ONTARIO

SUPERIOR COURT OF JUSTICE

COURT FILE NO.: CV-15-531688
DATE: 20151110

BETWEEN:

RJM56 INVESTMENTS INC.
Applicant

– and –

KEVIN KURNIK AND CANADA REVENUE AGENCY
Respondents

Melvyn L. Solmon, for the Applicant

Michael R. Kestenberg, for Kevin Kurnik
Edward Park & Andrew Kinoshita, for Canada Revenue Agency

HEARD: October 6, 2015

s.a.Q. akhtar j.

I. FACTUAL BACKGROUND AND OVERVIEW

Overview of the Allegations

[1] The applicant, RJM56 Investments Inc., formerly known as RJ McCarthy (and hereinafter known as “McCarthy”), brings an application for the determination of rights under Minutes of Settlement (“the Minutes”) that resolved two ongoing actions. The settlement resulted in the payment of $1.5 million dollars (“the settlement amount”) to Kevin Kurnik and brought to an end an employment dispute between the parties.

[2] Regrettably, payment of the settlement amount gave birth to a new dispute. McCarthy, purporting to comply with the Minutes, claimed that it was entitled to deduct a withholding tax from the entire payment as well as subtract the amount of Canada Pension Plan, Employment Insurance and Employer Health Tax contributions (“CPP/EI/EHT”) that it was obligated to make on Kurnik’s behalf. McCarthy asks this court to determine whether these deductions were proper under the terms of the Minutes.

[3] Kurnik, for his part, brings a separate motion for summary judgment asking that the Minutes be enforced. He submits that, under the terms of the Minutes, a portion of the settlement amount constituted compensation for legal costs and was to be paid without deduction. McCarthy’s debiting of funds, he argues, was a unilateral breach of the Minutes. Kurnik also relies upon a term in the Minutes which imposes an increased payment in the event of default and submits that he is now entitled to that increased payment because of McCarthy’s actions.

Kurnik’s Initial Action

[4] Kurnik was employed as the Chief Financial Officer at McCarthy and its related companies from February 1999 to mid-2008 when the company was sold. Following the sale, a dispute arose over a bonus claimed by Kurnik on the basis of a previous oral agreement. Both Kurnik and McCarthy commenced legal proceedings claiming funds they alleged were owing from the other. A trial date of 15 June 2015 was scheduled to resolve the claims. However, on 1 June 2015, following a judicial pre-trial, the parties reached an agreement to settle the matter.

The Settlement Agreement

[5] Both parties agreed that McCarthy would pay Kurnik the sum of $1.5 million which would result in a full and final release by both parties of any other existing claims. The Minutes provided for the payment to be made in three separate payments and included a “penalty clause” which would be triggered if McCarthy failed to complete the payments as agreed.

[6] These sections of the handwritten Minutes read as follows:

Whereas all of the parties to both actions have agreed to settle both actions on the terms hereafter

The parties directly or through counsel agree as follows

1. the defendant in the Kurnik action #CV-11-427649 agreed to jointly and severally pay to Kevin Kurnik (KK)

a) $250,000 towards KK’s cost of the actions

b) $1,250,000 less withholding taxes payable to CRA in the following payments

i) $250,000 for costs inclusive of HST on July 4/15 (with no deductions) payable to Kestenberg Siegel Lipkus In Trust

ii) $250,000 towards the settlement on July 4/15 payable to Kevin Kurnik

iii)$1 million towards the settlement on Feb 14/16 payable to KK; each of the payments in ii) and iii) above represent a bonus due to KK resulting from his employment with RJM56 Investments Inc. and are subject to withholding tax by said co.

2. To secure the payments required in Para. 1) the cos, RJM 56 Investment Inc. and RJM56 Holdings Inc. consent to judgment in the amount of $1,750,000 such consent to judgment to be held in escrow by counsel for KK and shall only be acted upon for the balance then owing i.e. $1,750,000 less payments made to date of default with default being defined as the failure to form any obligations by the obligors set out herein.

[7] For the purposes of this judgment, the cheque made payable to Kurnik’s lawyers is referred to as “the first payment”.

The Deductions Made by McCarthy

[8] On 19 June 2015, McCarthy delivered the following three post-dated cheques to Kurnik’s counsel, Kestenberg Siegal Lipkus:

1. Cheque payable to Kestenberg Siegal Lipkus LLP, in trust, dated 4 July 2015 in the amount of $250,000;

2. Cheque payable to Kevin Kurnik dated 4 July 2015 in the amount of $960.49; and

3. Cheque payable to Kevin Kurnik dated 14 February 2016 in the amount of $466,496.91.

[9] A memo from Erika Schlager of WBM Partners LLP, McCarthy’s accountants, accompanied the cheques. That memo set out the rationale for the withholding tax deductions from the amounts paid to Kurnik.

