Her Majesty the Queen v. Charles Guay, [1973] CTC 148, 73 DTC 5108

Walsh, J:—This is an appeal from a decision of the Tax Review Board dated May 9, 1972 which maintained the appeal of the taxpayer against assessments dated December 8, 1967 assessing additional income tax in the amount of $1,599.33 for the year 1965 and $1,428.64 for the year 1966. The assessments and defendant’s grounds for opposing same arise out of a series of agreements made between Lanrol Motors Ltd (hereinafter called the “old company’’), Lanrol Motors (1960) Ltd (hereinafter called the “new company”), Chrysler Corporation of Canada Limited (hereinafter called “Chrysler”) and defendant in 1960 and 1962 as a result of which defendant received in 1965, 1966 and subsequent years certain sums by way of bonuses based on the profits of the new company from that company but, according to his contentions, did not receive them personally but rather on behalf of the old company to which he turned them over and in whose financial statements they appear. The situation leading up to these agreements was as follows: Defendant and a number of business associates were the shareholders and officers of the old company which had been operating for some years. He himself held 36% of the outstanding stock and was president of the company. After some years of reasonably prosperous operations it began to get into financial difficulties in 1960 largely resulting from lack of capital. Chrysler, for which it was a dealer, agreed to put up $150,000 provided the old company or its principal shareholders could put up another $50,000. Chrysler insisted that a new company be formed, however, in which it would purchase $150,000 of redeemable preferred voting shares of a par value of $100 each. Defendant and his associates allegedly did not have sufficient capital to put up the necessary $50,000 but using the credit of the old company and endorsing the loan personally, borrowed $50,000 from Industrial Acceptance Corporation which sum was then invested in non-voting common shares of the new company of a par value of $25 each. Chrysler insisted in dealing with one individual only, so the shares were registered in the name of defendant, C L Guay. An agreement was entered into between Chrysler and the defendant dated April 19, 1960 providing for the orderly retirement of the preferred shares held by Chrysler on the basis that within five days after receiving any bonus from the company defendant would use at least 50% of it either to purchase preferred shares of the company from Chrysler or to purchase additional unissued common shares at par, at Chrysler’s discretion. In the event of defendant purchasing the common shares at par then it was provided that the company would immediately use all moneys so received for the purchase for cancellation of as many preferred shares held by Chrysler as could be purchased with this money. In the event of defendant purchasing preferred shares from Chrysler then each preferred share so purchased was to be immediately converted into four common shares. In either event the effect was to reduce Chrysler’s preferred shareholdings in the new company and increase defendant’s common shareholdings in proportion to the amount of his bonus money so applied. Other clauses in the agreement requiring that any surplus be also used to redeem preferred shares make it apparent that Chrysler’s objective was to have ell of its preferred shares redeemed as soon as possible. Additional clauses provided that in the event of defendant ceasing to be president of the company Chrysler would either purchase his common shares at a value to be fixed on the basis of the total net worth of the company less the aggregate value of the preferred shares or, alternatively, could dissolve the company and liquidate its assets. Moreover, defendant’s common share certificates were to be endorsed in blank by him and held by Chrysler as trustee until all its preferred shares should be redeemed or purchased for cancellation. Defendant could not assign or transfer any of his rights and benefits under the agreement or dispose of any common shares of the company without the written consent of Chrysler. Pursuant to this agreement each stock certificate for the common shares of the company had the following endorsement on the face thereof:

This certificate and shares represented thereby are subject in all respects to the provisions of the stock agreement between Charles Laurie Guay and Chrysler Corporation of Canada, Limited dated the day of

1960, a copy of which is on file at the office of the Secretary of Chrysler Corporation of Canada, Limited, Windsor, Ontario, whereby among other things Charles Laurie Guay grants to Chrysler Corporation of Canada, Limited, its successors and assigns, an irrevocable option to purchase such shares on the terms therein set forth, and whereby selling, assigning, pledging, hypothecating, transferring or otherwise disposing of said shares is prohibited without the express written consent of Chrysler Corporation of Canada, Limited. Each taker or holder hereof is hereby charged with notice of all of said provisions and by acceptance hereof consents thereto and agrees to be bound thereby.

