Date: 20000728
Docket: T-2706-87
T-2707-87
BETWEEN:
1056 ENTERPRISES LTD.
Plaintiff
and
HER MAJESTY THE QUEEN
Defendant
Docket: T-2709-87
AND BETWEEN:
JOHN PANKIW
Plaintiff
and
HER MAJESTY THE QUEEN
Defendant
REASONS FOR JUDGMENT
HANSEN J.
[1] This matter involves three separate actions commenced by the plaintiffs John Pankiw and 1056 Enterprises Ltd ("1056") pursuant to subsection 172(2) of the Income Tax Act ("Act"). All three actions arise out of the same facts.
[2] As the Court"s ruling with respect to the action in which John Pankiw is the plaintiff is central to the outcome in the two related matters, it will be dealt with first.
[3] John Pankiw asks the Court to set aside the Notice of Reassessment for his 1984 taxation year in which he was reassessed to tax for that year in the amounts of $15,926.34 and $807,377.09 as appropriations under subsection 15(1) of the Act.
Background Facts
[4] The background for the current dispute between the plaintiffs and the Minister of National Revenue ("Minister") is a longstanding disagreement between John Pankiw and his brother William Pankiw regarding their respective interests in 1056, formerly known as Cantex Engineering & Construction Co. Ltd. ("Cantex").
[5] The dispute also involves a property purchased by William Pankiw in 1973 known as the Wiltse property. Title to this property was in the name of Ellis Creek Holdings Ltd. ("Ellis Creek ") a company owned by William Pankiw.
[6] In 1970, John Pankiw, who had been working as a professional engineer in British Columbia, and William Pankiw discussed and planned the formation of a new company to engage in the business of heavy equipment leasing. The understanding between the brothers was that John Pankiw would be responsible for the operation of the business and William Pankiw would provide the seed money of $20,000 and the equipment to the company to get it started. Further, in consideration of William"s contribution of seed money and equipment, he would be paid 50% of the earnings of the new company. In fact the seed money was paid and the equipment was provided by Northland Drilling and Construction Co. Ltd. ("Northland") a company owned by William Pankiw.
[7] It was also agreed that William Pankiw would receive 51% of the issued shares and John Pankiw would receive 49% of the shares of the new company. Upon reimbursement to William Pankiw of the seed money and to Northland the cost of the equipment, it was agreed the shareholding in the company would change whereby John Pankiw would have 51% of the shares and William Pankiw would have 49% of the shares.
[8] In early 1971, the new company was incorporated as Cantex. John Pankiw received 99 shares and his spouse received 1 share. Although a number of attempts were made to change the shareholding to reflect the initial agreement, the shareholding has remained the same throughout the course of this dispute. The details of these various attempts are not relevant to these proceedings. William Pankiw steadfastly refused to accept any shares in Cantex because of his concern that his company Northland and Cantex would be considered as associated companies.
[9] Over time, Cantex expanded its business to include road construction, sale of culvert pipes and consulting engineering. For its road construction business, Cantex needed a source of gravel which resulted in the purchase of the Wiltse property. Again the details surrounding the acquisition of the Wiltse property are not relevant to these proceedings. The result, however, is that the property was purchased by William Pankiw for $52,500 and title to the property was registered in the name of Ellis Creek, a company owned by William Pankiw. Apparently, William Pankiw insisted on this arrangement so as to have security for his entitlement to 50% of the earnings of Cantex. Cantex was to pay royalties to Ellis Creek for any gravel removed from the property. There is no dispute, however, that John Pankiw was a beneficial owner of 50% of the Wiltse property.
[10] Although the seed money of $20,000 and the cost of the initial equipment were repaid by Cantex, no royalties for gravel were paid to Ellis Creek nor were any earnings ever paid to William Pankiw.
