SMI Sales Inc. v. Service Mold Inc., 2007 ONCA 451

CITATION: SMI Sales Inc. v. Service Mold Inc., 2007 ONCA 451

DATE: 20070620

DOCKET: C44337

COURT OF APPEAL FOR ONTARIO

O’CONNOR A.C.J.O., DOHERTY and GILLESE JJ.A.

BETWEEN:

SMI SALES INC.

Appellant (Respondent in Appeal)

and

SERVICE MOLD INC.

Appellant (Respondent in Appeal)

and

THE MINISTER OF FINANCE

Respondent (Appellant in Appeal)

Dona M.H.Y. Salmon for the appellant

Myron W. Shulgan, Q.C. for the respondents, SMI Sales Inc. and Service Mold Inc.

Heard: April 24, 2007

On appeal from the judgment of Justice Richard C. Gates of the Superior Court of Justice dated September 23, 2005, with reasons reported at [2005] O.J. No. 4061.

O’CONNOR A.C.J.O.:

[1] This appeal raises the issue of whether the partners in a partnership that provided management services to the two respondent corporations were employees of those corporations for purposes of the Employer Health Tax Act, R.S.O. 1990, c. E.11 (the “EHTA”).

Facts

[2] The appellant, the Minister of Finance (the “Minister”), is responsible for the administration and enforcement of the EHTA.

[3] The respondents, Service Mold Inc. (“Service Mold”) and SMI Sales Inc. (“SMI Sales”), carry on business in Windsor, Ontario. Service Mold manufactures molds for the automobile industry and SMI Sales markets and sells the finished products.

[4] The respondents entered into management agreements with Service Mold Associates (S.M.A.), a partnership, pursuant to which S.M.A. agreed to provide executive, managerial and consultant services. The payments to S.M.A. for these services were calculated as a percentage of the respondents’ profits.

[5] The only two partners of S.M.A. were Mike Munger and Martin Schuurman (together “the partners”). The partners were also the only officers and directors of both respondents during the relevant period. They also held shares in SMI Sales both personally, and indirectly through corporations they owned with members of their families. The shares of Service Mold were held in equal shares by the partners’ spouses.

[6] This appeal concerns the amount of employer health tax owed by the respondents for the tax years from 1995 to 1998. Section 2(2) of the EHTA requires employers to remit employer health tax in respect of the total Ontario remuneration they pay in a tax year. “Total Ontario remuneration” is defined in s. 1(1) of the EHTA as the total remuneration paid by an employer to employees working at or paid through a permanent establishment of the employer located in Ontario.

[7] For the tax years in question, the respondents did not include payments they made to S.M.A. in their total Ontario remuneration, taking the position that no tax was owed on these payments as they were not paid to an employee.

[8] Instead, the partners paid employer health tax on the payments they received from S.M.A. as self-employment income. Doing so attracted a lower rate of tax than that which would have applied if the respondents had included the payments to S.M.A. as part of their total Ontario remuneration.

[9] In 1999, the Minister issued notices of assessment to the respondents requiring that they include their payments to S.M.A. in their total Ontario remuneration. The respondents filed notices of objection to the Minister’s assessments and the Minister confirmed the assessments.

[10] The respondents filed notices of appeal which led to the hearing and judgment that give rise to this appeal. The respondents paid the tax as assessed on a without prejudice basis pending the outcome of their appeals.

[11] The trial judge held that the payments made by the respondents to S.M.A. were not payments made to an employee and as such, the respondents were not required to include these payments within their total Ontario remuneration. He ordered the Minister to reimburse the respondents the tax they had paid on a without prejudice basis. The trial judge further awarded costs to the respondents on a substantial indemnity basis.

The Issues

[12] The trial judge framed the issue before him as follows:

The narrow issue to be resolved in this matter is whether [S.M.A.], the partnership in question is to be considered as an individual employee under the [EHTA], whose receipt of payments from the two corporations, SMI and Service Mold, would trigger the imposition of employer health tax.

[13] The trial judge concluded that S.M.A. was not an employee because the EHTA requires that an employee be an individual and a partnership is not an individual.