On the same date, April 19, 1960 a bonus agreement was entered into between the new company and defendant which provided that in addition to his salary he would receive a bonus equal to 25% of the operating profit of the corporation for each fiscal year where the operating profit was in excess of 15% of the paid up capital (ie in excess of $30,000). The bonus agreement was also to terminate automatically if he ceased to be president of the company by reason of death, resignation or removal and defendant recognized that his employment was at the will of the board of directors who could remove him as president at any time and thereby terminate the bonus agreement. This agreement was ratified at a meeting of the directors of the company which also took note of the stock agreement entered into between defendant and Chrysler to which the company was not a party. This agreement was annexed to the minutes as a permanent record, however.* [1] The same directors’ meeting also authorized the purchase for $50,000 of parts, accessories, furniture, fixtures and equipment of the old company. The various leases of the old company for business premises were also assigned to the new company.

Defendant relies on an agreement entered into between the old company and himself on April 30, 1960 which merely read as follows:

Pursuant to the sale of certain assets of LANROL MOTORS LIMITED to LANROL MOTORS (1960) LIMITED and pursuant to a bonus agreement signed by CHARLES GUAY and LANROL MOTORS (1960) LIMITED and a stock agreement signed between CHRYSLER CORPORATION OF CANADA LIMITED and CHARLES GUAY, it is understood that CHARLES GUAY is acting on behalf of LANROL MOTORS LIMITED and if there are any bonuses to be paid to CHARLES GUAY, it has to be turned over to LANROL MOTORS LIMITED.

It is to be noted that neither the new company nor Chrysler intervened to take cognizance of or accept this undertaking and in both the bonus agreement between the new company and defendant and the stock agreement between the defendant and Chrysler there is no indication whatsoever that defendant was in any way acting on behalf of the old company rather than for himself. When the 2,000 shares of the common stock to which he subscribed as an initial subscription were allotted they were allotted to him personally and bore the endorsement prohibiting their transfer without the approval of Chrysler. While it can therefore be said that the old company and defendant were both fully cognizant of all the agreements, there is nothing to indicate that either the new company or Chrysler took any note of the private agreement between defendant and the old company or would in any way see to its enforcement.

At a meeting on April 22, 1965 the financial statements of the new company for the fiscal year ended December 31, 1964 were submitted and it was resolved to pay defendant a bonus of $7,905.28 in accordance with the terms of his bonus agreement. Defendant authorized the entire bonus to be used for the purchase of common stock ana his subscription for 316 common shares of a par value of $25 each was accepted and the said shares were allotted to him. The subscription price of $7,900 was applied by the company to purchase for cancellation from Chrysler 79 of the outstanding preferred shares of the company. Similarly, at a meeting on March 28, 1966 the financial statements of the new company for the fiscal year ended December 31, 1965 were considered and pursuant to the bonus agreement a bonus of $7,501.06 was paid to defendant who used the entire amount of the bonus to subscribe for 300 shares of the common stock at a par value of $25. This $7,500 was then used by the company to purchase for cancellation from Chrysler 75 of the outstanding preferred shares of the company. In both letters from defendant offering to apply the entire bonus, save for the odd amounts in excess of $7,900 and $7,500 respectively, to the purchase of common shares, no mention whatsoever is made of the fact that he is not purchasing them for his own account. Further bonuses were paid and used in the same manner in the following years but the assessments for these years are not before the Court in the present proceedings.

It is of interest to note, however, that by letter dated December 8, 1966 defendant asked that for the fiscal year of the company ended December 31, 1967 an incentive bonus be paid to four key employees being the sales manager, the service manager, the parts manager and the secretary-treasurer, in the amount of 15% of the audited profits of the company in excess of 20% of its capitalization before payment of his bonus under the bonus agreement or the federal or provincial taxes, provided that the total amount so expended would not exceed $10,000. This was approved at a directors’ meeting on April 26, 1967 and a similar incentive bonus was paid to these employees the following year.

