Date: 19991014
Docket: 96-4680-IT-G
BETWEEN:
NIKOLAI KHABIBULIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowie J.T.C.C.
[1] The Appellant was a non-resident of Canada in the year 1994, and this appeal concerns the application of the Canada-U.S.S.R. Tax Convention (the Treaty) to an amount paid to him by Jets Hockey Ventures, a partnership which owned and operated the Winnipeg Jets Hockey Club at that time. The amount in question was the first of two instalments making up what is described in their contract as a "signing bonus". The Appellant reported his income for the 1994 taxation year on the basis that the amount paid to him as the first instalment of his signing bonus was exempt from taxation by reason of the Treaty and subparagraph 110(1)(f)(i) of the Income Tax Act (the Act). The Minister of National Revenue (the Minister) assessed the Appellant on the basis that the Treaty, while applying to his salary for the year, does not apply to the signing bonus, which therefore forms part of his income taxable in Canada.
[2] The parties agreed to most of the relevant facts in the following terms:
1. The Appellant was a resident of the State of Belarus in the Commonwealth of Independent States and was not a resident of Canada as that term is defined in the Act in respect of the 1994 taxation year.
2. The Canada/U.S.S.R. Income Tax Convention (the "Canada – USSR Treaty") applies to residents of Belarus.
3. During the 1994 calendar year, the Appellant was physically present in Canada for less than 183 days.
4. On August 15, 1994, the Appellant executed a contract (the "Contract") with the Jets Hockey Ventures (a limited partnership) by its general partner, 8 Hockey Ventures. Inc. (the "Winnipeg Jets").
5. The Appellant has been drafted by the Winnipeg Jets and was not a free agent on August 15, 1994 when he signed the contract with the Winnipeg Jets.
6. The Contract was approved by the President of the National Hockey League (the "NHL") on August 25, 1994.
7. During September, 1994 the Appellant attended the training camp of the Winnipeg Jets in Winnipeg, Manitoba.
8. On the completion of the training camp the Appellant was informed that the NHL season was subject to a lock-out, and he was to provide services to the Springfield Falcons, a minor league club of the American Hockey League, located in Springfield, Connecticut.
9. The lock-out by the owners started on October 1, 1994, when the 1994-1995 season was scheduled to commence, and ended on or about January 13, 1995. No NHL games were played during the period of the lock-out.
10. During the 1994 calendar year the Appellant provided services to the Winnipeg Jets and the Springfield Falcons for a total of 119 days. Of the 119 days the Appellant provided services in the United States for 87 days.
11. In accordance with the terms of the Appellant's contract with the Winnipeg Jets, the Appellant received the following amounts (Canadian dollars) in his 1994 taxation year:
|
Salary |
$ 26,833 |
|
Signing Bonus |
104,123 |
|
Training Camp Salary |
400 |
|
Total |
$131,356 |
12. The amount of the signing bonus paid was an amount that was deductible in computing the income of a taxpayer in Canada who was subject to tax under Part I of the Income Tax Act.
13. In calculating income for his 1994 taxation year, the Appellant deducted the amount of $130,753.54. In so doing, the Appellant relied upon paragraph 110(1)(f) of the Act. The Appellant also claimed that the Signing Bonus and the salary were exempt from Canadian taxation pursuant to paragraph 4 of Article 12 of the Canada-USSR Treaty.
14. By a Notice of Reassessment dated April 29, 1996 (the "Reassessment"), the Minister of National Revenue (the "Minister") reassessed the Appellant's 1994 taxation year by reducing the paragraph 110(1)(f) deduction of the Appellant from $130,753.54 to $27,233 on the basis that the Signing Bonus did not qualify for a deduction under paragraph 110(1)(f) of the Act.
[3] The only witness at the hearing was Mr. James Grossman, who is a sports agent of considerable experience. He has negotiated entry level contracts for more than 50 professional hockey players, including the Appellant. He testified that the Appellant was selected in the National Hockey League (NHL) draft, and that by the provisions of the NHL collective bargaining agreement he was therefore not free to negotiate a contract with any NHL team other than the Winnipeg Jets. He said that in representing the Appellant in the negotiation of what was his first North American contract, he approached it on the basis that what he had to obtain for the Appellant was a three-year agreement that would be more lucrative than the contract he could obtain to play hockey in Russia. He quantified this as $305,000, and he obtained a contract for that amount, made up of a guaranteed salary of US$60,000 per year minimum, plus a signing bonus of US$125,000 to be payable in two instalments, the first being US$75,000[1] payable July 15, 1994, and the second US$50,000 payable July 15, 1995. The contract also provided for certain performance bonuses which are not relevant to this appeal. According to Mr. Grossman, whose evidence I accept, a signing bonus is included in all entry level contracts. In this particular case, he said, it was necessary to insure a significant payment at the beginning of the contract, so that the Appellant, who was a resident of Belarus, would have some money available to him in a lump sum to cover the costs involved in travelling to and establishing himself in North America. He said that the contract was explained to the Appellant as being for an amount in excess of $100,000 per year for three years.
