Foresbec Inc. v. The Queen

Date: 20010118

Docket: 98-2034-IT-G,

98-2035-IT-G

BETWEEN:

FORESBEC INC.,

SOCIÉTÉ DE GESTION J.N.G. INC.,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Lamarre Proulx, J.T.C.C.

[1] These appeals were heard on common evidence. In both cases, the appeals are for the appellants' 1990 to 1992 taxation years.

[2] The issues as regards the appellant Foresbec Inc. are as follows:

(1) Was the $150,000 paid to Multi-Ind. from 1990 to 1992 so paid under a contract for services? Can the appellant claim the following amounts as expenses incurred to earn income within the meaning of subsection 9(1) and paragraph 18(1)(a) of the Income Tax Act ("the Act"): $12,500 for 1990, $75,000 for 1991 and $62,500 for 1992, for a total of $150,000?

(2) If the answer is no, was the Minister of National Revenue ("the Minister") justified in assessing the appellant for the 1990 taxation year outside the reassessment period in accordance with subsection 152(4) of the Act?

(3) Did the appellant knowingly, or under circumstances amounting to gross negligence, include an ineligible expense in computing its income for the taxation years at issue?

[3] As regards the appellant Société de Gestion J.N.G. Inc., the issues are as follows:

(1) Did the appellant, as a shareholder in Foresbec Inc., receive a taxable benefit within the meaning of subsection 15(1) of the Act through the payment of the above-mentioned $150,000 in the years at issue?

(2) If the answer is yes, was the Minister justified in assessing the appellant for the 1990 and 1991 taxation years outside the reassessment period in accordance with subsection 152(4) of the Act?

(3) Did the Minister properly assess a penalty under subsection 163(2) of the Act?

[4] When the hearing began, counsel for the appellant Société de Gestion J.N.G. Inc. told the Court that that appellant was withdrawing its appeal against the notice of determination of non-capital loss issued by the Minister in relation to the loss at the end of the 1992 taxation year. That notice is dated December 20, 1996.

[5] Counsel for the appellant Foresbec Inc. asked to amend that appellant's Notice of Appeal to remove any reference to 1993 and 1994. Counsel for the respondent told the Court that she had no objection to that request. The Notice of Appeal was therefore amended as requested by counsel for the appellant.

[6] The following witnesses testified at the request of counsel for the appellants: Guy Boissé, Louis Lagassé, Yvan Bouvet, Gérald Gagnon and Jacques Maltais. André L'Espérance testified at the request of counsel for the respondent.

[7] Guy Boissé explained that the appellant Société de Gestion J.N.G. Inc. (hereinafter J.N.G.) is a management company controlled by him. Prior to March 1989, J.N.G. controlled the appellant Foresbec Inc. (hereinafter Foresbec). Mr. Boissé was the president of both companies. Foresbec is a public company whose common shares are listed on the Montréal Exchange. It carries on its activities in two areas, namely the timber business and the sale of construction materials. Its activities in the timber business involve seasoning wood, grading it and marketing it, especially for the export market.

[8] Mr. Boissé explained that, as a public company, Foresbec was of interest to André L'Espérance, a substantial shareholder in Multi-Ind. Inc. (hereinafter Multi-Ind.), who wanted his group to gain access to the Montréal Exchange.

[9] On March 8, 1989, J.N.G. sold 3,600,000 shares it held in Foresbec to Multi-Ind. for $3,960,000. Part of that amount—$2,010,000—was paid in cash, while the balance of $1,950,000 was payable in three equal instalments on April 1, 1992, 1993 and 1994 (Exhibit I-1).

[10] After that sale, Mr. Boissé remained in charge of running the company and Mr. L'Espérance became the chairman of its board of directors. He reorganized Foresbec's corporate structure and made changes to its contractual agreements with certain foreign customers, particularly a German company named Offerman, with which he signed an exclusivity agreement. That agreement provided that Foresbec would not sell to any German purchaser other than Offerman. Moreover, sales to Offerman went through another Canadian company, Prime Wood Lumber. Offerman owned 50 percent of the shares of Prime Wood Lumber. Mr. Boissé totally disagreed with the aforementioned changes. According to him, the decisions were clearly not in Foresbec's interest.