[14] On this appeal, the Minister agrees with the trial judge’s conclusion that the partnership, S.M.A. was not an employee of the respondents. However, the Minister argues that the trial judge framed the issue incorrectly. The question is not whether the partnership was an employee of the respondents, but rather whether the two partners were employees.

[15] To be fair to the trial judge, it is not entirely clear how the issues were framed before him. Whatever the case, the Minister now bases his submissions solely on the argument that the two corporations were liable to pay tax because the partners, not the partnership, were employees of the two corporations within the meaning of the EHTA.

[16] The Minister also appeals the trial judge’s award of costs in favour of the respondents on a substantial indemnity basis.

Analysis

(a) Were the partners employees?

[17] The relevant provisions in the EHTA are as follows:

1(1) In this Act …

“employee” means,

(a) an individual employed by an employer,

(b) an individual who holds office from an employer and receives remuneration in respect of the performance of the duties of the office …

[18] The Minister argues that the partners were employees under both paras. (a) and (b).

[19] As to para. (a), the Minister relies upon the common law in arguing that the partners were employees of the respondents. In particular, the Minister argues that the four indicia of an employment relationship set out in Wiebe Door Services Ltd. v. M.N.R. (1986), 87 D.T.C. 5025 (F.C.A.) lead to the conclusion that a common law employment relationship existed in this case. The four factors that must be examined under Wiebe Door are control, ownership of tools, chances of profit/risk of loss and integration. No single factor governs. The test requires a court to look at the total relationship in light of the four factors.

[20] The trial judge did not apply the Wiebe Door analysis and thus he did not decide some of the relevant questions. That said, I am satisfied that there is a sufficient factual record before this court to address the Minister’s submission. I have concluded that the partners were not employees of the respondents.

[21] To start, unlike the situation in Wiebe Door, there were no direct agreements between the partners and respondents. The respondents made payments to S.M.A. and S.M.A.’s profits were distributed to the partners according to the terms of the partnership, rather than according to agreements between the respondents and S.M.A. Neither of the partners received direct or individualized compensation from the respondents for the work he performed.

[22] The first factor in Wiebe Door is control. Typically, an employer exercises control over an employee’s activities. The Minister argues that the element of control was present in this case because the agreement specified that S.M.A. would not provide services to the respondents’ competitors.

[23] While this is true, I hardly think it constitutes the type of control that lies at the heart of an employment relationship. The more important consideration is how much control the respondents exercised over the partners themselves in performing the work under the contract (see Wiebe Door at 5027). The answer is virtually none. The management agreements require only that S.M.A. provide services. They did not impose obligations on either of the partners to perform any particular duties, or any duties at all, nor do they specify how either partner is to be compensated. Indeed, under the terms of the management agreements, it is open to S.M.A. to have persons other than the partners perform some or all of the work for the respondents.

[24] Even if the respondents directed S.M.A. how the work was to be performed, they did not dictate who was to perform it or what remuneration those who did the work would receive. In my view, the factor of control in these circumstances weighs very strongly against the existence of an employment relationship between the respondents and the partners.

[25] The second factor is the ownership of tools. In an employment relationship, the employer generally supplies the equipment and tools required by the employee. In this case, the record is sparse as to this element of the relationship. Apparently, the respondents and S.M.A. operated out of the same facilities and shared equipment and supplies. In addition, the management agreements provided that the respondents would reimburse S.M.A. for its reasonable out-of-pocket expenses. Despite the lack of detailed evidence, this factor seems consistent with an employment relationship.

[26] The next factor relates to the chances of profit/risks of loss. While one cannot be categorical, it is a feature of most employment relationships that employees are paid regardless of profitability. In this case, the compensation paid to S.M.A. depended entirely on the profitability of the respondents. If there were no profits, there would be no payment to the partnership. The partnership and the partners, to the extent they performed work, would have performed services for no compensation whatsoever.

[27] While it is true that the respondents agreed to pay S.M.A.’s out-of-pocket expenses, I am of the view that the overall payment structure in the management agreements point away from an employer/employee relationship.

[28] The final Wiebe Door factor is integration. The Minister argues that there was considerable integration between the respondents’ businesses and the partners’ activities and that the services performed by the partners were essential to the respondents’ businesses.