[10] Kurnik complained that the amounts differed to what had been agreed with at the pre-trial meeting and recorded in the Minutes of Settlement. Most significantly, the amount deducted from the second cheque was far greater than the applicable withholding tax. McCarthy’s reply informed Kurnik that, under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (“the ITA”), it was obliged to withhold tax from Kurnik’s legal fees as well as his bonus payments. Since the first cheque was expressly required to be delivered without deductions, McCarthy explained that it had calculated the cumulative tax applicable to the first two payments and subtracted that amount from the second cheque.

[11] McCarthy further informed Kurnik that a further sum of $36,815.58 had been deducted to provide compensation for the CPP/EI/EHT contributions that McCarthy had to make on behalf of Kurnik as its employee.

The Positions of the Parties

[12] McCarthy maintains its position that it was obliged, under the ITA, to deduct withholding tax on the entire settlement payment including the monies paid to Kurnik to cover his legal costs. It further submits that this was the intention of the parties when the Minutes of Settlement were drafted. With respect to the CPP/EI/EHT deductions, McCarthy concedes that it is obliged as an employer to pay these amounts on Kurnik’s behalf. However, it takes the position that by doing so, the payment raises the amount paid to Kurnik to a sum in excess of the $1.5 million agreed by both parties. As such, it was entitled to remove that amount from the settlement amount.

[13] Kurnik, on the other hand, seeks summary judgment pursuant to Rules 20 and 49.09 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194, to enforce the settlement. He argues that McCarthy’s unilateral deduction of funds was a violation of the settlement agreement, the plain wording of which made it clear that there were to be no deductions from the funds payable to Kurnik’s lawyers. He further submits that the CPP/EI/EHT contribution was an obligation borne by McCarthy separate and above from the payments agreed to in the Minutes of Settlement. As such, they were improperly deducted. As a consequence of these breaches, he is entitled to the penalty for default stipulated in the Minutes of Settlement.

[14] Finally, the Canada Revenue Agency (“CRA”), though named as a party in these proceedings, takes no position on the main application/motion.

The Issues

[15] The issues to be resolved may be summarised as follows:

(a) Did McCarthy have the right to withdraw tax under the Minutes of Settlement?

(b) Did McCarthy have the right to subtract the CPP/EI/EHT contributions it made from the payment made to Kurnik?

(c) Is Kurnik entitled to the default payment stipulated in the Minutes of Settlement?

[16] Although there are technically two separate matters before me - McCarthy’s application and Kurnik’s motion - the parties agree that the answer to these questions provide the resolution of both. It should also be noted that there is no dispute with respect to Kurnik’s motion that, under the principles enunciated in Hryniak v. Maudlin, 2014 SCC 7, [2014] 1 S.C.R. 87, this court can render summary judgment with respect to enforcement of the settlement: see Sentry Metrics Inc. v. Robert Ernewein et al., 2013 ONSC 959.

[17] Finally, all parties agree that this hearing should concentrate solely on the questions above and not determine the actual monetary amounts that were entitled to be deducted.

II. WAS MCCARTHY ENTITLED TO WITHOLD TAX ON KURNIK’S LEGAL FEES?

Sections 6 and 8 of the Income Tax Act

[18] McCarthy’s assertions that it was under a duty to withhold taxes from the settlement payment stems from the interplay between ss. 6 and 8 of the ITA which are reproduced as follows:

6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are:

(j) amounts received by the taxpayer in the year as an award or reimbursement in respect of an amount that would, if the taxpayer were entitled to no reimbursements or awards, be deductible under subsection 8(1) in computing the income of the taxpayer, except to the extent that the amounts so received

(i) are otherwise included in computing the income of the taxpayer for the year, or

(ii) are taken into account in computing the amount that is claimed under subsection 8(1) by the taxpayer for the year or a preceding taxation year;

8. (1) In computing a taxpayer’s income for a taxation year from an office or employment, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto

(b) amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect, or to establish a right to, an amount owed to the taxpayer that, if received by the taxpayer, would be required by this subdivision to be included in computing the taxpayer’s income; [Emphasis added].

Did the First Payment Constitute Employment Income?

[19] Mr. Solmon, counsel for McCarthy, submits that McCarthy’s contact with the CRA and Ms. Schlager led it to believe that the first payment, dealing with Kurnik’s legal costs, fell within ss. 6 and 8 of the ITA. Having accepted that conclusion, McCarthy had a statutory obligation to withhold the money: see Ahmad v. Northstar Motors Ltd, 2006 ABQB 616.