[11] Over time, a number of attempts were made to formalize the initial agreement between the brothers. None were successful. In August of 1981, following extensive negotiations, the brothers agreed to submit their dispute to arbitration. Following the release of the arbitration award in July of 1983, the attempts by Cantex and John Pankiw to exercise their rights pursuant to the terms of the award were rejected by William Pankiw. Accordingly, a petition was filed in the Supreme Court of British Columbia to have the award enforced. The petition was heard on January 16, 1984 and on that same day an Order was made enforcing the award of the arbitrator. Pursuant to that Order, on January 26, 1984 Cantex paid to the solicitors for William Pankiw and Ellis Creek the amount of $834,175.69.
[12] Cantex treated the payment of $834,175.69 as consisting of interest of $15,926.34 on the arbitration award, $663,125 as the cost of the Wiltse property and $155,124.35 as damages with respect to the claims advanced by William Pankiw and Ellis Creek against Cantex.
[13] An appeal of the January 16, 1984 Order resulted in an amendment to that Order whereby Cantex was ordered to pay William Pankiw $52,500 as reimbursement for the purchase of the Wiltse property and $55,500 in interest for a total of $108,000. Pursuant to the amended Order, Cantex paid William Pankiw $129,534.52 which included the interest that had accrued from the date of the original Order. Cantex capitalized $52,500 of this latter amount as the cost of the Wiltse property.
[14] In 1986, the Minister reassessed Cantex with respect to its 1978 to 1983 taxation years on the basis that it was associated under the provisions of section 256 of the Act with Northland and Paradise Industries Ltd. Cantex acknowledged that it was associated under the provisions of the Act with Paradice Industries Ltd., however, maintained that it was never associated with Northland.
[15] Cantex, now known as 1056 as a result of a name change, appealed the reassessments in what has now become known as the "associated companies case". Muldoon J. in 1056 Enterprises Ltd. v. The Queen , 89 DTC 5287 held that 1056 and Northland were not associated companies.
[16] As a result of the payments made by Cantex to William Pankiw and Ellis Creek, in 1987, the Minister reassessed John Pankiw for his 1984 taxation year by adding to his tax $15,926.34 and $807,377.09 as appropriations under subsection 15(1) of the Act.
Analysis
[17] Counsel for the Minister takes the position that William Pankiw had an "undefined interest" in 1056. He was, however, unable to particularize the nature of the interest and maintains this position even though in the associated companies case Muldoon J. held that William Pankiw never owned or exercised control over any of the shares in 1056. He acknowledged that the only factual support for his position is derived from the contents of the agreement to arbitrate and the arbitration award. In effect, because it was John Pankiw not 1056 who had the right to buy-out William Pankiw"s interest pursuant to the arbitration award, the payment made by 1056 should be treated as a benefit conferred on a shareholder under subsection 15(1) of the Act.
[18] The relevant text in the agreement to arbitrate relied on by the Minister states:
| (a) It is agreed by all parties: |
| (i) That William Pankiw and John Pankiw each hold a 50% interest in Cantex Engineering & Construction Co. Lt. (hereinafter called "Cantex")... |
| (g) ...Further, upon receipt of such decision as to the value of our respective interests, John Pankiw shall have the first right to purchase at such value, the entire interest of William Pankiw on the basis and as determined by [the arbitrator] |
[19] The relevant portions of the text of the arbitration award state:
Paragraph 2:
| The brothers have agreed (Exhibit A) that whatever ownership rights have been created by past events, the end result should be 50% ownership by each in Cantex and the Wiltse property, subject to reimbursement of Bill"s original purchase price of $52,000.00 plus interest, if any, as I may determine to be appropriate. |
Paragraph 4:
| Bill and John are not entitled to have any of their legal accounts and expenses arising out of the present issues paid by Cantex. I see the dispute between them as one between individuals regarding their respective rights of ownership, properly no concern of Cantex at all. |
Paragraph 13:
| While it is agreed now that the end result is to be that Bill emerge as if he were a 50% shareholder of Cantex, it does not follow that he was such from the outset, and the dividends having been paid to John alone is consistent with what the record shows and what has been reported to the Department of National Revenue, viz., John (with his wife) was the sole shareholder of Cantex when the dividends were paid. I think the best interests of all concerned will be best served by leaving the dividend situation undisturbed and there is a basic fairness in this solution because it is not unreasonable to regard the dividends as being in substance additional remuneration, John"s other claim for which, as noted, I reject. |
[20] With respect to the arbitration, the uncontradicted evidence of John Pankiw is that the terms of the agreement to arbitrate were finally settled after extensive and difficult negotiations. The term "interest" was used throughout because as he stated in his evidence "Well, William didn"t hold any shares in Cantex, and William was entitled to 50% of the earnings of Cantex. And so this is the way it was described."
