Citation: 2011 TCC 27
Date: 20110114
Docket: 2009-2545(IT)G
BETWEEN:
MICHAEL F.G. NOEL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
[1]
This is an appeal from
reassessments by the Minister of National Revenue (the “Minister”) disallowing
pursuant to paragraphs 18(1)(a) and (h) and section 67 of the Income
Tax Act (the “ITA”) business expenses incurred by the Appellant for
the 2004 and 2005 taxation years.
Factual Background
[2]
The Appellant testified
that he formed the law firm Noel, Urquhart and Associates with three colleagues
in 1994. The law firm had two offices, one located in Miramichi East (formerly
Chatham) and the other located in Miramichi West (formerly Newcastle). The firm had four partners, who shared the profits
equally.
[3]
The Appellant worked
out of the Miramichi East office. According to the Appellant, he generated more
revenue than his partners. This led to discord regarding the fairness of the
partners’ profit-sharing arrangement. The partners agreed to terminate their partnership
arrangement in 2002 and agreed instead to share a limited amount of common
expenses. The Appellant became responsible for the operation of the Miramichi
East office.
[4]
Connie Noel, the
Appellant’s wife, testified that she had worked for the Royal Bank of Canada in a career spanning approximately 25 years. She
had held various administrative and secretarial positions at the bank. In early
2000, the bank reorganized its business operations and centralized a number of
branch functions in a regional office. Ms. Noel’s branch position was
eliminated following the reorganization.
[5]
Ms. Noel had a
young daughter and decided to work on a part-time basis for the law firm
starting in 2000. She worked in the Miramichi West office where she was being
trained to take over from the firm’s bookkeeper. Following the restructuring of
the law firm in 2002, Ms. Noel found herself in an untenable position at the
Miramichi West office. She decided to work instead for her husband in the
Miramichi East office. The plan was for Ms. Noel to continue to work as a
bookkeeper on a part-time basis only. In 2002, the Appellant’s two senior legal
assistants decided not to return to work upon termination of their maternity
leave. Their temporary leave of absence thus became permanent. The Appellant
was unable to hire senior legal assistants. He had to settle for hiring two junior
legal assistants directly out of secretarial school. Ms. Noel agreed to
fill the void by working full‑time in the Appellant’s law practice. She
oversaw the handling of all of the law firm’s financial matters, including
billing and collection, payroll deduction remittances and management of the law
firm’s trust account. Ms. Noel stepped into the role of office manager.
She became responsible for the oversight of the administrative staff. This
allowed the Appellant to focus his attention on the practice of law.
[6]
The Appellant and his wife
testified that they would work long hours together, working many evenings and
on weekends. The couple would bring their daughter to the office in the evening
and on weekends.
[7]
I found both witnesses
to be credible. Their testimony was not challenged by the Respondent.
[8]
The Appellant explained
that he increased his wife’s salary to take into account her significant new
duties. Instead of the part-time salary of $10,000, the couple agreed on a
salary in the $40,000 to $45,000 range for full-time employment with the law
firm.
[9]
Ms. Noel received
fixed draws of $200 per week for an amount totalling $8,200 in 2004. The
balance of her remuneration was paid on a sporadic basis when the law firm’s cash
flow permitted. In 2004, Ms. Noel received additional cheques totalling
$34,005.
[10]
In 2005, the
arrangement changed slightly. This change was made following a CRA payroll
audit. The CRA determined that all of the wages payable to Ms. Noel
constituted insurable earnings. The Appellant had remitted employment insurance
premiums on the $200 weekly payments made to his wife, but not on the
additional payments. The couple decided to end the weekly payments knowing that,
if they did so, Ms. Noel’s employment would be excluded employment under
the Employment Insurance Act. That statute provides that non-arm’s
length employment is excluded unless the terms and conditions of the employment
are substantially similar to those that would exist in an arm’s length
arrangement. According to the Appellant, it was a relatively safe bet that he
could avoid the cost of premiums if he paid his wife on an entirely sporadic
basis. An arm’s length employee would not accept being paid irregularly.
[11]
Ms. M.L. Muir
appeared as a witness for the Respondent. She is the auditor for the Canada
Revenue Agency (the “CRA”) who concluded that the Appellant could deduct only
the weekly $200 payments made to his wife. She denied the Appellant a deduction
for the sporadic payments he made to his wife for the following reason:
To clarify the Agency’s position, this audit is not an examination
of the employer/employee relationship between you and your spouse. The salary
indicated to have been paid to her as per your payroll records has been allowed
as an expense. The amounts that are disallowed are the payments made in
addition to Mrs. Noel’s salary in each of the above noted years. Our
review indicates these additional payments have not been incurred to earn
income from your professional practice. In part, this is supported by the
fact that they were not based on a particular contract or employment rate of
pay, hours expended or completion of particular tasks. Arrangements
regarding her time of work and authorization to execute cheques from the
general account are not factors that have contributed to the determination that
the payments outside her basic pay were not incurred to earn your professional
income.
[Emphasis added.]
Analysis
[12]
The Respondent relies
on three provisions of the ITA to justify its decision to deny the
Appellant a deduction for the full amount paid to his wife. First, the
Respondent points out that paragraph 18(1)(a) provides that, in
computing business income, a deduction can be claimed for an expense only “to
the extent that it was made or incurred by the taxpayer for the purpose of
gaining or producing income”. Second, paragraph 18(1)(h) denies a
deduction for “personal or living expenses”. Finally, section 67 prohibits the
deduction of an expense otherwise deductible under the ITA if the
expense is unreasonable. According to the Respondent, the Appellant has failed to
establish that the additional amount paid to his wife does not run afoul of
these provisions.