[11] According to the agreement (Exhibit I-1), if the total value of the purchaser's claims was greater than an amount referred to in the agreement, the purchaser had 10 days to inform the vendor. That notification was given by the purchaser before the end of the year. The notification and the operational changes made by Mr. L'Espérance caused intense conflict within Foresbec that threatened its very existence. As a result, the banks wrote to each of the parties on January 22 and February 23, 1990. Those letters were filed as Exhibit A-4. The letter of February 23, 1990, to Guy Boissé and another similar letter to André L'Espérance were a kind of demand by the bank that the conflict between the two men be resolved by March 12.

[12] Mr. Boissé explained that the bank exerted a great deal of pressure to get Mr. L'Espérance and him to come to an agreement. Mr. Boissé decided to buy back the shares. To that end, J.N.G. was able to ally itself with nine other shareholders.

[13] On March 10, 1990, J.N.G. bought back the Foresbec shares. Mr. Boissé said that the negotiations were very difficult. It took 12 hours to reach an agreement. Proposal after proposal was made. The buyback agreement (Exhibit I-2) between J.N.G. and Multi-Ind. provided, inter alia, that $1,750,000 would be paid and that the $1,950,000 balance of the sale price from the 1989 agreement would be waived. Above all, the agreement contained a clause by which J.N.G. gave an undertaking that Foresbec would award a $150,000 contract to Multi-Ind. for André L'Espérance's services. The consulting contract (Exhibit A-1) was dated April 9, 1990, and signed by J.N.G. and Foresbec. Mr. Boissé signed for both companies.

[14] The ratification of the consulting contract (Exhibit A-1) took place at a meeting of Foresbec's directors on April 12, 1990. The minutes of that meeting were filed as Exhibit A-3.

[15] Mr. Boissé argued that, by signing the buyback agreement (Exhibit I-2), Mr. L'Espérance agreed to provide services. Mr. Boissé said that, where a company is taken over by another group, it is normal and desirable that the outgoing executive officer be offered a consulting contract. It is natural to think that that person has committed the company or taken actions in relation to third parties that require explanations or will require explanations in the future. Two types of co-operation were wanted from Mr. L'Espérance: active co-operation, that is, providing information on the contracts already negotiated, and passive co-operation, which involved preventing him from competing.

[16] Mr. Boissé admitted that he and Mr. L'Espérance did not get along but said that he expected Mr. L'Espérance to co-operate once the shares were bought back. According to Mr. Boissé, while Mr. L'Espérance did nothing wrong in terms of his passive co-operation, he did not give active co-operation. He did not want to return calls or sign the minute books covering the period when he had been in charge.

[17] In June 1997, the Foresbec shares were sold to an American company. Mr. Boissé told the Court that he had been authorized by Foresbec's officers to pursue this appeal.

[18] Oddly, it was the respondent who filed the 1989 share sale agreement (as Exhibit I-1) and the buyback agreement of March 10, 1990 (as Exhibit I-2).

[19] The clause from which this case arises, which can be found in the buyback agreement (Exhibit I-2), reads as follows:

[TRANSLATION]

4. J.N.G. promises that the Company will award MULTI-IND. a contract for André L'Espérance's services as a consultant for a period of two (2) years, starting on the closing date, for total fees of one hundred and fifty thousand dollars ($150,000) payable monthly in instalments of six thousand two hundred and fifty dollars ($6,250) to be paid on the last day of each month starting on the thirtieth of April nineteen ninety (April 30, 1990) and from month to month thereafter up to and including the month of March nineteen ninety-two (1992); should the Company have not made any of the said payments more than fifteen (15) days after being given written notice of default by MULTI-IND., the balance outstanding at that time shall become payable immediately with loss of the benefit of the term.

[20] It is also helpful to look at some of the agreement's other clauses. Clauses 5, 6(vi) and 8 read as follows:

[TRANSLATION]

5. André L'Espérance shall file a solemn declaration stating that there are no other agreements by which the Company may be bound that were entered into outside the Company's ordinary course of business and not disclosed in writing to the Company prior to the date hereof.

6. On closing:

. . .

(vi) André L'Espérance, Claude Grondin and Arnold Kostiner shall sign a trade restriction agreement in the usual form in favour of the Company for all of Canada and Western Europe for three (3) years; and

. . .

8. On closing, André L'Espérance shall represent that a verbal agreement, made subject to certain conditions, has been entered into by Primewood Lumber Inc./Guy Genest whereby they have undertaken not to compete directly or indirectly with the Company until the thirty-first of December nineteen ninety (December 31, 1990).

