Pellizzari v. MNR, 87 DTC 56, [1987] 1 CTC 2106 (TCC)

Couture, C.J.T.C.:—The appellant at the material time was the sole shareholder and director of a corporation known as Pamic Investments Limited, (Pamic) which was carrying on the business of providing bookkeeping, accounting and other related office services to its clients. She was also an employee of the corporation.

At the hearing she acted on her own behalf assisted by her husband.

The evidence is that criminal charges were laid against Pamic, the appellant and her husband under the Criminal Code. The informations were not filed as exhibits, but my understanding of the alleged facts upon which these charges were preferred, as described by the appellant, is that Pamic was accused of having overbilled some of its clients in accordance with a plan conceived by her husband and in which he participated. Her husband was not a shareholder or employee of Pamic, but was the manager of a local branch of a bank.

The appellant retained the services of a lawyer to defend her against these charges, which she vehemently denied having committed. This lawyer also represented Pamic. Her husband retained a different lawyer. It took several months to finally dispose of the charges.

The appellant explained that immediately before the trial was to begin the Crown prosecutor offered to settle the matter by dropping the charges against her and the corporation if the husband agreed to plead guilty to conspiring to commit less serious offences. The offer was accepted by all the defendants. Mr. Pellizzari denied any wrongdoing on his part respecting these lesser charges and explained that he reluctantly agreed to this settlement because he was anxious to put an end to a problem that had ravaged him personally and financially over many months and to avoid the burden of a long and costly trial which he could ill afford at the time.

In its income tax returns for the taxation years 1979 and 1980, Pamic claimed as a deduction in computing its income the legal fees paid to the lawyer who had acted on its behalf and on behalf of the appellant which amounted to $15,000 in aggregate, $10,000 in 1979 and $5,000 in 1980.

In assessing the appellant for these taxation years, the respondent added to her income the legal fees paid by Pamic for legal services rendered to both herself and the corporation as “indirect payments from Pamic Investments Ltd. Re: professional services” according to the notation on forms T7W-C which were attached to the notices of reassessment. However, in its reply to the notice of appeal the respondent invoked inter alia the provisions of paragraphs 8(1)(b), 15(1)(c), 18(1)(a), 18(1)(h) and 60(o) of the Act claiming:

(a) that the legal fees paid by Pamic were not incurred for the purpose of earning or producing income from the corporation's business or property,

(b) that they were personal and living expenses of the appellant and,

(c) that the fees did not qualify for a deduction under paragraphs 8(1 )(b) and 60(o) of the Act,

(d) that a benefit in the amount of the legal expenses had been conferred on the appellant who was a shareholder of the corporation.

The appellant submitted that the fees paid by Pamic were legitimate disbursements of the corporation and should not be attributed to her personally. However, she added that if the Court were to come to a different conclusion then they should be allocated between the corporation and herself, and only the portion of such allocation that may be reasonably considered as personal should be added to her income for the taxation years under appeal.

She also submitted that in 1979 and 1980 she had loans receivable from the corporation and that she should be permitted to offset the portion of the fees that would be allocated to her against these loans by reducing them accordingly.

The evidence clearly established that the charges laid against the appellant were in her capacity as an officer of Pamic, and not as a shareholder, for offences she allegedly had committed personally in the course of carrying on her duties as an employee of the corporation. This, to me, is consistent with the respective functions of each distinct personality within the corporate structure. It is not the responsibility and duty of a shareholder, in his or her capacity as a shareholder, to perform the duties which are related to the daily operations of a corporation in its income-earning process. These duties are the sole responsibilities of its officer and employees under the authority and guidance of its board of directors.

The appellant was therefore charged as an officer or employee of the corporation because of her alleged personal involvement in the commission of these offences.

In so far as Pamic was concerned it was also charged in its corporate Capacity and had to defend itself, and in so doing incurred legal fees on its own behalf as a separate legal entity. Its share of the fees, under such circumstances, cannot be attributed to the appellant. Legal services had been rendered to Pamic independently from the services rendered to the appellant and it was its sole responsibility to assume them.

Whether these fees were deductible by Pamic, as suggested by counsel for the respondent, is not germane to the present appeal. The question that the Court has to decide is whether the legal fees paid under the circumstances described above were personal expenses of the appellant and if they were, whether the payment of these fees gave rise to a benefit having been conferred upon her as a shareholder of the corporation within the meaning of the provisions of paragraph 15(1 )(c) of the Act or as an officer or employee as income from employment within the meaning of sections 5 and 6.

If a taxpayer is a shareholder and officer of a corporation and he or she receives a benefit or advantage from the corporation this is not, of itself, conclusive of the fact that the benefit or advantage was conferred on the taxpayer in his capacity of shareholder. In other words, it does not follow that in such a situation the provisions of subsection 15(1) automatically apply.