The manner in which defendant’s bonuses were dealt with in accordance with the stock agreement and as recorded in the minutes of the new company is at variance with the manner in which he testified they were dealt with and what is shown in the books of the old company. He testified that when he received a bonus cheque he would then endorse same and turn it over to the old company pursuant to his agreement with it as he considered he was not receiving it personally but only on behalf of the old company. According to him the old com- pany would then issue him a cheque for a similar amount which he would then use to buy preferred shares of the new company from Chrysler for redemption. In view of the entries in the Minute books of the new company one must presume that he is somewhat confused here, and that what actually happened was that he subscribed for common shares of the new company and the proceeds of his subscription were then used to redeem an equivalent value of Chrysler’s preferred shares in accordance with the stock agreement. He stressed that Chrysler would not deal with the old company but only with him personally and that he was at all times acting on behalf of the old company pursuant to his agreement with it. The balance sheets and profit and loss statements of the old company tend to corroborate this. In 1965 the profit and loss statement showed an amount of $7,900 as other income and on the balance sheet an amount of $57,900 as an investment in shares in Lanrol Motors (1960) Ltd with an auditor’s note stating “The shares are registered in the name of Charles Guay acting for the company”. In 1966 we again have an amount of $7,500 shown by the old company as income and the investment in shares of Lanrol Motors (1960) Ltd is now shown as $65,400 on the balance sheet with a similar note “The shares are registered in the name of Charles Guay acting for the company”. It would appear that the initial subscription of $50,000 made by defendant in the common shares of the new company must also have been considered as a subscription made by the old company. There is no indication, however, in the books of the old company of any reference to the $50,000 allegedly borrowed from the Industrial Acceptance Corporation on the guarantee of defendant and some of his associates. If the old company had used the $50,000 paid to it for the sale of assets to purchase shares of the new company, this would explain its initial holding of $50,000 of stock in the new company. However, the new company got the $50,000 to pay for these assets, as a result of share subscriptions by defendant, who allegedly had arranged the loan from the Industrial Acceptance Corporation, and had used same to subscribe to common shares of the new company as its minute book shows. This must then be the $50,000 worth of shares shown on the balance sheet of the old company which presumably used the $50,000 it received from the sale of its assets to the new company to pay off the loan to the Industrial Acceptance Corporation. This is a possible explanation as to why the loan is not shown in its financial statements.

Eventually, by this manner of proceeding, all Chrysler’s shares were redeemed by 1968 and the old company became the owner according to defendant of all the common shares of the new company. He allegedly then obtained the release from Chrysler of all these common shares which had been heretofore registered in his name, endorsed in blank and held by Chrysler and had them transferred to the old company, there now being no further restriction on their transfer. He was somewhat vague about this, however, and as the financial statements and books of neither company for 1968 or 1969 were before the Court, this could not be verified.

The significance from the taxation point of view of the passing on of the bonus from defendant to the old company is that the old company had accumulated losses amounting to $18,391.45 during its 1960 to 1964 taxation years when it had been practically inoperative. It had kept some used cars on its lot when its other assets were transferred to the new company and its December 31, 1965 statement shows sales of used vehicles in the amount of $8,941 less cost of sales $7,214.90 for a gross profit of $1,726.10. Miscellaneous expenses for interest and bank charges, insurance, audit fees, taxes and licences, and commissions amount to $1,157.30. showing net profit before other income of $568.80 for the year. When the payment of $7,900 from defendant however was added to other income the net profit is shown as $8,468.80 which, when deducted from the accumulated losses of $18,391.45, results in no taxes being payable and a balance of $9,922.65 losses remaining applicable to future years. Similarly, its 1966 statement indicates that it apparently did no business whatsoever during that year, its only income being the $7,500 received from defendant. Miscellaneous expenses amounted to $1,170.48 leaving net profit for the year of $6,329.52 which, when deducted from the accumulated losses of $9,922.65 again resulted in no taxes being due, a balance of $3,593.13 losses remaining applicable to future years.

