Tax Court of Canada Judgments

Date: 20000114

Dockets: 98-2055-IT-G; 98-2057-IT-G

BETWEEN:

WILLIAM A. DIGDON, ATLANTIC COMBUSTION PRODUCTS Ltd.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Bell, J.T.C.C.

[1] These appeals were heard together.

[2] ISSUES RE: ATLANTIC COMBUSTION PRODUCTS LIMITED ("Atlantic"):

1. Whether the following amounts in the following years paid to Willoughby Digdon, father of William A. Digdon ("William"), namely:

1993 $13,200

1994 $13,200

1995 $18,200

were deductible by Atlantic,

2. Whether the penalties assessed pursuant to subsection 163(2) of the Income Tax Act ("Act") in respect of the foregoing amounts were properly assessed, and

3. Whether certain vehicle allowance expenses paid by Atlantic to William in excess of amounts allowed by the Minister of National Revenue ("Minister") as follows:

1993 $1,917

1994 $10,139

1995 $13,161

were deductible by Atlantic.

[3] ISSUES RE: WILLIAM:

1. Whether William, on the purchase of an automobile from Atlantic in his 1992 taxation year received a benefit of $15,845 under subsection 15(1) of the Act. This issue may be resolved on the ground that the reassessment for that year, having been made more than three years after the date of the original assessment, was statute barred, William, having under subsection 152(4) of the Income Tax Act ("Act"), made no representation attributable to neglect, carelessness or wilful default in filing the return as alleged by the Respondent.

2. Whether amounts paid by Atlantic to Willoughby as above set out, namely:

1993 $13,200

1994 $13,200

1995 $18,200

should be included in William's income by virtue of subsection 56(2) of the Act, and

3. Whether penalties assessed in respect of the amounts in the above paragraph were properly assessed under subsection 163(2) of the Act.

FACTS:

[4] William, President of Atlantic, testified that Atlantic commenced business in 1975 servicing the wood-fired home heating market with a chimney cleaner called Co-Mate Chimney Cleaner. It decided, for survival purposes, to break into the industrial market in order to develop the equipment necessary for feeding boilers in businesses such as the pulp and paper industry, Atlantic engaged Willoughby Digdon ("Willoughby"), who had many years of experience in the construction business, to design an appropriate feeder system for same.

[5] William testified at length about the problems in developing workable equipment. Willoughby worked on this aspect of the business while William sought sales. William testified that Willoughby had worked about 500 hours in 1975, that he worked full-time from 1976 to 1986 inclusive, that he worked part-time in 1987 and 1988 and worked full-time in 1989. Willoughby had sold his business prior to 1975 and was, accordingly, available to help in the development of the business. William said in evidence that Willoughby worked as hard as he did in order to make the company "go". He said that he had told his father that he needed help, that the company couldn't pay him then but would pay him in the future. He said that he had this conversation with his father in mid to late 1975. He also testified that because of money shortage, in seeking sales, he drove a cheap car, stayed at the cheapest motels, carried a cooler with food and used a hot plate to prepare it.

[6] According to William, the equipment, developed and presently in 100 industrial establishments, is unique in North America.

[7] William testified that Atlantic reached the stage where it had money and paid Willoughby:

(a) $3,000 in 1987,

(b) $13,200, being $1,100 per month in 1988 and subsequent

taxation years, and

(c) $18,200 in 1995.

[8] He also said that his father was ill and that he would not live long enough for William to cause Atlantic to pay him what his service had been worth.

[9] On cross-examination William said that the payments in 1993, 1994 and 1995 to Willoughby by Atlantic were made at his (William's) direction. He testified that his father, Willoughby, had never invoiced him, that Atlantic had never set up a liability for an amount owing to this father and that from 1975 to 1987 there was no clear statement of amounts owing by Atlantic to Willoughby. William had, in discussions with the Revenue Canada auditor, Miss Leonard, asked how he could "set up a pension for his father". William had told her not to contact his father because of the state of his health. She said that the reason for disallowing the amounts as deductions to Atlantic was that there was no documentation. On numerous occasions during her evidence she referred to "no documents" and "no documentation". The amounts paid to his father were described as consulting fees on Atlantic's books.

