McGillivary Restaurant Ltd. v. R. – TCC: Husband found to exercise de facto control over corporation majority owned by wife

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McGillivray Restaurant Ltd. v. The Queen (November 28, 2014 – 2014 TCC 357) was a decision which boiled down to whether, for the purposes of the small business deduction, a husband exercised de facto control over a corporation which was owned, as to 76%, by his wife:

[1] The Appellant is a corporation that operates a Keg restaurant in the City of Winnipeg. A majority of its shares are owned by Ruth Howard. Mrs. Howard’s husband, Gordon Howard, owns the corporations which operate the other two Keg restaurants in Winnipeg, one of which is the Appellant’s landlord for its Keg restaurant, and one of which provides the financing and management services to the Appellant. Mr. Howard was also the sole incorporator and director of the Appellant and its President and Secretary at all relevant times, and he owned 24% of its shares. He also was Operations Director and General Manager for the three Keg restaurants and was responsible for operating the Appellant’s Keg restaurant.

[2] The tax issue in this case is whether, for the fiscal years 2007 through 2009, the Appellant corporation which is controlled de jure by Mrs. Howard, and the corporations wholly‑owned by her husband were “controlled, directly or indirectly in any manner whatever, by the same person or group of persons” for purposes of the associated corporations rules in paragraph 256(1)(b) of the Income Tax Act (the “Act”) and within the meaning of that phrase set out in subsection 256 (5.1). This will determine whether the Appellant has to share the so‑called small business deduction with Mr. Howard’s corporations or whether it is entitled to its own $500,000 small business income limit.

The two corporations owned by Mr. Howard were historically and legally inextricably linked with his wife’s corporation:

[6] In late 1997, Keg Restaurants Ltd. franchised a corporation wholly‑owned by Mr. Howard (“GRR”) to operate three Keg restaurants in Winnipeg. The franchisee entered into a Restaurant Development Agreement and three separate Franchise Agreements for restaurants at Garry Street, Portage Avenue and Pembina Highway locations.

[7] The Restaurant Development Agreement provided that so long as GRR operated at least three Keg restaurants in Winnipeg, neither Keg Restaurants Ltd. nor any franchisee could open a Keg restaurant in the city of Winnipeg unless GRR was given the right of first refusal option to open the new location. GRR’s rights under this agreement were not assignable without the consent of Keg Restaurants Ltd.

[8] The Franchise Agreements (at least the one for the Pembina Highway location in evidence) provided, among many other things, that the day‑to‑day operation, management and supervision of the restaurant was to be at all times under the complete, direct, exclusive, on‑premises control of a management employee of the franchisee. The franchisee was required to keep the franchisor informed of the identities of its management employees. It does not appear that Mrs. Howard was such an employee. The franchisor’s approval was required for the general manager of the restaurant. The Franchise Agreement also precluded the issue or transfer of any shares of the franchisee GRR without the consent of Keg Restaurants Ltd., and the GRR shares were required to be endorsed with such restrictions. GRR was also required to keep the franchisor Keg Restaurants Ltd. informed of its shareholders, officers and directors. The Franchise Agreement could not be assigned by the franchisee GRR without the consent of Keg Restaurants Ltd.

[10] GRR’s offer to purchase the McGillivray lot was in July 2004. The necessary consents were obtained from Keg Restaurants Ltd. to relocate and for the new restaurant building to be built. It had been recommended to Mr. Howard and decided by Mr. Howard, that the real property would be held by a new corporation incorporated for this purpose (“MorCourt”), which was wholly‑owned by Mr. Howard. MorCourt’s beneficial interest was held through a numbered company also wholly‑owned by Mr. Howard. MorCourt also became the owner of the Portage Avenue location’s real property. As with GRR, Mr. Howard was the sole shareholder, sole director and the President and Secretary of MorCourt.

[11] At the same time it was also recommended to Mr. Howard that the McGillivray location be operated by another new corporation, the Appellant McGillivray Restaurant Ltd.

[12] McGillivray Restaurant Ltd. was incorporated in 2005 by Mr. Howard as incorporator. He was its first and only director and its President and Secretary. The Articles of Incorporation required the unanimous consent of the directors for any transfer of shares of the corporation. Mr. Howard was elected the sole director by a resolution of the shareholders. By Director’s Resolution, the number of directors was limited to one unless otherwise designated by the directors. By Director’s Resolution, the President alone was appointed signing officer for the Appellant’s banking. The share subscriptions in evidence indicate that Mrs. Howard paid $76 for her 760 common shares and that Mr. Howard paid $24 for the remaining 240 common shares. (The Partial Agreed Statement of Facts says Mrs. Howard paid $100 ‑ the difference is not material.)