[20] McCarthy asks this court to rely upon the “expert opinion” rendered by Ms. Schlager who, after the Minutes had been signed, advised that the money constituting Kurnik’s legal fees was taxable as income by virtue of the fact that it fell within s. 8(1)(b) of the ITA and thus became employment income under s. 6(1). I find, however, that Ms. Schlager’s “expert opinion” is only helpful in explaining why McCarthy believed, post-agreement, it should make the deductions. It does not assist in determining whether McCarthy acted in accordance with the provisions of the Minutes.

[21] Mr. Kestenberg, counsel for Kurnik, does not take issue with the view that the settlement money for legal fees could fall within s. 8(1) of the ITA but instead relies upon the principle that when settlement money constituting legal expenses are paid directly to a taxpayer’s lawyer, it would no longer count as employment income: see Scharf v. Freure Homes Ltd. (1994), 95 DTC 5074 (Ont. Gen. Div.). In that case, Somers J. commented upon what might indicate whether a particular payment would avoid the deduction of withholding taxes, at para. 12:

Perhaps the way to have avoided this problem would have been for the parties to have stated specifically in the judgment that the monies were to be paid directly to the law firm. Settlements, and judgments incorporating such settlements, often do make such provision. This is generally to ensure that the legal fees are paid and I doubt that it is often done specifically with a view to ensuring that tax implications can be avoided.

[22] Mr. Kestenberg points out that the money was explicitly set aside to be payable to his firm in trust and therefore could not be intended as anything other than legal fees destined to end up his firm’s hands.

[23] Mr. Solmon, who also relied upon this case, responds that for this exception to apply, the money had to be paid directly to Kurnik’s lawyers and not through Kurnik himself. In this case, he argues, the Minutes directed the money to be paid to Kurnik and be held in trust by him for his lawyers. Kurnik was therefore in control of the funds which, in turn, represented his employment income subject to withholding tax under the ITA. I reject that submission as the court in Scharf found that the critical term in that case was that the monies were to be paid “to the plaintiff” and the cheques were made out in her name. That is a very different scenario to the case at bar where it was made clear that the funds were earmarked for Kurnik’s lawyers and the cheques specifically named “Kestenberg Siegel Lipkus” as the recipients.

[24] Mr. Solmon also points out that any tax deducted could be recouped by Kurnik by the simple task of submitting a T1213 form to Revenue Canada which would request a reduction from the CRA with respect to the withholding tax on his legal fees. Kurnik’s failure to do so should not be laid at McCarthy’s feet.

[25] I find the submissions with respect to the T1213 Form to be a red herring. McCarthy’s realisation of its tax obligations, post-settlement, did not permit it to unilaterally alter the text and intention of the Minutes. I take the same view with respect to the argument that Kurnik had an alternative method to recoup the deducted funds.

[26] If the Minutes prescribed that Kurnik’s legal costs be provided without deduction, it was not open to McCarthy to unilaterally decide otherwise. I recognise the fact that parties cannot contract out of the provisions of any applicable provisions of the ITA; however, if the intention of the parties was to allocate those funds as direct legal costs, the principles enunciated in Scharf would operate to make the ITA provisions inapplicable to those funds.

What Was the Intention of the Parties?

[27] In Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, [2014] 2 S.C.R. 633, Rothstein J, writing for a unanimous court, identified the proper approach to contractual interpretation in the following way, at para. 57:

While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement (Hayes Forest Services, at para. 14; and Hall, at p. 30). The goal of examining such evidence is to deepen a decision-maker’s understanding of the mutual and objective intentions of the parties as expressed in the words of the contract. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract (Hall, at pp. 15 and 30-32). While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement (Glaswegian Enterprises Inc. v. B.C. Tel Mobility Cellular Inc. (1997), 1997 4085 (BC CA), 101 B.C.A.C. 62).

[28] The Court of Appeal for Ontario, in Lombard Canada Ltd. v. Zurich Insurance Co., 2010 ONCA 292, 101 O.R. (3d) 371, also emphasised the importance of determining the intentions of the parties by restricting the analysis to the plain wording of the agreement. As Lang J.A. commented, at para. 33, “If the meaning is plain on the face of the contract, it is unnecessary to proceed further”. Consequently, extrinsic evidence is only to be looked at if an ambiguity exists in the language: see Lombard, at para. 33; and Holmes v. Desjardins Financial, 2014 ONSC 4695.

[29] Despite the fact the settlement directed the first payment be made to Kurnik, it is clear that these funds were (a) payment for Kurnik’s legal costs and (b) made payable specifically to his lawyers in trust.

[30] I reject the argument that because Kurnik might have control of the monies the first payment amounted to employment income under ss. 6 and 8 of the ITA. What is critical is the intention of the parties as reflected in the Minutes. Not only did Kurnik ask for the funds to be made payable to his lawyers but both parties explicitly stipulated there were to be no deductions from this payment.

