[OFFICIAL ENGLISH TRANSLATION]
2000-1696(IT)G
BETWEEN:
MÉPALEX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Agridanax Inc. (2000-1702(IT)G) on October 1, 2001, at Montréal, Quebec, by
the Honourable Judge Louise Lamarre Proulx
Appearances
Counsel for the Appellant: Serge Racine
Counsel for the Respondent: Johanne M. Boudreau
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed in respect of the amounts of remuneration determined by the auditor of the Minister of National Revenue, as described in Exhibit I-3, and the assessments are referred back to the Minister for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Costs are awarded to the respondent.
Signed at Ottawa, Canada, this 21st day of February 2002.
|
"Louise Lamarre Proulx" |
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
2000-1702(IT)G
BETWEEN:
AGRIDANAX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Mépalex Inc. (2000-1696(IT)G) on October 1, 2001, at Montréal, Quebec, by
the Honourable Judge Louise Lamarre Proulx
Appearances
Counsel for the Appellant: Serge Racine
Counsel for the Respondent: Johanne M. Boudreau
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1995 and 1997 taxation years are allowed in respect of the amounts of remuneration determined by the auditor of the Minister of National Revenue, as described in Exhibit I-3, and the assessments are referred back to the Minister for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Costs are awarded to the respondent.
Signed at Ottawa, Canada, this 21st day of February 2002.
|
"Louise Lamarre Proulx" |
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Date: 20020221
Docket: 2000-1696(IT)G
BETWEEN:
MÉPALEX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
and
Docket: 2000-1702(IT)G
BETWEEN:
AGRIDANAX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard on common evidence. The taxation years in issue in the case of Mépalex Inc. ("Mépalex") are 1995, 1996 and 1997 and, in the case of Agridanax Inc. ("Agridanax"), 1995 and 1997.
[2] The point at issue differs depending on the appellant's and the respondent's approach. In the respondent's view, it must be determined whether the amounts paid by the appellants as bonuses to the children of the shareholder-managers constitute reasonable expenses within the meaning of section 67 of the Income Tax Act (the "Act"). The appellants admit that those expenses were not reasonable but contend that this was a case of income splitting and that the bonuses must be added to the salaries of the shareholder-managers under either subsection 56(2) or subsection 74.1(2) of the Act. They claim the managers' salaries are reasonable within the meaning of section 67 of the Act and are thus deductible by the appellants. This is in fact a request for a change in tax planning to make it consistent with the Act.
[3] Daniel Paul-Hus and Monique Fontaine testified for the appellants; Chantale Yelle testified for the respondent.
[4] Mr. Paul-Hus explained that Monique Fontaine is his spouse. She is the majority shareholder of the common shares of Mépalex. The preferred shares are held by Fiducie Paul-Hus, the beneficiaries of which are the children of the spouses. Mr. Paul-Hus is the principal shareholder and manager of Agridanax. The fiscal year of Mépalex ends on December 31 and that of Agridanax on August 31.
[5] Mr. Paul-Hus explained that Agridanax held auction sales of herds and agricultural equipment and machinery in the Quebec farm market. Mr. Paul-Hus met with farmers wanting to part with their property, and he proceeded with the catalogue preparation and necessary advertising and organized and held the auctions. There was also the preparation and delivery of animals. In this area, Agridanax engaged the services of persons specialized in that type of business. The same was true of agricultural equipment and machinery: persons cleaned and prepared them for the auction sales.
[6] Agridanax can hold 100 or 125 auctions a year. It uses the services of auctioneers and secretaries for those sales. The auctioneers are paid $150 a day and the secretaries, $100 to $150 a day.
