that their evidence be applicable to all appeals mutatis mutandis.

The officers, directors and shareholders of ACL were: president— Thomas C Assaly; vice-president—Ernest W Assaly; secretary-treasurer

—Louis C Assaly.

The officers and directors of TDL were: president—Mary Assaly; secretary-treasurer—Gloria Assaly; vice-president—Robert Ménard. The shareholders were Mary. Gloria and Laureen Assaly, J W Johanson and Robert Ménard. There was some dispute as to Ménard’s qualifications and right to be an officer and a director. As well, it was disputed whether Laureen Assaly was in fact a shareholder but these matters are not before the Board for resolution.

Thomas C Assaly acted as management consultant to TDL. Ernest W Assaly stated that he was consultant and business adviser to his wife, Mary Assaly.

In 1971 differences arose between Thomas Assaly and Ernest Assaly. Thomas Assaly was of the opinion that ACL should continue to build for TDL and Ernest Assaly thought that it should not. Ernest Assaly refused to sign cheques for ACL and accounts were not being paid.

In TDL the situation was even more serious. Mary Assaly took the position in 1971 that TDL should sell developed land and not build and sell houses on the open market. Gloria Assaly was of the view that the relationship between ACL and TDL should continue as before. However, as this difference of views took more rigid form, the houses in the meantime were not being sold by TDL; documents were not attended to nor executed; bills were not being paid and a gradual shutdown of activities ensued, ending in a virtual standstill in 1972. ACL’s bill with TDL was unpaid and well over $1 million. Mary Assaly directed TDL’s bank that at least two signatures were required on the cheques. Consequently, no cheques were signed.

Gloria Assaly consulted Messrs Gowling & Henderson, as did Thomas C Assaly. The purpose of this consultation was to find ways and means to unplug the situation between ACL and TDL. It was decided to call a directors’ meeting of TDL.

On September 13, 1971 a telegram (filed as Exhibit A-1), signed by Gloria Assaly and Robert Ménard, was sent to Mary Assaly and reads as follows:

TAKE NOTICE THAT AS DIRECTOR OF TRENDSETTER DEVELOPMENTS LIMITED WE HEREBY CALL A MEETING OF THE BOARD OF DIRECTORS OF TRENDSETTER DEVELOPMENTS LIMITED TO BE HELD IN THE BOARD ROOM OF GOWLING AND HENDERSON, 10TH FLOOR, ROYAL TRUST BUILDING, 116 ALBERT STREET, OTTAWA, AT 4.00 PM EDT, THURSDAY, SEPTEMBER 16, 1971, TO TRANSACT THE FOLLOWING BUSINESS, NAMELY, THE SETTING OF THE DATE FOR THE’ HOLDING OF THE ANNUAL MEETING OF THE COMPANY AND AUTHORIZING THE SENDING OF THE NOTICE OF THE TIME AND PLACE OF THE SAID MEETING AND THE GENERAL NATURE OF THE BUSINESS TO BE TRANSACTED THEREAT.

Mary Assaly, as did her husband Ernest W Assaly, consulted Messrs Hughes, Laishley. On September 15, 1971 Mary Assaly caused to be issued a writ of summons against Robert Menard, filed as Exhibit A-20, claiming that Ménard was not a shareholder nor a director of TDL and asking for an interim injunction until the trial to restrain Ménard from calling, convening, attending, being involved in or voting at any directors’ or shareholders’ meetings of TDL. His Honour Judge C F Doyle granted the interim injunction on September 16, 1971 (Exhibit A-21) till September 21, 1971, or until the final disposition of any motion made on the day to continue the said injunction. Accordingly, no directors’ meeting was held on September 16.