[13]
I do not agree with the
Respondent’s interpretation of the evidence. In her Report on Objection, the
appeals officer acknowledges that Ms. Noel had the skills to perform the
duties for which she was responsible. Her conclusions are as follows:
- The taxpayer’s wife, Connie Noel, was on the
payroll.
- The taxpayer’s wife received a salary of $200 per
week for 41 weeks in 2004 and for 17 weeks in 2005.
- Other employees with less responsibility
were paid more than the taxpayer’s wife.
- The taxpayer’s wife was paid every Friday.
- The taxpayer’s wife received her last payroll
cheque on May 12, 2005.
- The taxpayer’s wife maintains that her work is now
done on contract.
- The taxpayer’s wife maintains that there is no
record of her hours and that she was not paid any particular amount per hour.
- The taxpayer’s wife maintains that she was paid
what the taxpayer thought her contribution was worth.
- The taxpayer’s wife does not have her own bank
account. Her cheques are deposited in a joint account.
The taxpayer’s wife, Connie Noel, previously worked for the Royal
Bank of Canada for 24 years. It
appears obvious that she had the background and skills to perform the duties
that the taxpayer has attributed to her. Why was her actual salary less
than other employees who had less responsibility? The additional cheques paid
to Connie Noel, or paid on behalf of Connie Noel, were made while she was on
the payroll. The amounts were paid at random and at times there was more than
one cheque issued on the same day. There is no doubt but that these amounts
were in addition to her salary. The cheques made out to the Receiver General
for Canada in both years were
credited directly to Connie Noel’s tax liability. The total of the additional
cheques issued to Connie Noel, or issued on behalf of Connie Noel, were
reported on Connie Noel’s tax returns as income. The objective appears to be
income-splitting; a means of diverting a portion of the taxpayer’s income to
his wife.
In 2004, 41 payroll cheques were issued to Connie Noel and another
48 cheques were issued to Connie Noel, or were issued on her behalf. With
the exception of 5 cheques, the amounts were multiples of $100.
6 cheques totaling $8,500 were issued to the Receiver General for Canada and were applied against Connie
Noel’s personal tax liability. 1 cheque in the amount of $444.43 was issued to
Options Mastercard and 1 cheque in the amount of $549.32 was issued to NB
Power. Of the 43 cheques issued to Connie Noel personally, 3 cheques in the
amounts of $950.91, $642.78, and $748.02 were noted as being for “Bills”.
In 2005, 17 payroll cheques were issued to Connie Noel and another
67 cheques were issued to Connie Noel, or were issued on her behalf. With the
exception of 1 cheque, the amounts were multiples of $100. 9 cheques
totaling $12,000 were issued to the Receiver General for Canada and were applied against Connie
Noel’s personal tax liability. Of the 58 cheques issued to Connie Noel
personally, 1 cheque in the amount of $667.22 was noted as being for “NB
Power & Phone $ Cell Phone”.
The taxpayer has not responded to my request to substantiate the
amounts paid to his wife as being paid to earn income from his legal practice. There
is no doubt that the taxpayer’s wife provided services to the taxpayer’s law
practice. However, the taxpayer has not provided evidence that the amounts paid
to his wife were for services rendered as opposed to splitting income between
himself and his wife.
[Emphasis added.]
[14]
It appears that the
CRA’s decision was influenced by the fact that Ms. Noel agreed to draw her
remuneration at times when it was financially beneficial to the law firm for
her to do so. The ITA does not require that a salary be paid on a
regular basis. The appeals officer appears to have concluded that only the $200 weekly
payments to Ms. Noel were salary. In point of fact, Ms. Noel’s salary
was the full amount she received in the year for her services. A spouse may
agree to be paid on an irregular basis because she has a greater interest in
the family‑owned business than an unrelated employee. This does not mean
that the amount she receives is not salary. Salary is the amount paid to an
employee under a contract of employment for that employee’s services. Whose
interest would have been served if Ms. Noel had demanded to be paid on a
regular basis like the other employees? Presumably the Appellant would have
been required to use his line of credit more often to meet such a demand. The
couple’s arrangement avoided unnecessary interest charges.
[15]
The only question at
issue here is whether Ms. Noel worked at the law firm and was paid a
reasonable wage for her services. Both of the CRA officials agreed that she
worked in the business. The appeals officer acknowledges in her report that
Ms. Noel was qualified to perform the duties that were entrusted to her.
The Respondent did not dispute the fact that the Appellant’s two senior legal
assistants had suddenly left. The Respondent did not dispute the fact that
Ms. Noel became the senior administrative employee of the law firm. The
Respondent did not attempt to refute the Appellant’s claim that he hired two
junior legal assistants straight out of secretarial school to replace his
senior legal assistants because he could not find more senior personnel. In
these circumstances, it is reasonable to infer that Ms. Noel was required
to play an important role in the operation of the law firm. The evidence does
not show that the couple was involved in an income‑splitting arrangement
as suggested by the appeals officer in her Report on Objection.
[16]
The Appellant testified
that a bookkeeper could earn up to $30,000 a year and that legal assistants
were paid from $18,000 to $40,000 a year depending on their level of
experience. Ms. Noel was much more than a bookkeeper or legal assistant.
In addition to performing the duties of those positions, she was the law firm’s
office manager. She ran the administrative side of the law practice. I am comforted
in my conclusion by Ms. Muir’s admission that Ms. Noel handled the
income tax audit for the law firm. According to Ms. Muir, Ms. Noel
was quite knowledgeable about the administrative and financial workings of the
law firm.
[17]
The appeal is allowed,
with costs to the Appellant, and the reassessments are referred back to the
Minister for reconsideration and reassessment in accordance with these reasons
for judgment.
Signed at Ottawa, Canada, this 14th day of January 2011.
"Robert J. Hogan"
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