[13] Mr. Howard understood that it was important that his wife have 76% of the common shares. His understanding was that, at that level, the new corporation would be fully independent of the existing corporations. At the same time his understanding was that, once incorporated and organized, he would not need his wife’s approval to make any decision on behalf of the Appellant.

This decision extensively reviews the law applicable to the small business deduction but ultimately boiled down to findings of fact:

[48] I am satisfied that, on the evidence in this case, Mr. Howard had and exercised de facto control over the Appellant corporation throughout, notwithstanding that his wife had de jure control of the Appellant. The result is that the Appellant is associated with the two corporations GRR and MorCourt over which Mr. Howard had de jure control. The appeal must therefore be dismissed.

[49] Firstly, overall it is simply hard to imagine how Mr. Howard could have had any more effective de facto day‑to‑day control, or greater long‑term control, over the management and operation of the Appellant and its business than he enjoyed. Similarly, it is hard to imagine how Mrs. Howard could have had or exercised much less effective de facto control. Indeed, the evidence of Mr. Howard is that this is precisely what was intended from the outset and throughout.

[50] Mr. Howard was the sole director and President and Secretary of the Appellant. He was the Operations Director and General Manager of all three restaurants including that of the Appellant. The General Manager of the Appellant’s restaurant reported to him. He did not need to obtain his wife’s approval or consult with her to make any decisions in these capacities.

[51] Mr. Howard was the person who had all of the discussions, negotiations and communications with Keg Restaurants Ltd., the franchisor, concerning the Appellant’s franchise restaurant. He alone had a decades long history with Keg Restaurants Ltd. He alone had experience running, managing and/or operating a Keg or any other restaurant.

[52] Mr. Howard alone sought the needed business‑related advice on behalf of the Appellant. The advice was given to him. He decided on the recommended course of action after minor and limited communication and consultation with his wife, and he alone implemented it.

[53] Mr. Howard had his companies arrange for the Appellant’s banking and financing. He had his companies provide the Appellant’s management, accounting and head office services and functions. The Appellant’s finances were integrated into GRR. The Appellant only ever used GRR’s bank account.

[54] Mr. Howard sought and obtained Keg Restaurants Ltd.’s consent to the assignment of GRR’s franchise to the Appellant. He obtained this only after he assured them nothing would change with the management, operations and running of the Appellant and its restaurant.

[55] Mr. Howard owned the company that owned the McGillivray location land and building, and was the Appellant’s landlord for it sole premises for its sole business. The agreed rent charged and paid was set by Mr. Howard.

[56] Mr. Howard did not deal at arm’s length with the controlling majority shareholder. They were related. The Howards had been married for decades and remained married and living together.

[57] Mrs. Howard did not have any other source of income disclosed in the evidence except her employment income from GRR. There is no evidence of her capital assets. Among other things, this brings into question the value of her personal guarantee as well as the extent of her dependence on the continued success of her husband in running these three restaurant businesses.

[58] Mrs. Howard could not sell her controlling interest to anyone else without obtaining Keg Restaurants Ltd.’s consent. Had she been able to that, and sell the shares to anyone other than her husband, this would result in the husband’s company losing its exclusivity rights because they were no longer operating three restaurants. This could be expected to negatively affect the value of her shares of the Appellant and the value of her husband’s companies.

[59] Secondly, Mr. Howard also had considerable influence when Mrs. Howard appointed him as sole director upon acquiring her 76% interest in the Appellant. GRR’s exclusivity rights would have precluded the company she controlled from opening a Keg Restaurant without the full support of her husband’s GRR. Mr. Howard proposed to Mrs. Howard, based upon the advice he received, that she could acquire the 76% interest in the new company on the recommended terms, which included that nothing else change. That certainly makes it appear that her opportunity to acquire shares was dependent upon him being the sole director etc. It was that offer which she agreed to accept. The evidence also makes it appear that their jointly owned new company, the Appellant, was only going to get the Franchise Agreement to run the new restaurant location if Mr. Howard was the sole director etc. That was the proposal he had put to Keg Restaurants Ltd. and that was the proposal he had made to his wife which she accepted and agreed to.

[60] This all constitutes very significant influence held and exercised by Mr. Howard over Mrs. Howard’s decision to appoint him as sole director.

[61] Thirdly, while Mrs. Howard could have replaced Mr. Howard as the Appellant’s sole director, she did not. Had she wanted to, she would have had to be concerned about, and influenced by, the effect that would have under the Franchise Agreement. If she considered doing it against Mr. Howard’s wishes, she would have had to consider, and be influenced by, the fact that the Appellant leased its business premises from his company and obtained all of its management and related services from his company.

[62] Had Mrs. Howard ever wanted to turn her mind to selling her shares or replacing her husband as sole director, or appointing additional directors, she clearly would have been influenced by several factors relating to her husband’s positions with the Appellant.

[Footnote omitted]

In the result the appeal was dismissed with costs.