On October 29, 1971, pursuant to section 109 of The Business Corporations Act, Gloria Assaly executed a requisition for shareholders’ meeting of TDL, said requisition being directed to TDL at its head office and to the directors thereof—Mary Assaly, Gloria Assaly and Robert Ménard (see Exhibit A-2). The purpose of this meeting, to be held not later than November 17, 1971. was to remove such of the present directors from their office as deemed in the best interests of the company and to elect new directors in their place and stead. A notice of motion, dated November 2, 1971 (Exhibit A-3) returnable on November 17, 1971 in the Supreme Court of Ontario before the presiding judge in Weekly Court was served on Mary Assaly and Robert Menard. It was an application for an order requiring the directors of TDL to call a general meeting of the shareholders. No meeting was called nor held. TDL was at a standstill. Gloria Assaly’s lawyers advised that steps be taken to appoint a liquidator to wind up TDL, not by reason of insolvency but because there was a deadlock amongst the directors which prevented it from carrying on its business. By notice of motion dated May 1, 1972 and returnable on May 11, 1972 in the Supreme Court of Ontario before Mr Justice Houlden in Chambers, an application by Gloria Assaly, qua shareholder, for an order appointing The Clarkson Company Limited as liquidator was served on TDL and its shareholders (Exhibit A-4). The said order was made by Mr Justice Houlden on May 11. 1972 (Exhibit A-5).

Both witnesses stated that it was not the real intention to wind up the company but merely to use Clarkson as interim manager-operator to get things going and to prevent serious damage to the company. Apparently, this aspect was discussed with Clarkson before and after its appointment as liquidator. The order (Exhibit A-5) was appealed from by Mary Assaly. In the meantime Clarkson did considerable work in settling accounts of the company and performing such services as were necessary in the circumstances. For summary of its services, see Exhibit A-8. Clarkson’s services herein were terminated around June 29, 1972. It turned over to TDL something in the neighbourhood of $400,000 in gross profits.

Immediately after institution of liquidator proceedings by way of notice of motion dated May 1, 1972 the two companies and the individual appellants herein commenced intensive negotiations to arrive at some form of modus operandi in their respective business operations. It should be mentioned at this point that in the summer of 1971 Thomas C Assaly incorporated his own company under the name of Thomas C Assaly Corporation Limited and this company had been doing some construction work in place of ACL for TDL. An agreement dated June 19, 1972, filed as Exhibit A-6, was executed by Mary Assaly, Gloria Assaly, Laureen Assaly, TDL, Thomas C Assaly Corporation Limited and Assaly Construction Limited. The agreement is over 8 pages in length and principally deals with the manner in which TDL and its principal shareholders will carry on the business. It was also agreed that the agreement will be tendered to the Court of Appeal at the hearing of the appeal from Mr Justice Houlden’s order, with the request that it be substituted for the said order of May 11, 1972. This was done. (See order dated June 29, 1972 and filed as Exhibit A-7.) This order also stipulated that the application for winding up be adjourned sine die but could be brought on by either party on seven days’ notice, upon default occurring with respect to any of the provisions of the agreement (Exhibit A-6).

It was not long till the directors of TDL were once again deadlocked. By notice of motion dated February 19, 1973 and returnable on March 1, 1973 before the presiding judge in Chambers in the Supreme Court of Ontario, in Toronto, Gloria Assaly. pursuant to the order (Exhibit A-7) applied for an order that winding up of TDL be continued or proceeded with and that Clarkson or an interim receiver be appointed to possess and preserve the property and assets of TDL. By order dated March 15, 1973, made by Mr Justice Cromarty, filed as Exhibit A-15, it was ordered that TDL be wound up and directed the Local Master to appoint a liquidator. The Local Master issued his certificate dated April 9, 1974, filed as Exhibit A-17, appointing Messrs Thorne, Gunn & Company as liquidator of TDL upon terms as therein more particularly stated. However, matters were eventually sorted out and by early fall of 1974 TDL was again operating on its own.

The affairs of ACL and its directors and shareholders were no less complicated. There was a fundamental disagreement as to construction of housing units for TDL. As stated earlier, Thomas C Assaly incorporated his own company and obtained a contract from TDL to do some construction on Westcliffe Estates where at least three separate areas were being improved. ACL was not getting any payments from TDL. Ernest and Louis Assaly blamed Thomas C Assaly. They issued a notice of directors’ meeting on February 8, 1973 to remove Thomas as president. Thomas C Assaly issued a writ of summons dated February 15, 1973 against Ernest and Louis Assaly out of the Supreme Court of Ontario, for a declaration that said notice is void and of no effect; and an injunction restraining the defendants from calling and holding a meeting of the board of directors.