[21] The consulting contract awarded to Multi-Ind. (Exhibit A-1) is dated April 9, 1990, and signed by J.N.G. and Foresbec but not by Multi-Ind. It is worded as follows:

[TRANSLATION]

SOCIÉTÉ DE GESTION J.N.G. INC.—a federally incorporated company, here acting through and represented by its president, Guy Boissé, and stipulating on behalf of Foresbec Inc., in whose name it gives an undertaking herein—hereby awards Multi-Ind. Inc. a consulting contract for a period of two (2) years under which André L'Espérance, as Multi-Ind.'s president, shall act as a consultant to Foresbec Inc. starting on the date hereof.

CONTRACT TERM

The contract term shall be two (2) years starting today. The contract shall therefore end on the ninth of April nineteen ninety-two (April 9, 1992), and it shall not be extended in any way, whether tacitly or explicitly, without an agreement in writing duly approved by both parties.

TOTAL FEES

The said consulting contract is thus awarded for a total of ONE HUNDRED AND FIFTY THOUSAND DOLLARS ($150,000.00) payable monthly in instalments of SIX THOUSAND TWO HUNDRED AND FIFTY DOLLARS ($6,250.00) to be paid on the last day of each month from the thirtieth of April nineteen ninety (April 30, 1990) up to and including the thirtieth of March nineteen ninety-two (March 30, 1992). Should Foresbec have not made such consulting fee payments more than 15 days after being given written notice of default by Multi-Ind., the balance of the said $150,000.00 outstanding at that time shall become payable immediately with loss of the benefit of the term.

[22] Exhibit A-2 is made up of the amounts paid to Multi-Ind. and the invoices prepared by Multi-Ind. for its administrative services.

[23] Louis Lagassé is a businessman who also has legal training. In 1989, he was on Foresbec's board of directors. He was involved in the negotiations for the share buyback. He stated that the purpose of the consulting contract awarded to Mr. L'Espérance was to make sure that he would be loyal to Foresbec. It was essential that he make himself available. Mr. Lagassé also indicated that it was normal to provide an outgoing manager with severance pay.

[24] Yvan Bouvet is a chartered accountant who has known Mr. Boissé since 1986. He was the tax advisor and auditor for Mr. Boissé's businesses. He said that, since Foresbec was a public company, purchase and buyback transactions had to be at close to the stock market value pursuant to Quebec's Securities Act, unless the specific procedure required by that statute was followed. The difference could not be more than 10 percent of the stock market value. He said that the purchase and buyback prices were therefore tied to the value of the shares on the stock market. The shares, he said, were listed at $1.10 on the stock market at the time of the purchase. One year later, when they were bought back, they were worth half that amount. His conclusion is that the share buyback price could only have been $1,750,000. According to Mr. Bouvet, the other amounts paid were not of the same nature as the buyback price. He is aware that there was a contract for services, but he was not involved in the negotiations to establish the quantum or anything else. The legal advisors had suggested to him that such a contract could be useful in dealing with Foresbec's sensitive issues. He admitted that, when J.N.G. disposed of its shares in Foresbec in June 1997, the $150,000 was included in the adjusted cost base of the shares. He had not included it initially, but after a conversation with the appellants' lawyers, the amount was included as a defensive measure.

[25] Gérald Gagnon testified at the request of counsel for the appellants. He was a basic file auditor at Revenue Canada for the Sherbrooke area. Counsel for the appellants asked him how he interpreted clause 4 (quoted in paragraph 19 of these Reasons) of the agreement between J.N.G. and Multi-Ind. dated March 10, 1990 (Exhibit I-2). His audit showed that the $150,000 had been paid but not for fees. He learned this from Mr. Boissé during his audit. His interview with Mr. Boissé took place at the end of November 1994 and was recorded in his T2020 report, which was filed as Exhibit I-7. He asked Mr. Boissé what services Mr. L'Espérance had provided and, after some hesitation, Mr. Boissé told him that no services had ever been provided but that that was the last point to be negotiated in order for the agreement to be concluded. He did not ask whether Mr. Boissé knew when he signed the agreement that services would not be provided.

[26] As regards the benefit to J.N.G. as a shareholder, Mr. Gagnon's view was that J.N.G. had used an asset owned by Foresbec, a corporation in which it was a shareholder, and that that was a taxable benefit. Mr. Boissé is a knowledgeable businessman who was well aware of the consequences of the transaction.

