Tax Court of Canada Judgments

Date: 20001219

Docket: 98-9401-IT-I

BETWEEN:

SAMUEL ZAMECK,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Archambault, J.T.C.C.

[1]            This is an appeal from an assessment made pursuant to subsection 160(1) of theIncome Tax Act (Act) and dated October 31, 1996. The Minister of National Revenue (Minister) assessed an amount of $14,472.41 in respect of transfers of property made to Mr. Zameck by Micropath Business Systems Inc. (Micropath)[1]. The Minister assumed that Micropath paid to Mr. Zameck a dividend of $17,000 during the taxation year ending on September 30, 1991 and a dividend of $11,300 during the taxation year ending on September 30, 1992 (relevant taxation years). Micropath had outstanding tax liabilities for these two taxation years totalling $14,472.41. In assessing Mr. Zameck, the Minister assumed that at the time of the payment of the dividends, Micropath and Mr. Zameck were not dealing at arm's length. The only issue raised by the parties is whether a non-arm's-length relationship existed at that time.

FACTS

[2]            Micropath was incorporated on November 7, 1978 and during the relevant taxation years, it carried on the business of providing computer services. Originally there were three shareholders who held an equal number of shares in Micropath. One year later, one of the three shareholders sold on a pro rata basis his shares to the other two remaining shareholders, namely Mr. Zameck and Mr. Seymour Ruby.

[3]            Messrs. Zameck and Ruby are not related within the meaning of the Act. They first met and became friends while working for the same employer prior to the incorporation of Micropath. In the first years of operation of Micropath, both Messrs. Zameck and Ruby had to continue their employment with another employer because Micropath could not hire them on a full-time basis. It only did so in 1988 when it had become more profitable.

[4]            Sometime prior to the departure of Mr. Zameck in April 1992, Micropath decided to acquire a 20% interest in Megadata Inc. (Megadata). On its balance sheet for the taxation year ending on September 30, 1991, Micropath shows a loan of $13,333 as being receivable from Megadata. On the balance sheet for the following taxation year, this loan receivable figure has increased to $20,405. In addition, there are accounts receivable of $11,770 which apparently relate to Megadata.

[5]            Subsequent to the acquisition of the interest in Megadata, the relationship between Messrs. Ruby and Zameck soured: Mr. Zameck did not feel that he was part of the decision-making process of Micropath and Megadata. On April 30, 1992, Mr. Zameck sold his shares to Mr. Ruby for $6,000. A resolution "effective April 30, 1992" approves the transfer by Mr. Zameck of all his shares in Micropath to Mr. Ruby. By letter dated April 30, 1992, Mr. Zameck resigned as director and as secretary-treasurer of Micropath.

[6]            During the 1991 taxation year and part of the 1992 taxation year, Micropath had only two employees, Mr. Zameck and Mr. Ruby. They both did essentially the same kind of work but did not receive any salary for their services. They received instead advances from Micropath on a monthly basis, although not necessarily in equal payments because their amount depended on the liquidity of Micropath. These advances were meant to allow them to meet their domestic needs. A resolution by the two directors of Micropath, Messrs. Zameck and Ruby, was signed "effective September 30, 1991" declaring a dividend of $34,000 which presumably was equal to the advances received during Micropath's 1991 taxation year. Another dividend of $22,600 was declared "effective May 1, 1992" and was payable to the "sole shareholder of record". Furthermore, the resolution to that effect was signed by Mr. Ruby as the "sole director of Micropath".

[7]            Although this May 1992 resolution states that the dividend is payable only to the sole shareholder of record, a T5 issued by Micropath to Mr. Zameck shows a dividend of $11,300 for the 1992 calendar year. This dividend amount was included in Mr. Zameck's 1992 tax return[2].

[8]            The tax returns of Micropath for the 1991 and 1992 taxation years were only filed with the Minister on July 15, 1994. On October 31, 1996, the Minister issued an assessment pursuant to subsection 160(1) of the Act.

Respondent's position

[9]            The respondent contends that Micropath and Mr. Zameck were not dealing at arm's length at the time of the payment of the dividends in 1991 and 1992. In support of her position, the respondent relies on two decisions by my colleague Judge Dussault: Fournier v. M.N.R., 91 DTC 746 and Gosselin v. Canada, [1996] T.C.J. No. 206 (QuickLaw).

[10]          In Fournier, Judge Dussault concluded that a shareholder who held 45% of the shares of a company was not dealing at arm's length with that company because that shareholder, who was also a director, had acted in concert with the other principal shareholder and director to declare and pay dividends. Judge Dussault describes the situation as follows (at page 748):

We have here two principal shareholders in a company who are for all practical purposes the only real shareholders and directors and who decide together, on the advice of the company accountant, to withdraw profits made by the company in the form of dividends declared at year-end.

