Date: 20001110
Docket: A-216-99
CORAM: Décary J.A.
McDonald J.A.
BETWEEN:
ARGUS HOLDINGS LTD.
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
Heard at Vancouver, British Columbia on Friday, September 15, 2000
Judgment delivered at Ottawa, Ontario on Friday, November 10, 2000
REASONS FOR JUDGMENT BY: McDonald J.A.
CONCURRED IN BY: Décary J.A.
Malone J.A.
Date: 20001110
Docket: A-216-99
McDonald J.A.
Malone J.A.
BETWEEN:
ARGUS HOLDINGS LTD.
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
McDONALD J.A.
[1] This is an appeal from a decision of the Tax Court of Canada reported at 99 D.T.C. 597. The Tax Court Judge upheld a reassessment of tax made by the Respondent under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) [the "Act"].
[2] The central issue in this appeal is whether the Tax Court Judge erred in concluding that the Appellant deducted a reserve in its 1991 taxation year under paragraph 20(1)(m) of the Act. The relevant portions of paragraph 20(1)(m) of the Act read as follows:
| 20. (1) Deductions permitted in computing income from business or property - Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
| (m) reserve in respect of certain goods and services - subject to subsection (6), where amounts described in paragraph 12(1)(a) have been included in computing the taxpayer's income from a business for the year or a previous year, a reasonable amount as a reserve in respect of |
...
| (ii) services that it is reasonably anticipated will have to be rendered after the end of the year. |
|
20. (1) Déductions admises dans le calcul du revenu tiré d'une entreprise ou d'un bien -- Malgré les alinéas 18(1)a), b) et h), sont déductibles dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qu'il est raisonnable de considérer comme s'y rapportant_: m) Provision relative à certaines marchandises et à certains services [à venir] -- sous réserve du paragraphe (6), lorsque des sommes visées à l'alinéa 12(1)a) ont été incluses dans le calcul du revenu tiré par un contribuable d'une entreprise, pour l'année ou une année antérieure, une somme raisonnable à titre de provision dans le cas_:
...
| (ii) de services qui, selon ce qu'il est raisonnable de prévoir, devront être rendus après la fin de l'année, |
|
[3] The relevant facts may be briefly stated. The Appellant was incorporated in February of 1980. It is engaged in the business of operating a racquetball club in Langley, British Columbia. The Appellant charges a one-time initiation fee when a new member joins the club.
[4] The manner in which the Appellant treated these initiation fees on its books of account gave rise to the tax dispute between the Appellant and revenue authorities. Mr. Robert Schultz, accountant for the Appellant, accounted for these fees on the assumption that they were not earned in the year of receipt. He treated them as coming into income on a straight-line basis month to month over ten years from the date on which a particular member paid his or her fee. Therefore, beginning with the month of receipt onwards, the Appellant included 1/120th of the initiation fee as income.
[5] Mr. Gregory Andron - director, president and majority shareholder of the Appellant - testified at trial as to why the Appellant decided to amortize the initiation fees over a period of ten years. At the beginning of operations, maintained Mr. Andron, some club members were concerned about what would happen to their initiation fees if the business had failed to prosper. To those concerned members, he promised that a pro rata portion of their initiation fees would be refunded based on a ten-year scale.
[6] The Tax Court Judge ruled that there was not enough evidence to support a finding that such a refund policy existed. At paragraph 10 of the Reasons For Judgment, the Tax Court Judge wrote as follows:
| No membership agreement was produced in evidence and Mr. Andron indicated in his testimony that the standard membership agreement did not contain any terms requiring the Appellant to refund any part of the initiation fee under any circumstances. What I am left with is Mr. Andron's testimony that he made the refund policy promise to certain concerned prospective members in the circumstances described above. If the Appellant had been required to suspend operations, I do not know how it would have distinguished those members to whom the refund policy promise was made from the other members who expressed no concern when they joined. Without an explicit term in the membership agreement, it may have been difficult for any member to prove that a refund policy promise had been made. |
[7] In the result, the Tax Court Judge found that the initiation fees were earned in the year of receipt and that there was no basis which warranted amortization. He then proceeded to rule on the issue of whether the Appellant claimed a reserve under paragraph 20(1)(m) of the Act. In so doing, he was not influenced by the accounting nomenclature which the Appellant used on its books of account.
[8] Rather, he found that, in excluding from income a portion of the initiation fees, the Appellant, in effect, deducted a reserve under paragraph 20(1)(m) of the Act. At paragraph 27 of the Reasons For Judgment, the Tax Court Judge stated:
| The Appellant maintained a liability account under the name "Deferred Initiation Fees". It is the account in which the Appellant stored that portion of initiation fees already received but not yet included in income because that portion was set aside to be included in income of later years. I find that that account was a reserve within the meaning of paragraph 20(1)(m) because it deferred income, already received, to a later year. The effect of the Appellant's bookkeeping and accounting procedures was the creation of a "reserve" whether it was called by that name or not. |
[9] He then went on to find that the balance which remained in the Appellant's "Deferred Initiation Fee" account should be included in income under paragraph 12(1)(e) of the Act. He cited I.B. Pedersen Limited v. The Queen, 94 D.T.C. 1085 (T.C.C.), as support for the proposition that, regardless of whether a taxpayer was entitled to the reserve, so long as the taxpayer deducted an amount as a reserve in the previous year, the amount must be included in income under paragraph 12(1)(e) of the Act.
[10] It is first noted that there is no amortization issue to adjudicate here. This appeal is not concerned with whether the entire amount of an initiation fee should be taxed in the year of receipt. The Appellant conceded that amortizing the initiation fees over a ten-year period was inappropriate.
