Executive Summary: Key Legal and Evidentiary Issues

• Dispute centered on whether biweekly cheques labeled “payroll” were employment income or shareholder draws

• CRA argued payments were salary based on cheque amounts, frequency, and partial remittances in early 2018

• Malamute asserted all payments were shareholder-related, not remuneration for employment

• Court found payor and payees intended payments as shareholder draws at the time they were made

• Mistaken CRA remittances in January and February 2018 did not define the character of subsequent cheques

• Penalties and assessments were vacated as no salary was received by Mr. and Mrs. Lynch for the years in question

Facts and outcome of the case

The factual background

Malamute Contracting Inc. is a small contracting company specializing in kitchen and bathroom renovations. Its principal shareholder, Mr. David Lynch, performs most of the work with the help of two trades employees. His wife, Mrs. Danielle Lynch, a commercial insurance broker by profession, is the other shareholder. During the relevant period, she handled the company’s bookkeeping.

Between January 2018 and February 2019, Malamute issued three types of payments to Mr. and Mrs. Lynch: biweekly “uneven-amount” cheques with “payroll” written on the re: line (referred to as the “Cheques”), other even-amount cheques, and Interac transfers. The legal issue focused solely on the Cheques.

The Cheques were in irregular amounts such as $1,889.12 and paid biweekly. Remittances to the Canada Revenue Agency (CRA) were made for the January and February 2018 Cheques but not for the remaining period. The CRA assessed Malamute under the Income Tax Act and Canada Pension Plan for failing to withhold and remit tax and CPP contributions, and imposed penalties under subsections 162(7), 227(8), and 227(9) of the Act.

Malamute argued that these payments were not employment income but shareholder-related draws. If correct, there was no obligation to withhold or remit tax or CPP contributions.

Discussion of the relevant legal test and policy terms

The tax treatment of a payment depends on its character at the time of payment. The Court relied on Adam v MNR, Irmen v The Queen, and Park Avenue Furniture (MFG.) Corporation v MNR to affirm that a payment’s nature is determined by the shared intention of the payer and payee at the time it is made.

The Respondent contended that the initial remittances made in January and February 2018 established the payments as salary and that subsequent similar Cheques must be treated the same. CRA appeals officer Ms. Slingerland testified that Malamute’s accountant, Mr. Pallard, admitted those Cheques were payroll. However, her file notes indicated only a conditional concession: “ok fine, maybe the ones in January can be called payroll, but not the whole year.”

The Court preferred the evidence of Malamute’s witnesses. Mr. Pallard, Mrs. Lynch, and Mr. Lynch testified consistently that the intent was to compensate the Lynches as shareholders, not as employees. The Cheques were treated as shareholder draws in Malamute’s financial statements. Dividends of $50,000 and $65,000 were declared to Mr. Lynch on January 2, 2018 and January 2, 2019, respectively. The 2018 and 2019 income tax returns of both Malamute and the Lynches showed no employment income.

Mrs. Lynch explained that the “payroll” notation was to distinguish the Cheques from loan payments and that she used a government calculator to estimate tax deductions, mistakenly resulting in January and February remittances. She no longer handles payroll due to these errors.

The CRA did not consult Mr. or Mrs. Lynch about their intent and discounted Malamute’s financial and tax filings for 12 months based on remittances made only during the first two. The Court found this to be an unwarranted extrapolation.

Outcome and court’s decision

The Court found that the Cheques were not salary from employment but payments issued in the Lynches’ capacity as shareholders. This was the shared intention of all parties at the time the payments were made. Mistaken remittances and poor bookkeeping did not change the nature of the payments.

As a result:

• The income tax reassessments and CPP assessments were returned to the Minister for reconsideration

• Mr. and Mrs. Lynch were found not to have received salary from employment for the tax years ending October 31, 2018, and October 31, 2019

• Related penalties were vacated

• Malamute Contracting Inc. was awarded costs. No amount was specified.