There were allegedly seven shareholders of the old company of whom four, including defendant, guaranteed the loan from Industrial Acceptance Corporation. The identity of the others was not given in evidence so it is not possible to say definitely whether among them were the sales manager, service manager, parts manager and secretary-treasurer for whom, at defendant’s request, an incentive bonus was subsequently provided for the 1967 and 1968 years of the new company. Although, according to his evidence, defendant was acting for all his close associates and not himself alone, it is not without significance that it was only his bonus which was used to buy stock in the new company allegedly on behalf of the old company. All his bonus payments were used up in this manner as well as any surplus accumulated by the new company which was also used each year to redeem further preferred shares of Chrysler until all the preferred shares had been redeemed by the combination of these two methods. In the long run, according to defendant’s evidence, the old company ended up with all the stock of the new company. The old company was by this time no longer an operating company and defendant only owned 36% of the old company’s stock yet, according to his evidence, it was the application of his bonus payments and his alone which enabled it to eventually acquire all the stock of the new company which was the operating company. There appears to have been no consideration given by the old company to account for his agreement with it to the effect that he was acting on its behalf and if any bonuses were paid to him by the new company they must be turned over to the old company. He claims that but for the old company there would have been no new company and no business and that it was the old company which borrowed the money to provide the $50,000 investment required from him and his associates by Chrysler before they agreed to invest $150,000 in the new company. This is all quite vague, however. The old company was admittedly in financial difficulties when Chrysler came to its assistance and it seems highly improbable that any loan could have been obtained by it from Industrial Acceptance Corporation but for the endorsements of defendant and his business associates so he cannot really say that the old company rendered them a service in obtaining this loan. In fact there is no indication whatsoever that the proceeds of this loan were ever paid to the old company. On the contrary, there is every indication that the proceeds were obtained by defendant personally and used by him to buy the common stock in the new company as required, with the new company then using the proceeds of this stock sale to acquire certain physical assets of the old company, which then presumably, although this was not established by proof, paid back the loan to Industrial Acceptance Corporation. If this was the case it hardly seems that the old company gave any consideration to defendant which could explain why he would agree to turn all his bonus payments from the new company over to it, or how the old company could consider these payments received from defendant as income in the years in which they were received since the old company had done nothing to earn this income. It appears, rather, that defendant voluntarily entered into an agreement with the old company which he was under no obligation to enter into and then carried it out voluntarily by making these annual payments to it which the old company then treated as income.

There is no doubt that defendant was not free to do whatever he wished with the bonus money he received. As a condition of receiving it he was obliged to invest at least one-half of it in common shares of the new company, and in practice he exercised his option to invest it all in this manner. He also considered himself obliged by his agreement with the old company to act on its behalf in acquiring shares of the new company with his bonus money, and, in fact, these shares are shown as assets of the old company in its balance sheet although they had not yet been transferred by him to it and, in fact, could not be so transferred in view of the special provisions prohibiting the transfer of these shares without the approval of Chrysler. The fact that he allegedly endorsed his bonus cheque to the old company and then received a cheque back from it for the same amount with which to purchase the shares does not alter anything nor would the ultimate result have been any different if a cheque of the old company had been made payable directly to the new company for the purchase of the shares, which the old company shows as capital assets in its balance sheets. In this latter event the new company could hardly have issued the shares in the name of defendant without any qualification as it did as appears from its minute book and its shareholders’ ledger. On the other hand, although defendant allegedly received back from the old company a cheque of equal amount to the bonus cheque which he endorsed to it and used this to buy the shares, registered in his name, there is nothing in the profit and loss statements of the old company to show any such payments to him set off against his cheque which is shown as income. The auditor’s note on the balance sheets of the old company was undoubtedly put there to reflect the agreement between the old company and defendant but it can in no way affect the relationship between defendant and the new company or in any way be considered as an acceptance by the new company of the fact that the shares were really acquired by him for the old company. It is not necessary for the decision of this case to express an opinion as to whether the old company could have enforced its agreement with defendant had he failed to carry it out or whether it would have failed for want of consideration, since it is clear in any event that this agreement could not in any way affect the new company or Chrysler.