[7] The parents said that Mélanie was born on February 1, 1978, Patrick on June 1, 1982, and Alexandre on November 28, 1983. In 1995, Mélanie received a bonus of $50,835, that is, $15,000 from Agridanax and $35,835 from Mépalex; and in 1996, she received a bonus of $34,000, that is, $18,700 from Agridanax and $15,300 from Mépalex. In 1995, Patrick received a bonus of $40,835, that is, $5,000 from Agridanax and $35,835 from Mépalex; in 1996, he received a bonus of $22,500, that is, $7,200 from Agridanax and $15,300 from Mépalex. In 1995, Alexandre received $35,380, all from Mépalex, and, in 1996, a bonus of $19,185, that is, $4,785 from Agridanax and $14,440 from Mépalex.
[8] The parents explained that their children cooperate in certain activities such as catalogue preparation and the auction sale. Mélanie assists her mother in the secretarial work during the sales. Patrick regularly maintains the Web site, and Alexandre provides much assistance during the sales. No time log is kept for the children.
[9] To take advantage of the lower tax rate granted under section 125 of the Act to small businesses whose business limit does not exceed $200,000, in previous years, Agridanax had paid the senior manager a bonus to reduce the income to the prescribed limit. According to Mr. Paul-Hus, an accountant had suggested that they pay a certain portion of the bonus to their children for tax planning purposes.
[10] In 1995, salary and benefits, including bonuses, amounted to $139,235 and, in 1996, to $153,636, as appears in the financial statements of Agridanax, filed as Exhibit A-1. Mr. Paul-Hus submitted that this was not an exhorbitant salary for a senior manager and that the bonuses or salaries paid to the children were in fact indirect payments within the meaning of subsection 56(2) of the Act. Mr. Paul-Hus said that what he had wanted was that the payments made to his children be included in computing his income and that he pay the tax on them. He felt that, otherwise, there would be double taxation because his children had paid taxes on those salaries and the corporation would no longer be entitled either to those deductions or to the benefit conferred on small businesses. He also stated that he and his spouse had always intended to comply with the Act. Mr. Paul-Hus thought his tax planning was consistent with the Act. What he was requesting was the privilege of retracting.
[11] Marie Fontaine testified for Mépalex. She explained that the purpose of Mépalex was to buy and resell farms. The farms may be resold together as a unit but, most of the time, Mépalex uses the services of Agridanax to auction properties, with the exception of the buildings and land themselves, which are sold in the supply-demand market. Marie Fontaine is the sole director and employee of the appellant. She and her children take part in the activities of Agridanax during sales.
[12] The financial statements of Mépalex were filed as Exhibit A-2. Under salaries and benefits, they show total amounts of $259,457 for 1995; $130,607 for 1996; and $224,739 for 1997.
[13] Chantal Yelle, an objections officer, testified and confirmed the assessment on the grounds that, in view of the ages of the children, the fact that they were attending school on a full-time basis, the amounts in question and the duties performed, the salaries paid to the three children were not a reasonable amount. There was no relationship between the duties and the amounts paid. There was no record of the hours worked. The children were at school and Melanie had worked at Wal-Mart 24 hours a week.
[14] The auditor admitted that she had read letters from the appellants' lawyers dated December 4, 1998, and filed jointly as Exhibit A-3. They were contained proposals to have the matter settled by allocating 91 percent of the salaries and benefits to Mr. Paul-Hus and Ms. Fontaine. The lawyers concluded by saying: [translation] "We suggest that the salaries and benefits expense, which would have been valid for the same amount had it been paid in full to the principal shareholder-managers, be allowed and that the tax payable by them and tax payable by the children be reviewed accordingly." This proposal was rejected by the auditor because choices made in previous years, which, moreover, affected various taxpayers in this case, cannot be changed retroactively.
[15] At the request of counsel for the appellants, the auditor filed as Exhibit I-3 an analysis made by the auditor during the investigation concerning the children's work and what might have been reasonable remuneration. That analysis had been done for settlement purposes.
Arguments
[16] Counsel for the appellants referred to the Report of Proceedings of the Thirty-Third Tax Conference, 1981, Canadian Tax Foundation, at page 757, question 42, concerning the reasonable nature of salaries and bonuses:
. . .