[10] With respect to William's first issue, he testified that Atlantic bought a 1990 Jaguar car on April 25, 1990 for $58,500. He also said that he purchased this car from Atlantic in December, 1992 because of what he regarded as an excessive stand-by charge under the Act. This sale was recorded in Atlantic's records. It appears that the automobile was not registered in William's name. Appellants' counsel filed a number of exhibits being, substantially, correspondence with Chapman Motors Limited ("Chapman") the dealer from which the car had initially been acquired and with Jaguar Inc., all respecting the multiple problems with the car. Indeed, there were many, many difficulties with the car which had not all been dealt with even at the expiration of the warranty.

[11] William obtained a letter of opinion from O'Regan Motors Limited dated December 21, 1992 showing the value of that automobile as $16,500. The author had been in the car business for many, many years and was qualified as an expert on automobile valuation. While he could not recall certain events respecting what he had done in connection with the valuation, he was so impressed with the frailties of the car that, for his company's protection, he included the following sentence in his appraisal opinion letter, namely:

This does not constitute an offer to purchase.

[12] The Respondent did not produce any valuation evidence. The sale price of the car of $16,500 plus taxes totalled $19,421 and was shown on the 1993 financial statements of Atlantic as

0% shareholder loan to purchase vehicle, payable

in equal annual instalments of $3,885.

It then showed the balance owing in 1994 as $15,536. Miss Leonard said that "we" thought that a reasonable value would be higher than $16,500. She admitted that Revenue Canada did not obtain a valuation appraisal of the car. She also admitted that she did not have the credentials to give a opinion on care evaluation.

Atlantic's third issue

[13] William also gave evidence that he drove his personal vehicle on many trips to areas where companies with which Atlantic was affiliated, were seeking to establish businesses. Although these projects were apparently in the names of those companies, William said that all mileage included in a log prepared by him was in respect of travel on behalf of Atlantic. He said that all the miles related to Atlantic activities. He said further that it was Atlantic's intention to acquire a portion of these companies when they became successful.

[14] Miss Leonard, the auditor, testified that the mileage with respect to the other companies was, in her view, an expense of those companies. She testified that she had looked at the mileage logs respecting each company and that all amounts had been deducted as an expense by Atlantic. She testified that all trips made on behalf of Atlantic had been allowed. The amounts claimed and the portion thereof denied as deductions by the Minister of National Revenue are:

Year	Total Claimed	Amount Denied by the Minister
1993	$6,182	$1,917
1994	$17,229	$10,139
1995	$17,981	$13,161

SUBMISSIONS, ANALYSIS AND CONCLUSION:

First issue respecting William

[15] I accept the submissions of Appellants' counsel that there was, within the meaning of subsection 152(4) no

... misrepresentation that is attributable to neglect, carelessness or wilful default.

respecting William's failure to include in his 1992 taxation year income, the amount of $15,845 as a benefit conferred by Atlantic upon him. When the automobile was transferred by Atlantic to him in that year it was done on the basis of a valuation opinion received from someone knowledgeable in that industry. Although that person had not been paid for such service, no valuation of any type was obtained by the Respondent in order to make this reassessment or indeed since the reassessment was made. William obtained this valuation upon the advice of his accountant. What more could he reasonably be expected to do? Apart from the valuation having been unchallenged, there was no misrepresentation attributable to neglect, carelessness or wilful default. Because the reassessment of William's 1992 taxation year was made more than three years[1] after the date of the original assessment, it is, therefore, invalid.

First and second issues of Atlantic and second and third issues of William

[16] With respect to the first issue of Atlantic and the second issue of William, are the amounts paid by Atlantic to Willoughby properly allowed as deductions to Atlantic and should those amounts properly be included in William's income under subsection 56(2) for the respective years?