Neither do I consider it of any significance that the old company, because of its losses, was not obliged to pay any taxation for the years in question despite the transfer of these bonus moneys to it by defendant. I am satisfied that defendant is sincere in stating that the main reason for the complicated series of agreements was the financial difficulties of the old company and the willingness of Chrysler to continue the dealership and assist by providing essential additional capital. In doing so, however, Chrysler insisted that a new company be formed and that they deal only with defendant personally rather than with a group consisting of himself and his associates who had also operated the old company. It was Chrysler’s lawyers who prepared the agreements and defendant had little choice but to accept them. I do not believe, therefore, that a primary objective of these agreements and specifically of his own agreement with the old company was the avoidance of taxation. In fact, in my view, even had the old company had no losses to write-off against the revenue so received, and hence had had to pay tax on same this would not have altered the situation. The existence of double taxation under the Income Tax Act is not unknown and if an individual who has received a payment from his employers for his services, whether by way of salary, bonus or otherwise, has assigned this to a third party to whom he may owe money, this does not affect his liability for tax on the sums so received, nor does the fact that the creditor to whom he has assigned these sums will be taxed on same as part of the creditor’s income receipts affect the taxability of the transferor. The only way in which defendant could avoid personal taxation on the sums so received would be if he could establish conclusively that he received them merely as the agent of a third person, such as the old company, and not in any way in his personal capacity.

The only facts on which he can rely in support of this are his personal contract with the old company and the entries shown in the accounting statements of the old company. Against this, however, are the clear entries in the minute book and shareholders’ ledger of the new company, his bonus agreement with it and stock agreement with Chrysler, all of which make it clear that the new company was dealing with him personally and not as agent for the old company in making the bonus payments to him and receiving his stock subscriptions. Even his letters offering to subscribe for common stock to the full value of his bonus rather than the 50% of it which was required carefully avoid any mention that he is making this subscription on behalf of the old company. The bonus agreement is terminable when he ceases to be the president of the new company for any reason whatsoever, and the stock agreement provides for the re-acquisition of his shares by Chrysler or liquidation of the new company at the option of Chrysler in this event. Clearly, in this event the old company could never have become registered owners of the shares which had up to that date been registered in the name of the defendant, and the mere fact that the old company shows itself as owner of the shares in its balance sheet cannot create any rights of ownership which it does not have and could not enforce against the new company in the event of termination of defendant’s employment as President of it. In fact it could only get these shares without Chrysler’s consent after all Chrysler’s preferred shares had been purchased or redeemed, and defendant’s common shares had acquired the right to vote, at which stage he would have control of the new company and could then transfer his shares in it to the old company without restriction, as he allegedly did. I find therefore that respondent was taxable on the bonus moneys received in 1965 and 1966 even though he may not have retained these moneys. What he did with them after having received them was his own business and resulted from the agreement he had made with the old company with whom he was moreover not dealing at arm’s length as it is not in dispute that he was the principal officer of the old company as well as of the new company.

In any event I believe the tax would clearly be due from defendant by virtue of section 23 of the Act, which reads as follows:

23. Where a taxpayer has, at any time before the end of a taxation year (whether before or after the commencement of this Act), transferred or assigned to a person with whom he was not dealing at arm’s length the right to an amount that would, if the right thereto had not been so transferred or assigned, be included in computing his income for the taxation year because the amount would have been received or receivable by him in or in respect of the year, the amount shall be included in computing the taxpayer’s income for the taxation year unless the income is from property and the taxpayer has also transferred or assigned the property.

Whether it was the money received by the bonus payment itself, which he transferred to the old company, or the stock certificates themselves purchased with this which, although he could not transfer them, he acknowledged to the old company to be held by him on its behalf, he was not dealing at arm’s length with the old company and if he had not transferred this income it would have been included in computing his income for the taxation year. I was referred by counsel for defendant to the case of Sazio v MNR, [1968] CTC 579; 69 DTC 5001, in which Cattanach, J held that where a football coach had transferred his salary received as such to a company formed by him which also operated other enterprises in which he was interested, including management of and acting as rental agents for real estate, writing news paper articles on matters pertaining to football, receiving revenue from radio and television programmes and so forth, he should only be taxed on the income paid to him by the company and not on the amount received by him as a football coach and turned over by him to the company. The judgment stressed that the corporation was not a “mere sham, similacrum or cloak” and that the agreements entered into between the taxpayer, the corporation and the club were bona fide commercial transactions permitted by law which determined the relationship between the parties. The facts in that case were, however, substantially different. The football club was not only aware of his agreement with the company but actually released him from his personal contract as coach and employed the company as such at the same remuneration. It is not unusual for an entertainer or person actively engaged in sports to incorporate himself and turn all the revenue which he would otherwise earn personally over to the corporation which then pays him a salary on which he is taxed, with the corporation being taxed on its profits derived from the income which he has turned over to it. The argument in the Sazio case seems to have turned primarily on the question of whether a corporation can carry on a business which is dependent mainly on the personal qualifications of the person who controls the corporation, and the judgment cited with approval the British case of The Commissioners of Inland Revenue v Peter McIntyre, Ltd, 12 TC 1006, to that effect. An opposite conclusion was reached by Cattanach, J in the case of Kindree v MNR, [1964] CTC 386; 64 DTC 5248, where a doctor incorporated himself and the learned judge expressed the view that the practice of medicine could only be carried on by a natural person in view of the general tenor of the Medical Act and the code of ethics of the medical profession. The practice of medicine could not be carried on by a corporation. A similar conclusion had been previously reached in a Tax Appeal Board case No 594 v MNR, 21 Tax ABC 212; 59 DTC 78.