3) Large bonuses are often paid in order to reduce the taxable income of a CCPC to $150,000. These bonuses are then reviewed in the light of section 67. Could you please comment?
Department's Position
. . .
3) Subject to the bounds of reasonableness with respect to both the level of salary and bonuses for services performed and the rate of return on investment in shares, the Department generally accepts that a principal shareholder-manager is entitled to determine a mix of salary and dividend that he considers appropriate....
[17] Counsel referred to this Court's decision in Safety Boss Ltd. v. The Queen, 2000 T.C.J. No. 18 (Q.L.), more particularly to the following passages:
27 "Reasonable" in section 67 is a somewhat open-ended concept requiring the judgement and common sense of an objective and knowledgeable observer. . . .
. . .
52 There have been numerous cases on the question of the reasonableness of expenses. Essentially the determination is one of fact. I shall refer to only one that sets out the principle and that has been frequently cited: Gabco Ltd. v. M.N.R., 68 D.T.C. 5210. At page 5216 Cattanach J. said:
It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind. I do not think that in making the arrangement he did with his brother Robert that Jules would be restricted to the consideration of the service of Robert to the appellant in his first three months of employment being strictly commensurate with the pay he would receive. I do think that Jules was entitled to have other considerations present in his mind at the time of Robert's engagement such as future benefits to the appellant which he obviously did.
53 It has in my view been overwhelmingly established that the bonus paid to Mr. Miller in 1991 and the fees paid in 1992 to his company SBIL were fully commensurate with the services rendered by Mr. Miller and were not in excess of the amounts that it would have been reasonable to pay had the parties been at arm's length.
[18] He also referred to the following passages from the decision by the Federal Court, Trial Division, in Murphy v. Canada, [1980] F.C.J. No. 706 (Q.L.), in which the Minister had included in the appellant's income amounts received by his spouse, in accordance with subsection 56(2) or subsection 74.1(1) (formerly subsection 74(1)) of the Act:
37 Under subsection 56(2), the transfer must be for the taxpayer's own benefit or for the benefit of some other person upon whom the taxpayer wished to confer a benefit. Such a requirement is not included in subsection 74(1). Under subsection 74(1) the transferee must be the spouse of the transferor and there is no mention of the conference of a benefit on the other spouse or upon the spouse who transfers. Further in subsection 74(1) when property is transferred it is any income therefrom or loss thereon that is deemed to remain vested in the transferring spouse.
38 As I appreciate this difference in language between the two subsections it follows from the purpose to be accomplished by each. Subsection 56(2) is to impute receipt of income to the taxpayer that was diverted at his instance to some one else. It is to cover cases where the taxpayer seeks to avoid the receipt of what in his hands would be income by arranging to transfer that amount to some other person he wishes to benefit or for his own benefit in doing so. Apart from any moral satisfaction the practical benefit to the taxpayer is the reduction in his income tax.
[19] Counsel for the appellants referred the Court to the decision by the Supreme Court of Canada in Neuman v. Canada (Minister of National Revenue), [1998] 1 S.C.J. No. 37:
32 In order for s. 56(2) to apply, four preconditions, each of which is detailed in the language of the s. 56(2) itself, must be present:
(1) the payment must be to a person other than the reassessed taxpayer;
(2) the allocation must be at the direction or with the concurrence of the reassessed taxpayer;
(3) the payment must be for the benefit of the reassessed taxpayer or for the benefit of another person whom the reassessed taxpayer wished to benefit; and
(4) the payment would have been included in the reassessed taxpayer's income if it had been received by him or her.
[20] Counsel for the appellants argued that the portion of the bonuses paid to the children that may be considered unreasonable must be attributed to the managers of the appellants in accordance with subsection 56(2) of the Act. That additional share would not render the salaries or bonuses received by the managers unreasonable. The salaries or bonuses could be deducted in computing the appellants' income.