[4] The NHL's collective bargaining agreement with its players defines "signing, reporting and roster bonuses" as follows:
... means any Compensation, regardless of when paid, for signing a Player Contract, reporting to training camp, making the roster or any other activity not contingent upon a player's attaining or surpassing a particular level of performance. Any non-cash item of value promised or received as Compensation shall automatically be deemed to be a Signing, Reporting or Roster Bonus. Any Compensation for non-roster related services paid or promised to be paid to a Player subject to the Entry Level System shall be deemed to be a Signing Bonus.
Paragraph 14 of the Collective Bargaining Agreement provides as follows:
The Club may also terminate this Contract upon written notice to the Player (but only after obtaining waivers from all other League clubs) if the Player shall at anytime:
(a) fail, refuse, or neglect to obey the Club's rules governing training and conduct of players, if such failure, refusal or neglect should constitute a material breach of this Contract.
(b) fail, refuse or neglect to render his services hereunder or in any other manner materially breach this Contract.
In the event of termination under subsection (a) or (b) the Player shall only be entitled to compensation due to him to the earlier of the date such notice is delivered to him or the date of the mailing of such notice to his address as set out below his signature hereto.
In the event this Contract is terminated by the Club while the Player is "away" with the Club for the purpose of playing games the instalment then falling due shall be paid on the first week-day after the return "home" of the Club.
Mr. Grossman agreed that, pursuant to this clause, if the Appellant had signed his contract, and on July 15, 1994 had received the first instalment of the signing bonus in the amount of US$75,000, and had thereafter refused to report to training camp or to play hockey as assigned, then he would be entitled upon his termination by the Club to keep the US$75,000 payment.
[5] Subparagraph 110(1)(f)(i) of the Act, so far as it is relevant, reads as follows:
110(1) For the purposes of computing the taxable income of a taxpayer for a taxation year, there may be deducted such of the following amounts as are applicable:
...
(f) ... any amount that is
(i) an amount exempt from income tax in Canada because of a provision contained in a tax convention or agreement with another country that has the force of law in Canada.
Sections 1, 2 and 4 of Article 12 of the Treaty read as follows:
Income Tax Agreement
CANADA AND
THE UNION OF SOVIET SOCIALIST REPUBLICS
1. Subject to the provisions of Articles 13 and 14, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.
2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:
(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned, and
(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
(c) the remuneration is not borne by a permanent establishment which the employer has in the other State.
...
4. Notwithstanding the provisions of paragraphs 1 and 2, income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio or television artiste, or a musician, or as an athlete, from his personal activities as such exercised in the other Contracting State shall be taxable only in the first-mentioned State if such income:
(a) is derived in respect of tour performances and other public performances; or,
(b) represents sums of prizes, premiums and remuneration paid to participants and winners of sportive and other performances and competitions.
It is agreed between the parties that the result in this case must turn upon the proper characterization of the $104,123 payment. Was it paid for signing a contract, or was it paid for playing hockey?
[6] The position of counsel for the Respondent is that the Appellant received the amount of C$104,123 as a signing bonus, that is as consideration or partial consideration for entering into a contract of service or an agreement to perform a service in Canada, and so that amount is to be included in income pursuant to subparagraph 115(1)(a)(v) of the Act. This is amplified in the following way at paragraphs 5 through 9 of his summary of argument, which read as follows:
5. The Appellant was a non-resident of Canada during the 1994 taxation year. As such, he was required to calculate his taxable income in accordance with section 115 of the Act. The opening words of section 115 read as follows:
115(1) For the purposes of this Act, the taxable income earned in Canada for a taxation year of a person who at no time in the year is resident in Canada is the amount of the non-resident person's income for the year that would be determined under section 3 if:
(a) the non-resident person had no income other than ...
6. Section 115 is a "limiting" section, meaning that it excludes from the computation of income for a non-resident certain things that would fall under the concept of "world wide income" required by section 3. In other words, the Appellant's income for Canadian tax purposes is limited to those amounts found in section 115.
7. It is the Respondent's position that the Appellant earned taxable income in Canada by virtue of the combined operations of paragraphs 115(1)(a)(v), 115(2)(c.1) and 115(2)(e). Paragraph 115(1)(a)(v) states:
115(1) For the purposes of this Act, the taxable income earned in Canada for a taxation year of a person who at no time in the year is resident in Canada is the amount of the non-resident person's income for the year that would be determined under section 3 if:
(a) the non-resident person had no income other than
...
(v) in the case of a non-resident person described in subsection (2), the total determined under paragraph (2)(e) in respect of the non-resident person ...
8. Where the person is a person described in paragraph 115(2), the income of the non-resident is the amount computed by paragraphs 115(2)(e) and 115(2)(c.1). Paragraph 115(2)(c.1) states:
(2) Where, in a taxation year, a non-resident person was
...
