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Citation: 2003TCC67
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Date: 20030331
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Docket: 2000-5079(IT)G
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BETWEEN:
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THOMAS COSTIGANE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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AMENDED REASONS FOR JUDGMENT
Miller, J.T.C.C.
[1] Thomas Costigane appeals by
way of the general procedure the Minister of National
Revenue's (the "Minister") assessments of his
1995, 1996 and 1997 taxation years on two fronts. First,
Dr. Costigane disagrees with the Minister's disallowance
of approximately $19,000.00 in each of the years in question as
deductible bookkeeping charges paid to Costigane Financial
Services. Costigane Financial Services was a trust established
for Dr. Costigane's three minor children. Second,
Dr. Costigane disagrees with the disallowance of a deduction
in 1996 of $14,656.00 and in 1997 of $22,277.00 for what he
considers replacement insurance paid to a British Virgin Islands
corporation.
[2] Dr. Costigane is a dentist.
On January 2, 1993, a trust agreement was entered into by
Linda Gillis settling $100.00 on the Costigane Family Trust.
Dr. Costigane signed the agreement as one of the three
trustees, the other two being his sister and
brother-in-law. Dr. Costigane's three minor
children were the beneficiaries of the Costigane Family Trust. On
the same date, Dr. Costigane entered into a service
agreement with Costigane Financial Services, an entity described
in the two-page agreement as a proprietorship owned by the
Costigane Family Trust.
[3] Pursuant to the terms of this
agreement, Costigane Financial Services was to provide to
Dr. Costigane's dental practice management, bookkeeping
and accounting services, including rendering accounts, collecting
receivables and maintaining accurate records. Dr. Costigane
agreed to pay Costigane Financial Services a monthly fee of
$2,450.00. Dr. Costigane paid $29,400.00 to Costigane
Financial Services for each of 1995, 1996 and 1997.
[4] Dr. Costigane testified that
he entered this arrangement to free himself of bookkeeping
duties, which he claimed required one to five hours a day of his
time. In searching for an appropriate bookkeeping service, he
wanted someone who would be familiar with his dental practice and
in whom he would have the confidence that they would retain
patient confidentiality. His search led him to his very own
employees, Ms. Lynch, Ms Briggs and Ms. Booth, who
he described as dental assistants, receptionist and preventive
dental assistant. He arranged for Costigane Financial Services to
hire these three employees of the dental practice to also become
employees of Costigane Financial Services for the purposes of
providing the services described in the service agreement.
Costigane Financial Services paid two of the three employees the
same rate as Dr. Costigane paid them for their work
performed directly for him. The other employee was paid $14.60 an
hour instead of $14.00 an hour. In 1996, only Ms. Lynch and
Ms. Briggs had this dual employment arrangement;
Ms. Briggs was paid the same wage ($11.72 an hour) in both
jobs, while Ms. Lynch received $15.84 per hour from
Costigane Financial Services and $15.90 from Dr. Costigane
directly. In 1997, a new employee was introduced to the
arrangement. All three employees received the same hourly rate
from both jobs in 1997. The amounts paid by Costigane Financial
Services to its employees in 1995, 1996 and 1997 were $8,152.00,
$8,494.00 and $8,531.00 respectively. Other expenses of Costigane
Financial Services in each of those three years were less than
$500.00.
[5] Costigane Financial Services
showed a profit in each of the three years of approximately
$21,000.00, which the Costigane Family Trust distributed equally
to the three minor beneficiaries.
[6] Dr. Costigane indicated that
he determined the $2,450.00 monthly charge based on his
understanding of what other professional practices, notably
accountants, up-charged for their staff. He also relied on what
he, in his dental practice, would charge for his assistants,
compared to what he paid them. He indicated this was a four or
five times mark-up. He also contacted a small bookkeeping
operation. He believed they charged employees out at $40.00 to
$60.00 an hour, but paid them only approximately $10.00 to $12.00
an hour.
[7] Dr. Costigane suggested there
were benefits to the arrangement, including more accurate cost
analysis given the separation of clerical from clinical work,
more equitable bonus determination for dental staff, reduction of
Worker's Compensation Board premiums for clerical staff, less
difficulties on termination and an ability to achieve a higher
price for the overall dental practice if the
management/bookkeeping side was sold separately.
[8] With respect to the second issue,
Dr. Costigane provided some considerable background to the
health/medical environment of the early and mid-1990s.
Healthcare was in some turmoil and there were signs of a shift to
the American phenomenon of health management organizations
("HMOs"). HMOs were funded by large insurance
companies, with a view to keeping costs down. HMOs would contract
with major subscriber groups who would be assured that their
healthcare costs would remain low. This was because,
notwithstanding what doctors could charge to the patient, a
doctor could only collect a reduced rate from the HMO. If HMOs
became the way of the future, a doctor who tried to practice
outside an HMO would have few, if any, patients.
Dr. Costigane feared a considerable drop in his income as a
result of this possible change of the status quo.
[9] He sought ways to protect himself
from a drastic drop in revenue. At a trade show, he encountered
Destiny Capital Management Corp., a British Virgin Islands
corporation. Destiny appeared to be offering a form of
arrangement Dr. Costigane believed would serve as a type of
income replacement insurance. He had previously been unsuccessful
in obtaining the type of protection he sought from Export
Development Corporation, as that organization only offered
something similar to entities that produced durable goods.
Dr. Costigane entered into an agreement with Destiny Capital
Corp. entitled a Resource Sale/Purchase Agreement
("RSPA").