[11] This appeal is concerned with whether the Tax Court Judge erred when he concluded that the Appellant deducted a reserve under paragraph 20(1)(m) of the Act.
[12] In deciding whether the trial judge erred, the following question must be asked. Is there a principled difference between:
| 1. excluding from income a portion of the entire amount of an initiation fee; and |
| 2. including the entire amount of an initiation fee and then deducting a portion of that amount as a statutory reserve? |
[13] The effect of these two accounting procedures is the same. Only a portion of the entire amount of an initiation fee is being taxed in any given year. The remaining portion is being deferred - which is exactly how a reserve under paragraph 20(1)(m) of the Act operates.
[14] Moreover, there is well established authority for the proposition that it is not the accounting treatment of an amount which governs deductibility, but rather the true nature of the amount deducted. The fact that the Appellant's books of account do not describe the amounts in question as a reserve does not mean that the Appellant did not in fact take a reserve. See, for example, Dixie Lee (Maritimes) Ltd. v. The Queen, 88 D.T.C. 6108 (F.C.T.D.); Mr. Muffler Ltd. v. The Queen, 74 D.T.C. 6615 (F.C.T.D).
[15] In Mr. Muffler Ltd., Walsh J. made the following comments with respect to the significance of the designation assigned to an entry in the financial statements:
| The fact that the plaintiff in its financial statements refers to the amounts set aside as (translated): "reserve for merchandise sold and not delivered" when it is perhaps not properly speaking a true reserve in the sense in which the use of this term is recommended by accounting authorities is not too significant. It is not the designation given to the amount which is set aside but the purpose for which it was so set aside which is important [emphasis added]. |
[16] As such, I can find no palpable and overriding error with respect to the Tax Court Judge's finding of fact that the Appellant deducted a reserve under paragraph 20(1)(m) of the Act.
[17] However, this does not end the matter. It remains to be considered whether the balance remaining in the "Deferred Initiation Fee" account should be taxed in its entirety in the 1992 taxation year of the Appellant, pursuant to paragraph 12(1)(e) of the Act.
[18] Paragraph 12(1)(e) of the Act requires a taxpayer to include in computing income amounts deducted as a reserve under paragraph 20(1)(m) in the immediately preceding taxation year. Paragraph 12(1)(e) reads as follows:
| 12. (1) Income Inclusions - There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:
...
| (e) reserves for certain goods and services - any amount |
| (i) deducted under paragraph 20(1)(m) (including any amount substituted by virtue of subsection 20(6) for any amount deducted under that paragraph), paragraph 20(1)(m.1) or subsection 20(7), or |
| (ii) deducted under paragraph 20(1)(n) |
|
12. (1) Sommes à inclure dans le revenu -- Sont à inclure dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien, au cours d'une année d'imposition, celles des sommes suivantes qui sont applicables_:
...
| e) Provision relative à certaines marchandises et à certains services -- les sommes qui ont été dans le calcul du revenu tiré d'une entreprise par le contribuable pour l'année précédente_: |
| (i) soit déduites en vertu de l'alinéa 20(1)m) (y compris celles substituées, en vertu du paragraphe 20(6), à de telles sommes) ou m.1) ou du paragraphe 20(7), |
| (ii) soit déduites en vertu de l'alinéa 20(1)n); |
|
in computing the taxpayer's income from a business for the immediately preceding year.
[19] The Appellant maintains that it is the actual deduction claimed in the return of income for a previous year which must be entered into income the following year under paragraph 12(1)(e) of the Act. Counsel cited The Queen v. Regina Shoppers Mall Limited, 91 D.T.C. 5101 (F.C.A.), in support of this proposition.
[20] In my opinion, that case does not overrule the accepted proposition of law that it is not the accounting designation but the true nature of the amount deducted which is important. The authority which counsel for the Appellant cited is only helpful to a degree.
[21] For the purposes of this appeal, it is unnecessary to rule on whether or not paragraph 12(1)(e) of the Act requires a taxpayer to include in income only those amounts which were in fact deducted as a reserve under paragraph 20(1)(m). For the following reasons, I am of the opinion that the balance which remains in the "Deferred Initiation Fee" account should not be included in income in its entirety in the 1992 taxation year of the Appellant.
[22] In Canderel Limited v. The Queen, [1998] 1 S.C.R. 147 at paragraph 36, Iacobucci J. observed that, whereas financial accounting is usually concerned with providing a comparative picture of profit from year to year, the computation of income for tax purposes,
| ... is solely concerned with achieving an accurate picture of income for each individual taxation year for the benefit of the taxpayer and the tax collector [emphasis added]. |
[23] It would be a gross distortion of the Appellant's picture of income if the balance remaining in the "Deferred Initiation Fee" account were taxed in the 1992 taxation year. This is because portions of that balance were earned in tax years prior to 1992. The Appellant neither earned nor received the entire $441,154 in question in its 1992 taxation year. Portions of that amount are referable to taxation years other than 1992. In other words, the amount in question does not represent profit from the 1992 commercial activities of the Appellant, but represents profit from the 1982 to 1991 taxation years inclusively. Accordingly, it would not yield an accurate picture of income if the entire $441,154 were taxed in the hands of the Appellant in its 1992 taxation year.
[24] With the greatest respect, the Tax Court Judge erred in seeking to rectify the Appellant's under-reported income from 1982 to 1991 by adding those amounts into the Appellant's income in its 1992 taxation year. The Tax Court Judge failed to consider whether, by adding the entire $441,154 into income for the 1992 taxation year, an accurate picture of income would result.
DISPOSITION
[25] The appeal is allowed with costs, the decision of the Tax Court Judge is set aside and the matter is referred back to the Minister of National Revenue for redetermination on the basis that
the initiation fees are taxable in the year of receipt.
J.A.
"I agree
"I agree
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