By notice of motion dated February 16, 1973 and returnable March 1, 1973 in the Supreme Court of Ontario, before the presiding judge in Chambers, Thomas C Assaly applied for an order that ACL be wound up not for the reason that it was insolvent but because of a deadlock which existed between the two principals and the continuing mistrust and suspicion between the shareholders, all of which effectively prevented any carrying out of the business and affairs of ACL (see Exhibit A-12). The matter was argued for two, days before Mr Justice Cromarty who then made the order, dated March 15, 1973, filed as Exhibit A-14. Here, as in TDL, it was ordered that the corporation be wound up and the matter of appointment of a liquidator was referred to the Local Master. The Local Master appointed Messrs Thorne, Gunn & Company (see Exhibit A-16).

There followed a period of considerable turbulence but by late summer of 1974 matters giving rise to disagreements were straightened out, outstanding court actions and applications, other than those referred to herein, were settled or abandoned and ACL was once again on its feet and economically viable.

The foregoing is a much condensed résumé of the legal entanglements of both companies. Several court applications and/or appeals from orders were not referred to herein. The quantum of fees in each case is not in dispute.

The first issue herein is whether or not a benefit was conferred on each respective individual appellant, by the respective company, in the amounts as stated supra.

I am satisfied that in each case the individual appellants, who sought advice from the law officers herein mentioned, did so in their respective capacities as directors and officers of their respective corporations. The purpose in each case initially was to call a directors’ meeting to attend to company business. When that failed, a variety of legal proceedings ensued, including an application in each case for an order to have the company wound up. The directors were duty bound to take some action to resolve the impasse in each case. Counsel for the respondent submitted that the applications for winding up were instituted by shareholders. That of course is a matter of record and is correct. However. one must also remember that under The Corporations Act of Ontario this is the only procedure available unilaterally. The companies, however, were not wound up in the final analysis. The shareholders did not obtain any. benefits per se from the fact that the companies paid the legal expenses. After some three years of turmoil each company once against became a viable entity and the benefits would then flow to each shareholder in the ordinary course of business. I would accordingly allow the appeal of each individual appellant and refer the matter to the respondent for reassessment on that basis.

The next issue to determine is whether or not legal expenses paid by ACL and TDL respectively as stated earlier are chargeable to income in each case. Were these expenses incurred “once and for all” to procure or to protect an asset or an advantage of an enduring benefit; or were they in the ordinary sense simply current expenditures incurred for the purposes of earning income? In reviewing the various legal proceedings instituted herein, it is patently clear that there was a fundamental difference of opinion regarding the manner in which each company was to continue. The companies in each case ground to a halt because of the deadlock or impasse that came about. Unless some action was taken, each company’s business suffered serious damage daily and it well may have been that an unduly prolonged deadlock would have crippled each corporate entity beyond repair. This was indeed a very unique situation.

With deference, I cannot agree with counsel for the appellant companies that the expenses incurred are deductible because they were laid out to overcome obstacles which prevented the earning of income. It seems to me that it was to save the companies from eventual total destruction and this, in my humble opinion, cannot be characterized as an expense chargeable to revenue but to capital. The winding-up proceedings which gave rise to a substantial amount of fees paid to the liquidator, again, were instituted to preserve and save the companies. It is true that in the end the liquidator did remit to the company a net profit on which tax was payable. As I see it, the evidence is clear that the companies were not to be wound up but managed to prevent further damage. The income earned in the meantime was incidental to the main purpose—that of preserving the corporate structure until such time as the structure could look after itself.

In my view none of the legal or liquidators’ expenses are chargeable to income and the appeals in this connection are dismissed.

Appeals of individuals allowed.

Appeals of corporations dismissed.