(c.1) a person who received in the year an amount, under a contract, that was or will be deductible in computing the income of a taxpayer subject to tax under this Part and the amount can, irrespective of when the contract was entered into or the form or legal effect of the contract, reasonably be regarded as having been received, in whole or in part,
(i) as consideration or partial consideration for entering into a contract of service or an agreement to perform a service where any such service is to be performed in Canada, or for undertaking not to enter into such a contract or agreement with another party, or
(ii) as remuneration or partial remuneration from the duties of an office or employment or as compensation or partial compensation for services to be performed in Canada.
the following rules apply:
9. The relevant portions of paragraph 115(2)(e) state:
(e) for the purposes of subparagraph (1)(a)(v), the total determined under this paragraph in respect of the non-resident person is the total of
...
(v) amounts described in paragraph (c.1) received by the non-resident person in the year, except to the extent that they are otherwise required to be included in computing the non-resident person's taxable income earned in Canada for the year ...
[7] The Appellant's position is that the amount in question was not paid for signing a contract, but was all part of a total consideration of US$305,000 paid to him for playing hockey for three years.
[8] The principle which governs the application of tax treaties was stated by Addy J. in Gladden Estate v. The Queen[2] and recently approved by the Supreme Court of Canada in Crown Forest Industries v. Canada:[3]
Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned. [Emphasis added by the Supreme Court.]
[9] Counsel for the Crown takes the position that the words "signing bonus" in the contract are clear, and that the payment must take its character from them. For this reason, he says, it falls to be taxed under subparagraph 115(2)(c.1)(i), which specifically brings such bonuses into income. This is said to distinguish it from amounts paid as remuneration from the Appellant's employment as a hockey player.
[10] In my view, this is the kind of legalistic and literal approach against which Addy J. warned in Gladden Estate. The correct approach to the characterization of the July 1994 payment is to be found in the Supreme Court's judgment in Curran v. M.N.R.[4] The Appellant in that case was a senior executive of a large oil company, whose services where sought after by a rival organization which paid him a lump sum of $250,000 to leave the service of his employer and take up employment with it. In a written agreement, the payment was expressed to be made as compensation for loss of his pension rights with his previous employer, and for loss of chances for advancement and loss of the opportunity for re-employment within the petroleum industry. The Appellant took the position that this $250,000 was a capital payment, and not subject to income tax. The Supreme Court of Canada held that, notwithstanding the wording of the agreement, the payment was made for personal service only, and was taxable under section 3 of the Act as income from an office or employment. In the course of his reasons for judgment, Kerwin C.J. said at page 856:
... However, the payment of $250,000 was made for personal service only and that conclusion really disposes of the matter as it is impossible to divide the consideration. The mere fact that the first agreement of August 15, 1951, states that Brown agreed to pay the appellant $250,000 in consideration of the loss of pension rights, chances for advancement and opportunities for re-employment in the oil industry cannot change the true character of the payment. Its true nature must be found in the terms of the two agreements and the surrounding circumstances including the fact that the $250,000 did not come from Imperial Oil Limited.
[11] In the present case, I must have regard to the following surrounding circumstances. First, the amount described as a signing bonus in the contract was to be paid in two instalments. The first of these was payable in July 1994, and the second in July 1995. It is true that the Appellant, in the unlikely event that he accepted the July 1994 payment and then refused to perform any services, would be entitled to keep the amount that had been paid to him. He would not, however, be entitled to receive the July 1995 payment, and that fact alone demonstrates that the character of the amount is something other than simply a signing bonus. Moreover, the evidence does not indicate that the Appellant had such a reputation as a hockey player as would lead the Winnipeg Jets Hockey Club to pay him such a substantial amount of money simply to prevent him from playing for a competing team. The evidence was that he was an eighth round draft pick, and had not previously played in North America. He was not considered by his own agent as a probable NHL player. Finally, the evidence of Mr. Grossman was clear that, when acting as agent for the Appellant in the negotiation of his contract, he considered the entire US$305,000, made up of three years annual salary plus the two instalments of the signing bonus, to be the remuneration that he had to get for his client for three years of playing hockey. After it was negotiated, the contract was explained to the Appellant in exactly that way. I have no doubt that he considered that all of the money was being paid to him for playing hockey, and not that part of it was paid simply to sign his name. There were sound reasons why the Appellant required a substantial lump sum payment prior to the opening of training camp in 1994, in order to establish himself with a place to live and the basic amenities of his new life in North America. It was, in my opinion, a payment made in consideration of his playing for the Winnipeg Jets, or a team designated by them, in the forthcoming three years. As such the "signing bonus" comes within the exempting provision of paragraph 4 of Article 12 of the Treaty, and the Appellant is therefore entitled to deduct it in computing his taxable income by reason of paragraph 110(1)(f) of the Act.
[12] The appeal is allowed, with costs.
Signed at Ottawa, Canada, this 14th day of October, 1999.
"E.A. Bowie"
J.T.C.C.