[27] André L'Espérance became a director on Foresbec's board of directors before the share purchase, but he does not remember attending meetings of the board. The Multi-Ind. group immediately began talks to acquire Foresbec.

[28] Mr. L'Espérance explained that, before the shares were purchased by Multi-Ind., he went over the company's financial statements and inventories with accountants and met the company's senior managers. After all that, he thought that the shares were not worth the price being asked. The main issues were the accounts receivable and the quality of the inventories. He was nonetheless interested in buying, and he asked his lawyers to draft a failsafe clause concerning the vendor's representations and warranties. That clause is article 8 of Exhibit I-1.

[29] When the shares were purchased, it was agreed that Mr. L'Espérance would become the chairman of the board of directors and that Mr. Boissé would remain the corporation's executive president. Mr. Boissé continued to be a director of Foresbec and worked there every day.

[30] Offerman wanted to be Foresbec's only customer in Germany. Offerman would resell to Foresbec's other customers in Germany through Primewood Lumber. Primewood had been incorporated at Offerman's request and was owned in part by Offerman and in part by Guy Genest, a former important employee of Foresbec. Mr. L'Espérance saw that way of doing business as appropriate and advantageous.

[31] The facts that led to the dispute between Mr. Boissé and Mr. L'Espérance have already been set out.

[32] As for the contract for services, Mr. L'Espérance said that it was nothing of the kind but was rather a share payment method proposed by Mr. Boissé. Mr. Boissé's concern was that he not see Mr. L'Espérance any more. Mr. L'Espérance said: [TRANSLATION] I did not want to work and he did not want me to work. They never asked me to co-operate. Mr. Boissé did not want him to be entitled to do anything in the company. Mr. L'Espérance pointed out that, under the so-called consulting contract, he had no obligation to provide services. A dispute was being ended, and that was all. The non-competition clause (quoted in paragraph 20 of these Reasons) was not negotiated. It is a normal clause, and he had no intention of getting involved in that type of business anyway.

[33] Jacques Maltais is a businessman who was on Foresbec's board of directors. He said that, as a director, he considered it essential to bind Mr. L'Espérance to ensure that he co-operated to some extent.

The appellants' arguments

[34] Counsel for the appellants argued that, in the circumstances, with the Foresbec shares being bought back by a group of shareholders, it was reasonable for Foresbec to want to ensure that it had the co-operation of the outgoing owner, who was also its senior director. The expense is eligible even though, in the end, it did not have the expected effect.

[35] What counts, counsel said, is the purpose for which the expense was incurred. Even if the ultimate goal of an expense is to bind someone, the expense is not capital in nature if the method chosen in order to incur it is a contract for services. The purpose of the contract for services was to ensure the loyalty of the former owner and to obtain from him a minimum level of co-operation, whether passive or active.

[36] Counsel for the appellants referred to the Tax Appeal Board's decision in Brock et al. v. M.N.R., 67 DTC 52, especially at page 54. That case involved the purchase of an accounting practice. Along with the purchase price, there was a contract for the employment of the former owner. The cited passage is as follows:

There is, it appears to me, no vagueness, no ambiguity in the indenture. There was a set price on the one hand, and, on the other hand, a contract of employment for a definite period and for a definite amount of money to be determined under the agreement. The parties to the agreement dealt in good faith and with no intention to deceive the fisc. It was a perfectly legal document called for by the circumstances of the business. True that Armfield was asking more and Muirhead could not raise more than $15,000. So they arrived at the compromise that the price would be $15,000 and Armfield would become an employee whose remuneration would be a commission of 3% of the gross revenue of the business. It is also true that Armfield did not do much to develop the business. Meanwhile, he visited the business on a few occasions, saw some of his former clients and did nothing to hurt the trade one way or the other. It cannot be said that the transaction was artificial and that by such agreement the income of the appellant was "unduly or artificially reduced" . . . .

[37] Counsel also referred to Kerim Brothers Ltd. v. M.N.R., 67 DTC 326, especially at page 336. That case involved the sale of a rental business. The breakdown of the sale price showed that the price paid was for the undepreciated capital cost of the building and equipment and for the land and goodwill. The cited passage is as follows:

A consideration of all the facts and circumstances as disclosed in the evidence has led to a conclusion that the agreement of sale of November 9, 1961, was, without doubt, an arm's length agreement in which each party had bargained for the best possible terms and every possible advantage to be had. There is nothing in the evidence which would support a finding that the agreement was in any sense or to any degree a sham or subterfuge or a mere device in the sense referred to by Thurlow, J., in the Klondike decision.