[31] Mr. Solmon’s explanation of the phrase “no deductions” was that it was simply an administrative measure to ensure the legal costs were paid in full without subtraction. However, he argues, the funds were still intended to be subject to withholding taxes. With respect, this makes very little sense in light of the terminology contained in the rest of the Minutes. The parties ensured that the payments, other than the payment to Kurnik’s lawyers, were to be expressly stipulated as “bonus” payments accruing to Kurnik as employment income and therefore subject to withholding tax. If withholding tax was intended to apply to the entire settlement, there would be no reason for this distinction.

[32] In other words, if the parties had intended the first payment to be treated as employment income, that intention would have been written into the Minutes in explicit terms as was the case for the remaining two payments. Alternatively, all three payments would have been indistinguishable in terms of deduction and description. In this case, however, the opposite is true as the first payment was specifically directed to be paid with “no deductions” whilst the remaining payments were explicitly characterised as “employment income”.

[33] The text of the Minutes leaves very little doubt that the first payment was intended as payment directly to Kurnik’s lawyers “with no deductions” and, as per the Scharf decision, should not have been subjected to withholding tax. To hold otherwise, would, as per Rothstein J.’s comments in Sattva, amount to effectively creating a new agreement.

[34] Finally, Mr. Solmon drew my attention to affidavit evidence concerning comments made at the judicial pre-trial leading to the settlement. In light of my finding that the Minutes provide a clear understanding of the true intention of the parties, I am satisfied that this extrinsic evidence need not be considered.

III. WAS MCCARTHY ENTITLED TO DEDUCT THE CPP/EI/EHT CONTRIBUTIONS?

[35] McCarthy sought to justify its deduction of the additional sum of $36,815.58 on the basis that this sum constituted employer CPP/EI/EHT contributions for 2015-16 payable on Kurnik’s behalf. As a result, the total payment to Kurnik exceeded the $1.5 million agreed by the parties. I find this argument to be disingenuous. As its factum recognises, McCarthy was under an obligation to make the contributions regardless of any settlement with Kurnik. What McCarthy now seeks to do is to merge its obligations to Revenue Canada with the settlement agreement. Once again, this amounts to an impermissible rewriting of the Minutes.

[36] It is telling that, on 26 June 2015, Mr. Solmon wrote to Mr. Kestenberg accepting McCarthy’s obligation to pay the contributions and conceding that “there may be an issue as to whether the obligations of the employer are deductible in these circumstances.” As a result, Mr. Solmon enclosed a cheque for the amount subtracted. It is somewhat surprising that McCarthy now seeks to have this court declare that the $36,815.58 was properly deducted. For the above reasons, I conclude that it was not.

Is Kurnik Entitled to Default Payment?

[37] Turning to the increased payment claimed by Kurnik as a result of the unilateral deductions, I decline to order payment of the increased amount stipulated in the default provision. I do so because McCarthy was obliged to deduct withholding tax from any applicable employment income. It acted upon recommendations from Erika Schlager whose view was that tax had to be deducted from the entire settlement amount. Despite my finding that this advice was misplaced in the context of the agreement made by the parties, an increased payment would not be appropriate in these circumstances. In my view, the default clause was intended to apply to a situation of deliberate default rather than an erroneous deduction for tax purposes.

[38] I would add that my conclusion would be different had McCarthy not repaid the $36,815.58 it unilaterally deducted to cover the CPP/EI/EHT contributions that it had to make.

Conclusion

[39] For the reasons set out above, I dismiss McCarthy’s application and grant Kurnik’s motion, in part. Accordingly, I order that:

(a) McCarthy pay Kurnik in accordance with the Minutes as interpreted in this judgment;

(b) The amount of withholding tax deducted from the first payment (of 250,000 paid as legal costs) must be paid to Kurnik;

(c) McCarthy is only entitled to deduct the amount of withholding tax applicable to the second and third payments totalling $1.25 million;

(d) McCarthy is not entitled to deduct the CPP/EI/EHT contribution made on Kurnik’s behalf from the settlement amount;

(e) Kurnik is not entitled to the increased payment of $1,750,000 less payments made to the date of default under the default provision in the Minutes; and

(f) Nothing in this judgment affects Kurnik and McCarthy’s liability to Revenue Canada.

[40] If the parties cannot agree on costs, I invite Kurnik to submit a written application for costs no longer than 5 pages within 30 days of these reasons. McCarthy is to file written reasons of the same length within a further 20 days of receipt of Kurnik’s submissions.

S.A.Q. Akhtar J.

Released: November 10, 2015

COURT FILE NO.: CV-15-531688
DATE: 20151110

ONTARIO
SUPERIOR COURT OF JUSTICE

BETWEEN:

RJM56 INVESTMENTS INC.
Applicant

– and –

KEVIN KURNIK AND CANADA REVENUE AGENCY
Respondents

REASONS FOR JUDGMENT

S.A.Q. Akhtar J.