[17] Appellants' counsel submitted that the services of Willoughby had been performed over a long time for no remuneration and that payments to him from Atlantic commenced when Atlantic had the ability to pay. He referred to Bartlett v. M.N.R., 83 DTC 461. Bartlett founded an agricultural chemical business in 1912. This business carried on as a proprietorship until 1950 or so when it was incorporated. In each of 1972, 1973 and 1974, payments of $17,150 were made by the company to Bartlett's widow, Lydia. Those payments were deducted by the company. The Minister disallowed the deduction on the basis that in those years Lydia was not employed by the company and had performed no services for the company and that the deduction was therefore prohibited by paragraph 18(1)(a) of the Act.[2] The evidence made it clear that Lydia had, in the past, made substantial contributions to the business. A son testified that his mother was "really a partner" of his father. He said she had never been paid in spite of always being in the office in the early years. A description of her services followed.

[18] The Tax Review Board said:

The Appellant and his witnesses clearly misused the word "salary" when they employed it to describe the payments made to Lydia Bartlett. They were simply ex gratia payments in the nature of a pension granted to a lady who was both widow of the appellant's former chief executive officer and also a person who had, in her own right, made a material contribution to the success of the company's business. It seems evident that paragraph 18(1)(a) of the Act would not serve to prohibit the deduction of payments of the sort in question here, in a case where payor and payee deal with each other at arm's length. There is no basis for reaching a different conclusion as to the effect of paragraph 18(1)(a) simply because the payor and payee here do not deal at arm's length. The appeals of the corporation therefore succeed on this issue.

[19] In anticipating the Respondent's submission respecting the principle of matching services and payment for same in a given year, Appellant's counsel submitted that paragraph 18(1)(a) does not refer to the year of outlay and does not refer to matching.

[20] Counsel then made reference to Canderel Ltd. v. R., 98 DTC 6100. He quoted the words of Iacobucci, J. at page 6108 as follows:

On the other hand, if some other method is appropriate, is permissible under well-accepted business principles, and is not prohibited by the Act or by some specific rule of law, then there is no principled basis by which the Minister should be entitled to insist that the matching principle -- or any other method, for that matter -- be employed.

[21] The learned Justice made this statement after saying that the goal of the legal test of "profit" should be to determine which method of accounting best depicts the reality of the financial situation of a particular taxpayer. Indeed, the Canderel case was devoted to determining whether an amount paid as tenant inducement payment could be deducted in the year of payment or whether it should be deductible in appropriate amounts over the term of the lease. That case discussed the selection of a method of presenting the Appellant's profit and settled on the premise that

... where no one method emerges as clearly superior or more properly applicable than another, the taxpayer should retain the option of ordering its affairs in accordance with any method which is in accordance with well-accepted business principles and which is acceptable in light of the reality of its business. That is to say, just because a particular tactic is acceptable under well-accepted business principles will not necessarily justify its application in a given context if it is out of step with the actual manner in which the taxpayer conducts its affairs.

(emphasis added)

[22] Later, in his concluding paragraph, the learned Justice said:

... there is no basis for treating the matching principle as a "rule of law".

[23] Judge Sarchuk of this Court, in Hassanali Estate v. R., 97 DTC 905, allowed the taxpayer to deduct salary expenses relating to past services. A Count Sajan Hassanali ("Count") who operated an apartment building as a commercial enterprise, cohabited with his friend, Helga Georg ("Georg"). After approximately 15 years, the relationship deteriorated and they separated. During that time Georg had worked for the enterprise without remuneration. The Supreme Court of Ontario ordered Count to pay Georg $725,000. With respect to the Count's claim for deduction of this amount as a business expense, the learned Judge said, at 908:

Rather I am satisfied that the award made by Walsh, J. represented his view of the appropriate compensation to Georg on a value received or quantum meruit basis for the services she rendered on the ground of an implied obligation to pay arising from the need to remedy unjust enrichment. Although the Reasons for Judgment are not specific with respect to the basis upon which the amount of $725,000 was calculated, the transcripts of the testimony before Walsh, J. suggest that the focus of Georg's case was directed toward the services provided by her and, I note, the only expert testimony adduced related principally to the value of those services. While it is not possible in cases such as this to calculate the value of the services received by the Count on a strict accounting basis, the award was approximately equal to the value of the reasonable expectation of Georg for services provided by her as property manager, superintendent and with respect to her labour involved in maintenance and repairs.