Counsel argued that the contract for services in the instant case was also an arm's length agreement and that it reflected what the parties intended.

[38] He referred as well to this Court's decision in Farm Business Consultants Inc. v. The Queen, 95 DTC 200, [1994] T.C.J. No. 760, to show that the facts of that case differed from the facts here. The cited passage is at page 203:

Before the closing Mr. Whalls became concerned that he and his wife might have somewhat onerous obligations under the consulting agreement and at closing an amendment of the consulting agreement was made and signed by all parties. It read as follows:

1. The parties hereto agree to amend their consulting agreement dated May 17, 1982, as follows:

The Company agrees that Agricultural and Whalls will only be required to devote a maximum of five days service per year to the Company.

The Minister disallowed the deduction of the so-called consulting fees, allowed a deduction of a portion as an eligible capital expenditure and a further portion as an interest component. He took this reassessing action with respect to all years under appeal, including those that were statute-barred, and imposed penalties under subsection 163(2) for all years which he reassessed.

I have set out the agreements to show what the parties purported to agree to. The agreements do not reflect the legal reality. Apart from the obligation to make the weekly payments of $1,665 the consulting agreement was never intended to be acted upon. The Whalls were not expected or intended by the appellant to render any consulting services and in fact they did not do so. . . .

There is no need to repeat the jurisprudence on substance over form. That has been done in other cases. The essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not its nomenclature, that governs. The idea of dressing up the payments for the customer list in the garb of consulting fees was the idea of Mr. Ibbotson, the president of the appellant, because he wanted to turn the payments for goodwill into currently deductible expenses. Evidently the Whalls were prepared to go along with this suggestion but their acquiescence, and the fact that they were prepared to include the payments in income, does not assist the appellant, nor indeed does the fact that the Minister did not question the Whalls' inclusion of the payments in income. After all, why would he?

[39] Counsel for the appellants argued that, in Farm Business Consultants, supra, the number of days in the contract for services had been determined—namely five days a year, which was ridiculously low—and that the judge could see from the evidence before him that neither of the parties intended to comply with the agreement. Counsel argued that the primary purpose of the agreement in the case at bar, unlike that in Farm Business Consultants, was not to make the expenses deductible but to secure the former owner's loyalty and services.

[40] He referred to this Court's decision in Molinaro v. The Queen, 98 DTC 1636, [1998] T.C.J. No. 197, particularly at page 1642:

The witnesses called by the respondent testified that they regarded the salary arrangement with Mr. Molinaro reasonable and essential and I can see why. He struck me as a dynamic and forceful person essential to the success of the enterprise.

Quite apart from the fact it strikes me as most anomalous that where a person enters into a binding agreement with an arm's length party who relies upon the maintenance of a legal relationship as set out in the formal documentation and that person is advised of the legal and fiscal consequences of what he or she is signing that person should be entitled to repudiate the agreement not only as against the Minister of National Revenue but as against the other party. I suppose that in theory one might be able to make a case that a party to an agreement can invoke the substance over form doctrine but it seems to run counter to all principles of commercial morality and indeed of commonsense that one can, after solemnly and formally entering into carefully drafted legal documents upon which the other party relies, simply snap his fingers and say "That legal relationship isn't to my liking. It doesn't suit my fiscal objectives. Therefore I shall clothe it in a different nomenclature that I like better." I cannot believe that Mr. Molinaro's advisors would have told him to go ahead and sign the agreements because it was necessary to get the deal through, but it was not the real deal and he could ignore it and conjure up another deal that was more attractive to him and, perhaps more importantly, to Bluevest.

I do not need to resurrect the ancient doctrine of estoppel by deed, although it might apply (the employment contract was in fact under seal, an essential prerequisite to invoking this venerable rule). Rather I prefer to place my reasoning upon an even more ancient principle that if one makes one's bed in a particular way one should — particularly if one has had help from professional accountants and lawyers in making the bed — be prepared to lie in it. In Collins v. The Queen, 96 DTC 1034 at page 1039 this court quoted from Savoie v. The Queen, 93 DTC 552 as follows:

The situation here differs from that of spouses who, with a full appreciation of the legal consequences of what they are doing, choose that property be held jointly, or solely by one spouse or in any other of the variety of ways in which property can be owned. Such deliberate choices must be respected because the legal form is consistent with the economic reality and the informed intentions of the parties.