[11]          And this is the conclusion that he arrived at page 748:

I cannot find a situation more suited to application of the concept of a non-arm's length transaction between unrelated persons, in that the company's two principal directors and shareholders apparently acted in concert and with a common economic interest to decide how they would withdraw the profits made by the company for their personal use. Acting both as directors of the company and its shareholders, they were in a position where the concept of not being at arm's length in fact as established by our courts could hardly be better applied. In this sense, therefore, I consider that Les Évaluateurs Fra-Mic Inc. was not at arm's length with the appellant at the time of the property transfer made during its 1983 taxation year, and that accordingly the respondent was right to apply subsection 160(1) of the Act to this transaction.

Analysis

[12]          The main issue to be decided is whether Mr. Zameck was dealing at arm's length with Micropath at the time of the payment of the 1991 and 1992 dividends. The concept of arm's length is defined in section 251 of the Act as follows:

251. Arm's length

(1) For the purposes of this Act,

(a) related persons shall be deemed not to deal with each other at arm's length; and

(b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length.

[13]          When we analyze the concept of arm's length as it is found in the Act, it is clear that persons who are related by blood constitute related persons for the purposes of the Act and are considered not to be dealing with each other at arm's length. This is not the situation here where we have two strangers, although friends, who each own 50% of the shares of Micropath. The Act defines "related persons" as also including a corporation and a person who controls the corporation, that is, a person holding more than 50% of the voting shares of the corporation. Such is not the situation in this case as Mr. Zameck owned only 50% of Micropath and could not elect a majority of the directors on the board of directors. Furthermore, he was not a member of a related group that controlled the corporation because he was not related to Mr. Ruby, together with whom he controlled Micropath. He was therefore not related to Micropath.

[14]          What is surprising in the Gosselin decision (supra) is that two shareholders each holding 50% of a company and not related to each other were considered not to be dealing at arm's length with that company. That decision amounts in effect to considering a member of an unrelated group as being related to a corporation, and therefore as not dealing at arm's length with the corporation, contrary to subparagraph 251(2)(b)(ii) which applies only to a member of a "related group". If Parliament had intended to include members of an unrelated group, it would surely have said so. Instead, it pointedly made no mention of them.

[15]          Parliament, however, in its wisdom, saw fit to recognize that parties may not be dealing with each other at arm's length in a transaction even if they are unrelated. For example, it is conceivable that one shareholder could have de facto control of a corporation without holding more than 50% of the voting shares. Such a case can be seen in Peter Cundill & Associates Limited v. The Queen, 91 DTC 5543. The circumstances there were such that Mr. Cundill was in a position to bargain not only on behalf of the corporation that he legally controlled but also on behalf of the corporation that he did not legally control.

[16]          It has been held that an arm's-length relationship will exist where a common mind directs the bargaining for both parties to a transaction, where parties to a transaction are acting in concert and without separate interests and where there is de facto control. Here, it is important to recognize that we are trying to determine whether an arm's-length relationship existed between Mr. Zameck and Micropath. These are the relevant parties for the purpose of applying the test referred to above.

[17]          The transaction in question does not involve the acquisition of property nor any other kind of bilateral contract. What we have here is a corporation which declared a dividend to be paid to its shareholders. That is the transaction in issue. As a shareholder, Mr. Zameck had nothing to do except elect the directors on the board of directors. Since he held only 50% of the shares in Micropath, he could not by himself elect a majority of directors. It is clear that Mr. Zameck did not have de facto control over Micropath and that, acting alone, he was not able to exercise his influence so as to direct Micropath to declare and pay the dividend.

[18]          The decision to declare and pay a dividend belonged to the directors of the corporation. It is as a director that Mr. Zameck could have exercised an influence on Micropath. But, Mr. Zameck was not the only director of the company when the 1991 dividend was declared; his co-shareholder Mr. Ruby was also a director. Therefore he could not by himself exercise influence over the corporation and decide alone whether the corporation would declare the dividends. With respect to the 1992 dividend, Mr. Zameck was not even one of the directors who declared it. As a matter of fact, he was not even a shareholder at the relevant time.

[19]          Counsel for the Respondent contends that Mr. Zameck acted in concert with Mr. Ruby and had no separate interest. I do not accept this argument. It is true that both Messrs. Zameck and Ruby acted in concert to declare the 1991 dividend. As they were the only two directors of Micropath, they had to agree in order to have Micropath declare and pay the dividend. However, this does not necessarily mean that they were acting in concert without any separate interest.

[20]          First, it should be remembered that directors of a corporation have a duty to act in the best interest of the corporation and not in the interest of the shareholders. Second, special circumstances would have to be present showing that the two shareholders and directors were acting without separate interest. There is no evidence of such circumstances here. For a more in-depth explanation of my reasoning supporting this conclusion and of why the approach adopted in Fournier and in Gosselin should not be followed, reference should be made to the reasons in Gestion Yvan Drouin Inc., 1999-1856 (IT)G, issued concurrently with the reasons herein.

[21]          For these reasons, the appeal of Mr. Zameck is allowed and the assessment is vacated.

Signed at Ottawa, Canada, this 19th day of December 2000.

J.T.C.C.

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