[10] Pursuant to the RSPA,
Dr. Costigane sold his accounts receivable to Destiny for
95 percent of the face amount of the invoices. In effect,
what Dr. Costigane did is simply pay Destiny
five percent of his total invoices. Dr. Costigane's
understanding of the arrangement was that if his collection ever
fell below 95 percent, Destiny would make up the difference
to the 95 percent amount. Collections never did fall below
95 percent before the agreement was terminated.
Dr. Costigane paid Destiny $14,656.00 in 1996 and $22,277.00
in 1997. He testified that Destiny would audit the dental
practice's transactions and never found a discrepancy. It
never had to pay anything out to Dr. Costigane.
Dr. Costigane did not advise them of his true purpose in
shielding himself from the possible impact of the introduction of
HMOs.
[11] Dr. Costigane argued that, with
respect to the management/bookkeeping fee paid to Costigane
Financial Services, this was a fair market value fee for
legitimate bookkeeping services rendered. He maintained that
Costigane Financial Services, through the Costigane Financial
Trust, was established for appropriate business purposes, and
only his existing employees met all the qualifications he sought
in a provider of bookkeeping services: confidentiality,
efficiency due to on-site access, familiarity with the
practice and a knowledge of codes for goods and services tax
rebates.
[12] With respect to the Destiny expenses,
Dr. Costigane likens them to any other form of insurance, be
it fire or disability. He believed he had found appropriate
income-replacement insurance.
[13] The Respondent's position was that
the family trust was created to provide these bookkeeping
services, even though Dr. Costigane knew he could get the
exact same services from his existing employees for only the cost
of their wages. He knew the dental practice could save $21,000.00
a year rather than passing that on to the trust for his children.
To pay about four times as much as was necessary was
unreasonable.
[14] With respect to Destiny, the Respondent
contended the agreement was not income-replacement insurance. The
way the arrangement worked, Dr. Costigane was paying
five percent of invoices he already collected ¾ there
was no insurance element. The expenses did not pass the test of
being incurred for the purpose of gaining or producing
income.
[15] Dealing first with
Dr. Costigane's claim for the deduction of the annual
$29,400.00 bookkeeping fee, I am not convinced that that payment
was reasonable. Dr. Costigane provided no comparables from a
bookkeeping or accounting firm indicating that they would charge
close to $30,000.00 a year for the type of bookkeeping that
Dr. Costigane's dental practice required. The only real
comparable in evidence was to those very employees who could have
performed the work directly and not through the trust.
Dr. Costigane's expenses would have been just the
approximate $8,000.00 a year for such work.
[16] There is nothing illegal or
inappropriate for a taxpayer to arrange his affairs to provide
for some income-splitting. That is not the issue. The issue is
the reasonableness of the expenditures. Taking three employees,
trained in something other than accountancy, paying them the same
wage for bookkeeping duties as for the more dental related duties
and then introducing a family trust to mark-up those
employees' costs threefold, with the result being $7,000.00
annually going into each of his children's hands, does not
yield a reasonable deduction to Dr. Costigane's
business.
[17] Section 67 of the Income Tax
Act demands that every expense must be reasonable to qualify
as a deduction for purposes of computing income. The Minister
allowed a 15 percent mark-up on Costigane Financial
Service's employees' wages. While I agree with
Dr. Costigane that that is arbitrary, I do find that it is
reasonable. What Dr. Costigane attempted to do, however, is
not.
[18] With respect to the Destiny expenses, I
appreciate what Dr. Costigane was trying to protect. I
believe his assessment of the healthcare environment in the
1990s, that is, that HMOs were knocking on the Canadian door and
that if it opened, it could have a significant impact on
Dr. Costigane's income. I am also satisfied that he did
look around to consider what options were available to protect
himself. I am not convinced that the agreement he entered into
with Destiny would, if push ever came to shove, provide the
extensive coverage Dr. Costigane thought it would. I am,
however, convinced that Dr. Costigane believed it would. His
mind was at ease as he had, as he thought,
income-replacement insurance.
[19] I do not accept the Respondent's
argument that because Dr. Costigane had already collected
his accounts receivable when the five percent fee, based on
accounts receivable, was paid, renders such payment non
deductible. Although the agreement was a bit peculiar, I read it
as Destiny paying to Dr. Costigane 95 percent of all
invoices every month, retaining five percent for itself. The
practical application, however, was that Dr. Costigane
collected the invoices and as long as he collected greater than
95 percent, he simply submitted five percent to
Destiny. As he explained it, should the collection ever fall
below 95 percent, Destiny would have to pay him the
difference. While I can imagine Destiny balking at a reduction of
the 95 percent collection rate due to the introduction of
HMOs on a number of grounds, Dr. Costigane clearly believed
he had insurance. Insurance expenses incurred to replace income,
for whatever reason, are deductible. Such expenses, as with other
forms of insurance, are directly related to earning income. I
find Dr. Costigane's expenses meet both the
reasonableness test and the test of having been incurred for the
purpose of gaining of producing income.
[20] The appeal from the assessment for the
1995 taxation year is dismissed, and the appeals from assessments
for the 1996 and 1997 taxation years are allowed, without costs,
and the assessments are referred back to the Minister of National
Revenue for reconsideration and reassessment on the basis that
Dr. Costigane is entitled to deduct expenses paid to Destiny
in 1996 and 1997 of $14,656.00 and $22,277.00,
respectively.
Signed at Ottawa, Canada this 31st day of March,
2003.
J.T.C.C.
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