Counsel for the appellants argued that deliberate choices must be respected.

[41] He referred to R.P. Bell v. M.N.R., [1962] C.T.C. 253 (Ex. Ct), particularly at pages 268-69:

In my opinion, the contract of employment of June 4, 1953, between the Company and the appellant is exactly what it purports to be. There is no doubt that the appellant could have successfully sued the Company on it if it had refused to carry out its terms and it could not have defended the action on the ground that the contract was not what it purported to be.

Moreover, the contract contains the very terms that the appellant had insisted upon as a condition of his offer to sell the pooled shares to Messrs. Morrow, Lee and Smith. There is no doubt that he desired the contract of employment that they had arranged for him. . . .

Moreover, the terms of the agreement are clear and free from ambiguity and neither the appellant nor the Company could be heard to deny them. The Company has not sought to do so and the appellant's attempt to do so should not be allowed to succeed.

. . .

The fact that the appellant was never asked by Mr. Morrow, Mr. Lee or Mr. Smith to render any service to the Company under his contract of employment and that he never rendered any service is immaterial. If he had sued on the contract for failure on the part of the Company to comply with its terms it would not have been a valid defence on its part that it had never asked him for advice or consulted him. . . .

[42] With regard to the application of subsection 152(4) of the Act, counsel referred to M.D. Glazier Ltd. v. M.N.R., 83 DTC 48, particularly the following passage at page 50:

Ultimately, therefore, there remains the view in my mind that what happened in this instance should not be characterized as misrepresentation. A mistake it may have been, but I am prepared at this stage of the development of the law on section 152(4) to believe that a mistake is different from misrepresentation, as it is applied to the facts in this case. I cannot see from the evidence presented that there was neglect or carelessness to the degree that one might not expect to find in the work of a normally cautious and wise taxpayer.

The appellant corporation, I believe, did everything within its grasp to put forward for the Minister the circumstances as it interpreted and saw them. I see nothing of either misrepresentation, neglect or carelessness in its conduct.

[43] Counsel for the appellants referred to the decision of the Federal Court-Trial Division in M.N.R. v. Bisson, [1972] F.C. 719, especially the following passage at page 730:

. . . I therefore conclude that a taxpayer who, without any negligence on his part, commits an error in declaring his income, does not make a misrepresentation within the meaning of s. 46(4)(a)(i). When the Minister seeks to rely on this provision to proceed with a re-assessment after four years, he must therefore not only show that the taxpayer committed an error in declaring his income but also that that error is attributable to negligence on his part.

[44] He referred again to Farm Business Consultants, supra, at pages 205-06:

A court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statue-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established. Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted. I think that in this case the required degree of probability has been established by the respondent, and that no hypothesis that is inconsistent with that advanced by the respondent is sustainable on the basis of the evidence adduced.

[45] Counsel argued that, if the Court concludes that Foresbec cannot deduct the payments in question, their inclusion in computing that company's income must be considered merely an honest mistake by the appellants.

The respondent's arguments

[46] Counsel for the respondent pointed out that the respondent was the one who filed the agreement dated March 8, 1989, through which Multi-Ind. purchased the Foresbec shares, and the agreement dated March 10, 1990, through which the same shares were bought back by J.N.G. Those documents were filed as Exhibits I-1 and I-2. Counsel expressed surprise that documents so important to the evidence were not filed during Mr. Boissé's direct examination. She argued that the reason those important documents were not introduced in evidence by the appellants is that they did not want to adduce clear evidence.

[47] Counsel for the respondent referred to Exhibit I-1, which is the agreement entered into by J.N.G. and Multi-Ind. on March 8, 1989. In agreeing to purchase the Foresbec shares for $3,960,000, Multi-Ind. required from J.N.G. warranties as to the value of the assets. The request that those warranties be honoured and the refusal to pay the balance of the sale price were what gave rise to the dispute between Multi-Ind. and J.N.G.

[48] Counsel noted that J.N.G. had a liquidity problem at the time of the buyback transaction in March 1990. J.N.G. managed to bring together other investors, but it would seem that there was a lack of money. It was at that time that the decision was made to involve Foresbec. The Notice of Appeal seems to suggest that it was Mr. L'Espérance who insisted on having a consulting contract, whereas in their testimony all of the appellants' witnesses said that it was essential to secure Mr. L'Espérance's services. Mr. L'Espérance testified that he was not the one who requested such a contract for services and that he considered it a method of paying for the shares owned by Multi-Ind.