[29] The trial judge did not consider whether the partners were integrated into the respondents’ businesses. Clearly, S.M.A. provided important services to the respondents’ businesses. However, viewed from S.M.A.’s perspective, there is nothing in the management agreements that required it or the partners to devote all or even a specific portion of their time to the respondents’ businesses. The management agreements, which created the relationship relied upon by the Minister did not require integration. Those agreements permitted S.M.A. and the partners to provide services to anyone who did not compete with the respondents.

[30] Looking at the total relationship between the partners and the respondents in light of the four Wiebe Door factors, I conclude that the partners were not employees of the respondents pursuant to the common law test or within the meaning of para. (a) of the definition of an employee in the EHTA.

[31] The Minister also argues that the partners were employees by virtue of the definition of employee in para. (b) which defines an employee as:

an individual who holds office from an employer and receives remuneration in respect of the performance of the duties of the office.

[32] The partners were officers and directors of the respondents and thus held office from the respondents within the meaning of the paragraph. The question then becomes whether the payments they received from S.M.A. constituted “remuneration in respect of the performance of the duties” of being officers or directors of the respondents.

[33] The trial judge rejected this argument. He found that the partners “were not paid as officers or directors of the [respondents]”. This finding was supported by the evidence. The respondents paid S.M.A. pursuant to the management agreements. Those agreements required S.M.A. to perform executive, managerial and consultant services. The agreements contemplated S.M.A. being compensated for the provision of those services. They made no reference to the partners providing services to the respondents as officers or directors. Moreover, the amounts of any payments made to the partners for the work they performed through S.M.A. were determined pursuant to the partnership arrangement, not as a result of directions from the respondents to compensate the partners for duties performed as officers or directors. I see no basis to interfere with the trial judge’s finding that the partners were not paid as officers or directors of the respondents.

[34] Thus, in my view, the Minister’s argument that the partners were employees pursuant to para. (b) of the definition of “employee” set out in the EHTA must fail.

[35] The only other argument of the Minister that requires comment relates to the application of s. 2(3)(a) of the EHTA. That section reads as follows:

2. (3) In determining the tax payable under this Act by any person, a payment made by the person, including a payment in kind, may be deemed by the Minister to be part of the total Ontario remuneration paid by the person where,

(a) the payment is made to an employee of the person or to another person who at the time of the payment did not deal at arm’s length, within the meaning of section 251 of the Income Tax Act [Canada], with an employee of the person; and …

[36] The Minister argues that the partners directed and controlled the respondents and S.M.A. at all relevant times. The parties, therefore, did not deal at arm’s length with S.M.A. and payments made to S.M.A. should be deemed to be part of the total Ontario remuneration paid by the respondents.

[37] This argument is based on a flawed reading of the section. Section 2(3)(a) is a specific anti-avoidance provision. It captures only payments made to an employee or to a person who did not deal at arm’s length with an employee. Because neither the partners nor S.M.A. were employees of the respondents, s. 2(3)(a) does not capture the payments made to S.M.A.

[38] Accordingly, in my view, s. 2(3) does not help the Minister. I note in passing that the EHTA does not have a general anti-avoidance provision similar to s. 245 of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.).

(b) Substantial indemnity costs

[39] The Minister appeals the trial judge’s award of substantial indemnity costs. The trial judge provided no reasons for awarding costs on the higher scale.

[40] In my view, the trial judge erred. Substantial indemnity costs should be awarded only where there are special grounds or there has been some wrongdoing by the party against whom the award is made: Hunt et al. v. T.D. Securities Inc. (2003), 66 O.R. (3d) 481 (C.A.) These requirements were not satisfied in the present case.

[41] In his judgment, the trial judge awarded substantial indemnity costs in the amount of $13,855.14, inclusive of GST.

[42] On appeal, the respondents indicated that the amount awarded at trial reflected what was a fair award on a partial indemnity scale. I agree. Thus, in the result, there is no need to interfere with the trial judge’s award of costs.

Disposition

[43] I would dismiss the appeal. I would award costs of the appeal to the respondents on a partial indemnity scale fixed in the amount of $8,500, inclusive of GST and disbursements.

RELEASED: “DOC” “JUN 20 2007”

“Dennis O’Connor A.C.J.O.”

“I agree Doherty J.A.”

“I agree E.E. Gillese J.A.”