[21] Further, from the evidence it is clear that it was not intended that the arbitrator would define the respective interests of the parties. Rather, the arbitrator was to proceed on the assumptions agreed to by the parties irrespective of what the actual interests might have been. The purpose of the arbitration was to establish a value of the assets in question and to provide a mechanism to resolve the long standing dispute.
[22] The arbitrator was instructed for the purpose of resolving the dispute to treat the brothers as if they each held a 50% interest in 1056. However, it does not follow they in fact each held a 50% interest in the company. The Court must ascertain the true nature of the transaction. As stated by Christie J. in Rowland J. Purdy v. M.N.R., 85 DTC 254 at 256:
| It must be borne in mind that in deciding questions pertaining to liability for income tax the manner in which parties to transactions choose to label them does not necessarily govern. What must be done is to determine what on the evidence is the substance or true character of the transaction and render judgment accordingly. In M.N.R. v. Saskatchewan Co-operative Wheat Producers Ltd. (1930), 1 DTC 186, Lamont, J. in delivering the judgment of the Supreme Court of Canada said at page 189: |
| In revenue cases it is a well recognized principle that "regard must be had to the substance of the transactions relied on to bring the subject within the charge to a duty and the form may b disregarded". Pollock, M"R., in Inland Revenue Commissioners v. Eccentric Club, Ltd. [1924] 1 K.B. 390, at p. 414. |
[23] The undisputed facts are that William Pankiw provided the seed money to 1056 and his company Northland provided the equipment to 1056. For this, William Pankiw was to receive 50% of the earnings of the company. From this, the obligation rested with 1056, not John Pankiw, to repay the seed money to William Pankiw, the cost of the equipment to Northland and 50% of its earnings to William Pankiw. In fact, 1056 did repay William Pankiw and Northland but it failed in its obligation to payout 50% of its earnings. In my view, one can only characterize this initial agreement as loans from William Pankiw and Northland to 1056. The payment by 1056 which triggered the reassessment of John Pankiw for his 1984 taxation year was in fact payment of its original obligation to William Pankiw.
[24] The agreement to arbitrate, with the resulting arbitration award, was simply a mechanism to resolve the dispute between the two brothers and did not change the nature of the obligations flowing from the initial agreement which was in substance a loan.
[25] For these reasons, the Notice of Reassessment dated April 29, 1987 is set aside.
[26] At the conclusion of the trial, counsel for the Minister stated that if the Court held the payments by 1056 did not confer a benefit on John Pankiw then it would not challenge the deductions by 1056 pursuant to subparagraph 20(1)(e)(ii) of the Act. Accordingly it is not necessary for the Court to deal with 1056's claims for relief. Nor is it necessary to make rulings on the remaining claims for relief by 1056, as I understand these matters were resolved prior to trial.
[27] Costs are awarded to the plaintiffs.
[28] Counsel for the plaintiffs is directed pursuant to Rule 394(1) to prepare for endorsement a draft order to implement the Court"s conclusion, approved as to form and content by counsel for the defendant.
"Dolores M. Hansen"
J.F.C.C.