In another Tax Appeal Board case, that of Adams v MNR, 24 Tax ABC 154; 60 DTC 253, dealing with a stockbroker who incorporated two private companies to carry on business as general financial agents, brokers and promoters, to whom he turned over his commissions receiving salary in return, it was held that all the commissions earned by him were taxable as income in his hands as neither of the private companies was actually carrying on a business of any kind or really functioning as a company and that what they received from the appellant was the product of his personal efforts and not due to any activity on their part. What was done was nothing more or less than an assignment by the appellant to the two companies of income after it had been earned by him, which sums were voluntarily transferred to them by the appellant. A similar finding was made by Gibson, J in the case of Marvin E Goldblatt v MNR, [1964] CTC 185; 64 DTC 5118, in which a dormant family corporation, of which the taxpayer was general manager and a small shareholder, was activated and received from him commission which he had earned as a middleman’s commission in negotiating an arrangement between it and a US scrap dealer, which latter company paid him the commission. The activated company’s shares were owned by a Nassau corporation of which the taxpayer was the sole beneficial shareholder. It was held that the corporation to whose credit the commissions were paid had been activated for the express purpose of receiving the commissions in question and that the said company was not actively engaged in business except incidentally and had nothing to do with the earning of the commissions. The Adams case (supra) was referred to with approval and Gibson, J found that the commissions in question were income of the appellant within the meaning of either subsection 16(1) or section 23 of the Act.

Defendant in the present case argued that the old company was actively doing business. It was certainly doing so to a very limited extent in 1965 and not at all in 1966. Its profit and loss statement for 1965, as already stated, shows sales of used vehicles totalling $8,941 and profits resulting therefrom of $1,726.10. Its 1966 statement shows no income whatsoever except the $7,500 received from defendant. Between 1960 and 1964 the old company apparently continued to do some business disposing of the used cars which were left with it when its other assets were sold to the new company. Since the conciliation of losses statement annexed to its 1965 tax return shows losses for each of these years reducing from $8,290.78 in 1960 to the very small loss of $167.48 in 1964, it is evident that its business was being phased out. In any event, this business was being carried on by defendant and his associates at the same time as they operated the new company, the business operations of the two companies being for all practical purposes indistinguishable. The old company was not a company operating various business enterprises of defendant and to whom he turned over whatever he earned from these enterprises, as in the Sazio case (supra) but was being operated primarily as a holding company for the shares of the new company which defendant could acquire for it by use of the bonuses received by him from the new Company. The old company would eventually end up owning all the shares of the new company and defendant would benefit at least in part as the owner of 36% of the shares of the old company. I believe that the facts of this case are closer to those in the Adams and Goldblatt cases (supra) than to those in the Sazio case (supra).

Having found that defendant was taxable whether by application of sections 3, 5 and 25 of the Act or by the application of section 23, it is unnecessary for me to consider whether he would also be taxable by the application of section 16. The appeal of plaintiff against the decision of the Tax Review Board is therefore allowed, and the assessments by the Minister in the amount of $1,599.33 for the year 1965 and $1,428.64 for the year 1966, with interest, are restored, the whole with costs.