Having concluded that the amount in issue represents quantum meruit payment for services rendered by Georg, it is necessary to consider its characterization for income tax purposes. The Reasons for Judgment of Walsh, J. make it evident that the vast majority of the services provided by Georg were related to the management of Kennedy Towers. Furthermore, it is indisputable that Georg owed no duty at common law, in equity or by statute, to perform the duties of property manager, superintendent, or to provide maintenance and janitorial services to the Count's property. The monetary award to Georg for services rendered when viewed in the context of the evidence before Walsh, J. can most readily be equated with the commercial value of those services. On balance, I have concluded that the services performed were of a character that had they been provided for immediate compensation in the ordinary course, payment therefor would have given rise to taxable income in her hands. Correspondingly, from the perspective of the Appellant in this case, the cost of those services, if incurred at the time they were provided, would have been expenses incurred by the Count in the operation of the rental property. It follows therefore that the amounts paid by the Count pursuant to the Order of Walsh, J. fall within paragraph 18(1)(a) of the Act and are deductible by him.

[24] Atlantic did not have the funds necessary to pay Willoughby during the years when he performed services. In spite of the fact that no amounts were set up as owing to him in those years, William's evidence, uncontradicted, was that he had advised his father that the company would pay him when it was able so to do. Respondent's counsel's suggestion that amounts payable by Atlantic to Willoughby could have been set up in Atlantic's, under the mechanism of section 78 of the Act, books makes no sense whatsoever in these circumstances. Section 78 simply provides formulae for dealing with amounts incurred as deductible outlays or expenses owing by a taxpayer to a person which were not paid in the year of such deduction. This section has been used in circumstances where an employer wished, in a given taxation year, to reduce taxable income by an amount which could be paid to an employee in a subsequent year. That situation could not pertain here where Atlantic simply didn't have the money to make payments in the years during which Willoughby performed services for it and, therefore, had no need to claim such deduction. The "matching" principle of accounting[3] can have no application where a company received the benefit of sterling services performed by someone at a time when the company was simply unable to pay for same. It would be wholly inappropriate to conclude that in a democratic, business oriented society, amounts subsequently paid by a taxpayer to someone who had provided valuable and productive services to it when it was unable to pay for same, would not be deductible. This conclusion is reached "in light of the reality of the [Atlantic's] business".

[25] Canderel and other cases, discussing the "matching principle" did so in the circumstances of profitable taxpayers where the Courts were concerned with determination of profit. As set out above the circumstances in the case at bar are entirely different. The logic employed in Bartlett and Hassanali has application here. Accordingly, the above amounts paid by Atlantic in the three years under examination will be deductible to it. Obviously, the penalty assessed in respect of Atlantic will be deleted.

[26] In the circumstances, such sums were paid by Atlantic to Willoughby for services performed and, accordingly, are not payments made "pursuant to the direction of, or with the concurrence of" William for the benefit of his father and are not includable in William's income.[4] Subsection 56(2) having no application to William, the penalty assessed in that regard will be deleted.

Third issue respecting Atlantic

[27] With respect to the automobile expenses claimed by Atlantic and denied by the Minister, I have concluded that same were properly disallowed. The Appellant did not satisfy me that the amounts denied by the Minister were expended for the purposes of the business of Atlantic. William's testimony established that journeys were made for the purpose of establishing new business of which Atlantic would ultimately, when successful, own a part. This simply falls short of providing the specifics necessary to establish a valid claim for same by Atlantic.

[28] In result, the appeal will be allowed to the extent that:

(a) the amounts of $13,200 in 1993, $13,200 in 1994 and $18,200 in 1995 paid by Atlantic to Willoughby are deductible by Atlantic,

(b) the penalties in respect of Atlantic will be deleted,

(c) the amounts of vehicle allowance expenses namely, $1,917 in 1993, $10,139 in 1994 and $13,161 in 1995 are not deductible by Atlantic,

(d) the Minister had no authority to reassess William for his 1992 taxation year,

(e) the amounts of $13,200 in 1993, $13,200 in 1994 and $18,200 in 1995 were improperly added by assessment to William's income by virtue of subsection 56(2) of the Act, and

(f) the penalties assessed to William in respect of those amounts will be deleted.

[29] The Appellant is entitled to costs.

Signed at Ottawa, Canada this 14^th day of January, 2000.

"R.D. Bell"

J.T.C.C.

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