It must first be ascertained whether the advantage or benefit, assuming that the amount in question was in the nature of an advantage or benefit, was conferred on the taxpayer in his or her capacity as a shareholder or an employee of the corporation. Once this determination is made then the application of paragraph 15(1)(c) or sections 5 and 6 of the Act must be considered. If the advantage or benefit was conferred on the taxpayer as an employee again it must be established whether it was in the nature of income from an office or employment within the meaning of the provisions of subsection 5(1) and subsection 6(1) and following.

Cattanach, J., in Minister of National Revenue v. Pillsbury Holdings Ltd., [1964] C.T.C. 294; 64 D.T.C. 5184, held that a waiver and forgiveness of interest by a subsidiary corporation to its corporate shareholder did not on the facts before him constitute an advantage or benefit conferred on the taxpayer in its capacity as a shareholder. He said at 303 (D.T.C. 5188):

In effect, the Minister takes the position that waiver of interest payable by a borrower who happens to be a shareholder of the lender is the conferring of a benefit within paragraph (c) regardless of the circumstances surrounding the waiver. In my view, the mere fact of waiver, even if legally effective to cancel the debt, is not sufficient of itself to bring the transaction within paragraph (c). To come within that paragraph, it must be an arrangement or device whereby a corporation confers a benefit or advantage on a shareholder qua shareholder.

I have reached the conclusion on the evidence that the reason for the payment of the legal fees by Pamic on behalf of the appellant was because she was an officer of the corporation, not because she was a shareholder. This eliminates subsection 15(1), but does not dispose of the appeal. Consideration must now be given to the possible application of subsection 5(1), that is whether such payment constituted income from employment.

In dealing with this aspect of the assessment, I am satisfied that the amount of the $15,000 paid by the corporation over two taxation years must be allocated between the two taxpayers since each one of them was charged and legal services were rendered to each one of them accordingly. They each must assume their respective share of these fees. Taking into account all the circumstances of this case and especially the fact that the charges against both the appellant and Pamic were eventually withdrawn by the Crown, I consider that a just and equitable allocation of these fees would be to divide them equally between the two taxpayers.

The next question to be answered is whether an amount of $5,000 paid by Pamic in 1979 and $2,500 paid in 1980 on behalf of the appellant constituted income from employment to her for the said taxation years.

Paragraph 6(1)(a) of the Act reads:

6(1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:

(a) the value of the board, lodging and other benefits of any kind whatever received and enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment, except any benefit . . .

The phrase “benefits of any kind whatever” is of such broad and sweeping scope that it is difficult to envisage the kind of benefit that could be bestowed on an employee by an employer which could escape from the reach of these words, except of course those benefits which are specifically exempted by the legislation.

In Cutmore et al. v. M.N.R., [1986] 1 C.T.C. 2230; 86 D.T.C. 1146 Christie, A.C.J. of this Court had to consider the meaning of the provisions of paragraph 6(1)(a) in a situation where a corporation as a matter of business policy required its executive employees to have their personal income tax returns prepared by a professional income tax specialist. The fees for these services were paid by the corporation.

Relying on the decision of the Supreme Court of Canada in The Queen v. Savage, [1983] C.T.C. 393; 83 D.T.C. 5409 he held that the payment by the corporation of these professional fees constituted a taxable benefit to the executive under the provisions of paragraph 6(1)(a), even though it was conferred on the executive in circumstances under which he had no discretion over whether he should avail himself of these professional services.

In the present situation the appellant was defending herself against charges of alleged criminal acts committed by her while employed by the corporation. The fact that the charges were eventually withdrawn does not alter her involvement as the person directly affected by this whole affair and as the person who was seeking to vindicate herself from those accusations. The legal fees paid by Pamic were in my opinion her personal expenses and their payment by the corporation did constitute a benefit to her and therefore must be included in her income pursuant to paragraph 6(1)(a).

Her request that she be permitted to offset the amounts of $5,000 in 1979 and $2,500 in 1980 against her loans receivable from the corporation which were then outstanding cannot be granted. It is not legally feasible, in my opinion, to allow in 1986 a retroactive deduction of these fees against the loans that were outstanding in 1979 and 1980 in the books of the corporation. Its fiscal years have been closed, and they reflected at the time its financial position as it legally existed then. I know of no procedure that could permit the appellant to adjust some of the accounts recorded in the financial statements for 1979 and 1980 in order to give effect to her submission.

Finally in the light of my comments with respect to these fees, I cannot see any possible application of the provisions of subsection 56(2) invoked on the forms T7W-C as the basis of the assessments. It provides:

A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer's income to the extent that it would be if the payment or transfer had been made to him.

For the above reasons the appeal is allowed and the assessments are referred back to the respondent for reconsideration and reassessment in accordance with these reasons.

The appellant is entitled to her costs on a party-party basis.

Appeal allowed in part.