[49] Counsel also noted that Mr. Bouvet was unable to explain in his testimony how the $150,000 had been calculated. Was it based on the salary or fees that Mr. L'Espérance was to receive? The buyback agreement of March 1990 (Exhibit I-2) was between J.N.G. and Multi-Ind., with J.N.G. giving an undertaking that Foresbec would award a contract to Multi-Ind. Foresbec, however, did not participate in the agreement. That is why, on April 12, 1990, it was very important to have the consulting contract ratified by Foresbec's board of directors.

[50] Counsel argued that the parties to the agreement did not intend to enter into a contract for services. She noted that Mr. Boissé gave lengthy testimony to show that Mr. L'Espérance had made bad business decisions. With regard to the non-competition clause, counsel for the respondent referred to the agreement (Exhibit I-2). Mr. L'Espérance undertook to sign a trade restriction agreement in favour of the company, which agreement was to cover all of Canada and Western Europe for a period of three years. Counsel argued that the last part of the clause giving the undertaking regarding Foresbec clearly shows that there was no contract for services. That part reads as follows:

[S]hould the Company fail to make any of the said payments more than fifteen (15) days after being given written notice of default by MULTI-IND., the balance outstanding at that time shall become payable immediately with loss of the benefit of the term.

[51] The consulting contract (Exhibit A-1) repeated this last clause in its entirety. That contract, which was not signed by Multi-Ind., did not provide for the performance of services but rather provided a guarantee of payment in connection with the buyback of the shares. There was no clause stating that no payment would be made if no services were provided. Mr. Boissé had remained a shareholder and director of Foresbec even while Mr. L'Espérance was its principal shareholder. Mr. Boissé had been aware of everything that happened at Foresbec even though he had disagreed with a number of decisions. Counsel for the respondent argued that, according to Mr. Boissé, Mr. L'Espérance had made decisions that made no sense or that were not in Foresbec's interest, that were even detrimental to Foresbec, in fact. Mr. L'Espérance never considered himself to be working for Foresbec, and the very wording of the alleged contract for services contradicted the existence of such a contract.

[52] Counsel for the respondent, like counsel for the appellants, referred to Farm Business Consultants, supra, arguing that that decision must be followed, especially since it has been affirmed by the Federal Court of Appeal, 96 DTC 6085.

[53] She also referred to my decision in Thibault v. The Queen, 99 DTC 489, and in particular paragraph 31 thereof:

Counsel for the respondent argued that the important point to be determined is whether the contract for services between Vermonbec and Navimex that was part of the agreement dated January 29, 1987 (see paragraph 12 of these reasons) reflected the economic reality of the transaction. Counsel for the respondent argued that the contract was a sham transaction, as that term is used in tax law, because it did not create between the parties the legal relationship that they intended to create. He referred to Stubart, supra, at page 572:

The element of sham was long ago defined by the courts and was restated in Snook v. London & West Riding Investments, Ltd., [1967] 1 All E.R. 518. Lord Diplock, at p. 528, found that no sham was there present because no acts had been taken:

. . . which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.

This definition was adopted by this Court in Minister of National Revenue v. Cameron, [1974] S.C.R. 1062, at p. 1068 per Martland J.

[54] Finally, counsel for the respondent argued that Foresbec knew the payments made to Multi-Ind. from 1990 to 1992 were not for Mr. L'Espérance's services but were made to enable J.N.G. to buy the Foresbec shares. The Minister was therefore entitled to assess the appellant Foresbec for 1990, which was outside the normal assessment period, and for 1991 and 1992, and in so assessing, to disallow the deductions claimed under section 9 and paragraph 18(1)(a) of the Act. The Minister was also entitled to assess J.N.G. for 1990 and 1991, which were outside the normal assessment period, and for 1992, on the basis that it received a benefit under subsection 15(1) of the Act. He was also entitled to assess penalties against the two appellants under subsection 163(2) of the Act because they knowingly made a misrepresentation in computing their income.

Conclusion

[55] The relevant parts of subsections 152(4), 15(1) and 163(2) of the Act read as follows:

152(4) The Minister may at any time make an assessment, reassessment or additional assessment of tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the year, except that an assessment, reassessment or additional assessment may be made after the taxpayer's normal reassessment period in respect of the year only if

(a) the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or

. . .