[21] Counsel further contended that the total amount of salaries and benefits that should have been included in the salaries of the appellants' managers could be deducted in computing the appellants' incomes since those expenses, even if attributed to the children, were in fact incurred for the purpose of earning the appellants' income.
[22] As a final argument, he submitted that during the investigation, the auditor had considered that the children might be entitled to a certain remuneration, even a minimal one. He therefore asked that it be granted.
[23] Counsel for the respondent stated that the actual issue was the unreasonable nature of the bonuses paid to the children. It was on this basis that the appellants were reassessed. On this point, she referred to the decision by the Federal Court of Appeal in Mohammad v. Canada, [1998] 1 F.C. 165.
[24] She argued that the Court must consider what the taxpayer actually did, not what he might have done. She relied on this point on a decision by the Federal Court of Appeal in Friedberg v. Canada (F.C.A.), [1991] F.C.J. No. 1255 (Q.L.), more particularly to the following passage:
In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax (see The Queen v. Irving Oil, 91 DTC 5106, per Mahoney J.A.). If a taxpayer fails to take the correct formal steps, however, tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions. Taxpayers and the Crown would seek to restructure dealings after the fact so as to take advantage of the tax law or to make taxpayers pay tax that they might otherwise not have to pay. While evidence of intention may be used by the Courts on occasion to clarify dealings, it is rarely determinative. In sum, evidence of subjective intention cannot be used to 'correct' documents which clearly point in a particular direction.
Conclusion
[25] I will start with this last aspect. There are indeed various ways in which a taxpayer may organize his affairs, and each way entails specific tax treatment. It is well-settled in tax matters that the Court must consider what the taxpayer has done.
[26] There is in fact the decision of the Ontario Court of Appeal in A.G. of Canada v. Juliar et al., 2000 DTC 6589 (affirming the decision of the Ontario Superior Court, 99 DTC 5743), in which the parties to an agreement had obtained an order rectifying an agreement. The common intention of the parties was to take part in a rollover under section 85 of the Act, and that was not what the wording of the agreement had reflected. It was not a transaction that had been designed to obtain a certain result, a result which subsequently proved to be a mistake from a tax standpoint.
[27] That case was not argued before me. An application for rectification of legal transactions is not the path that was taken. Could it have been taken? I prefer not to comment since, the decision being relatively recent and case law not yet being settled, a legal debate is necessary.
[28] Counsel for the appellants asks the Court to force the Minister to exercise his authority under subsection 56(2) to attribute to the appellants' managers the indirect payments made with their concurrence to their children. Counsel for the appellants did not refer me to any decision supporting what he chose to propose and enabling me to do what he wishes.
[29] He argued that, if those amounts were attributed to the managers of the appellants, that would not result in unreasonable amounts of salary. However, the question arises as to whether assessment of the managers under subsection 56(2) of the Act would make it possible to increase the businesses' expenses retroactively? Moreover, and most importantly, this is not what is at issue in the instant appeals. It is not the managers who are appealing. The assessments in appeal before me are those of the corporations.
[30] The appellants were reassessed because the bonuses or salaries paid to the managers' children were unreasonable, and it is those assessments that are in appeal here. The Minister was entitled to find those bonuses unreasonable. Even the appellants agreed with him, but they are asking that the salaries paid to the parents and children be amended by increasing the salaries of the parents and reducing those of the children. The Court cannot restructure what has been done.
[31] The salaries and bonuses paid to the children were clearly unreasonable. Some services were rendered by the children and might deserve remuneration. I find the analysis conducted by the auditor and filed as Exhibit I-3 reasonable. No evidence was adduced to suggest that this remuneration might have been increased and by how much. It is therefore my view that the amounts that were apparently attributed to the children according to that analysis are reasonable and may be deducted in computing the appellants' income.
[32] The appeals are allowed on that basis only. The respondent is awarded her costs.
Signed at Ottawa, Canada, this 21st day of February 2002.
|
"Louise Lamarre Proulx" |
J.T.C.C.