(Prior to December 20, 1991)

15(1) Where, in a taxation year, a benefit has been conferred on a shareholder, or on a person in contemplation of the person's becoming a shareholder, by a corporation otherwise than by . . .

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year.

(As of December 20, 1991)

15(1) Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by . . .

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year.

163(2) Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a "return") filed or made in respect of a taxation year as required by or under this Act or a regulation, is liable to a penalty of the greater of $100 and 50% of the total of

. . .

[56] In his argument, counsel for the appellants focused on the fact that the contract for services was a genuine contract and that the appellant Foresbec was entitled to deduct the costs associated therewith in computing its income under section 9 and paragraph 18(1)(a) of the Act. As a result, in computing the income of the appellant J.N.G., no benefit could be included under subsection 15(1) of the Act. With regard to the application of subsections 152(4) and 163(2) of the Act, he argued that, if the Court is of the view that there was no genuine contract for services, it should take into consideration the fact that everything was done in good faith and not for the purpose of tax evasion.

[57] In each of the decisions cited above in support of counsel for the appellants' argument, the reality of the contract for services was accepted on the ground that certain services had been rendered or that it was plausible to think that certain services would be requested and rendered. In Bell, for example, the employee had kept his office and was available to provide services. Moreover, in each case, the terms and conditions of the contracts were those of a contract for services and the contracts were signed by both parties.

[58] In the instant case, the evidence could not be any clearer that the two main players do not want to see each other again. Mr. Boissé in particular cannot stand Mr. L'Espérance. It is therefore not plausible to say that certain services were requested and rendered. As for terms and conditions in the alleged contract for services quoted in paragraph 21 of these Reasons, all things considered, there were none. No description was given of the services to be provided or of the terms respecting the consultant's availability. The contract even provided that, if Foresbec had not made a payment more than 15 days after being given a written notice of default, the balance of the $150,000 would become payable immediately. No provision was included to cover the failure to provide services.

[59] Counsel for the appellants submitted that the contract was useful to ensure that Mr. L'Espérance did not act against Foresbec's interests. In this regard, it should be noted that clauses to that effect had been included in the buyback agreement itself. Those clauses had been obtained without any problems, since Mr. L'Espérance no longer wanted to work in the timber industry. The clauses in question are reproduced in paragraph 20 of these Reasons.

[60] I must conclude that the terms of the alleged contract for services were not in fact those of a contract for services. As in Farm Business Consultants, supra, and Thibault, supra, the contract for services did not reflect the legal reality of the parties' rights and obligations. It was never contemplated that the consulting contract would be implemented. All that was provided for was the obligation to make the payments for the share buyback. The contract was a sham for the purposes of the Act, being intended to lead the Minister to believe that rights and obligations were created that were different from the actual rights and obligations that the parties intended to create.

[61] Since what was involved was not a contract for services but payment for J.N.G.'s buyback of the Foresbec shares, Foresbec cannot deduct the payments. Foresbec, by making the payments to Multi-Ind. for that buyback by its shareholder, J.N.G., conferred a benefit on that shareholder.

[62] Both of the appellants knew that the contract for service was a sham. There was thus an intentional misrepresentation and so subsection 152(4) of the Act is applicable. That same element of intent allows the application of subsection 163(2) of the Act. This was not simple negligence in relation to the duty to comply with the Act; it was a deliberate act, namely claiming as operating expenses what was actually a payment for shares.

[63] The appeals are dismissed with costs being awarded on the basis of a single hearing.

Signed at Ottawa, Canada, this 18th day of January 2001.

"Louise Lamarre Proulx"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

98-2034(IT)G

BETWEEN:

FORESBEC INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on common evidence with the appeal of Société de Gestion J.N.G. INC. (98-2035(IT)G), on June 1 and 2 and July 25, 2000, at Montréal, Quebec, by

the Honourable Judge Louise Lamarre Proulx

Appearances

Counsel for the Appellant: Christopher R. Mostovac

Counsel for the Respondent: Sophie-Lyne Lefebvre

JUDGMENT

The appeals from the assessments made under the Income Tax Act for the 1990, 1991 and 1992 taxation years are dismissed in accordance with the attached Reasons for Judgment.

Costs are awarded to the respondent on the basis of a single hearing.

Signed at Ottawa, Canada, this 18th day of January 2001.

"Louise Lamarre Proulx"

J.T.C.C.