Citation: 2010 TCC 532
Date: 20101019
Docket: 2008-2977(IT)G
2008-2710(GST)G
BETWEEN:
LYNCORP INTERNATIONAL LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1]
The income tax appeal is
about the deductibility by the Appellant, Lyncorp International Ltd.
("Lyncorp"), of flight expenses incurred in 2002 and 2003 on a plane
fractionally owned by the Appellant. At that time, the Appellant was owned,
operated and directed by one man, Mr. David Mullen. Mr. Mullen
left the impression of being the consummate businessman – fingers in a number
of commercial ventures. The flights in issue relate primarily to Mr. Mullen’s
trips checking on the Appellant’s several business ventures. The Respondent
denied approximately $400,000 of the flight expenses claimed by the Appellant
on the basis that the disputed flight expenses were not, in accordance with
paragraph 18(1)(a) of the Income Tax Act (the "Act"),
incurred for the purpose of gaining or producing income from a business or
property of the Appellant, as the expenses were either personal, simply for the
convenience of Mr. Mullen, or, if they were not personal, but commercial,
they were not incurred for the benefit of the Appellant but for the benefit of other
companies, in which the Appellant had invested. This raises the intriguing
question, when are expenses of one company, that relate more directly to
producing income of an investee company, deductible on the basis that increased
income of the investee company could lead to the production of income from
property, being dividends (or even interest) to the investing company.
[2]
The Respondent also
denied input tax credits pursuant to the Excise Tax Act ("ETA")
on the basis the flight expenses were not incurred in the course of the
Appellant’s commercial activities.
Facts
[3]
While the issue is
relatively straightforward, the facts are anything but. Mr. Mullen
testified for a day explaining in some detail the various commercial
enterprises in which he was involved. I do not intend to get into such great
detail, but rather intend to limit my review of the facts to the commercial
enterprises, which Mr. Mullen maintains justified the flights, as well as a
review of his personal circumstances, including his full-time employment.
[4]
In 2002 and 2003, Mr.
Mullen was an executive with Mullen Transportation Inc. and Mullen Trucking
Inc.. Mr. Mullen’s father started a trucking company many years previously
which has grown into an enterprise with 16 to 18 subsidiary companies with
5,000 employees. I will simply refer to this trucking enterprise as the
"Mullen Group". Mr. Mullen appears to have worked his way up through
the organization, having started as a driver. There is no doubt he was devoted
to the family firm. His timesheets from the years in question showed a minimum
of approximately 2,200 to 2,400 hours a year, which if calculated on a five-day
week would work out to an average of regular 10-hour days. Mr. Mullen was adamant,
however, that these were minimum hours. All to say, he worked hard at his day
job. I will have more to say on his timesheets when discussing particular
flights.
[5]
Mr. Mullen was also
interested in business generally: in fact, I would describe him as being
passionate about being an entrepreneur.
[6]
Mr. Mullen incorporated
the Appellant in 1993 as an active company, though he was somewhat unclear as
to exactly what it was active in, but ultimately he used it to pursue
investments in other active companies, which he referred to as "business
ventures". The Appellant would invest either by buying shares or lending
money to the business ventures. For Mr. Mullen to consider an investment a business
venture, not only did Lyncorp have to hold shares or debt in the venture, but
Mr. Mullen personally would have to play an active role in the venture in
providing support services. By support services, he meant formulating business
plans and advising on financial matters, developing marketing strategies,
helping overcome technical operational challenges and investigating business
expansion opportunities. He relied on aircraft fractionally owned by the
Appellant to attend to these business ventures. Neither Lyncorp, nor the
business ventures, which I will describe shortly, ever paid Mr. Mullen for
these actual services. There was no written agreement between either Mr. Mullen
or the Appellant and the business ventures. My impression was that Mr. Mullen saw
a business need for these ventures to survive and thrive and, because of the
Appellant’s interest, he filled that need. It was also clear that Mr. Mullen
viewed himself and the Appellant as one and the same, as he stated
"Lyncorp is David Mullen".
[7]
Starting in June 2001,
Mr. Mullen undertook a major reorganization of his business affairs by moving
his personal investments into the Appellant. His explanation for this move was
rather sketchy, claiming the businesses had become too complicated for him to fund
personally. By far the major assets transferred into the Appellant were Mr.
Mullen’s interests in the Mullen Group. It was clear, looking at the
Appellant’s revenue in subsequent years, that wealth in the Appellant was
generated primarily from the Mullen Group investment (well over $8 million
between 2005 and 2007 alone).
[8]
Mr. Mullen noted that
one of his business ventures, Shulin Lake Mining Co. Inc. ("Shulin
Mining"), should have been transferred into the Appellant at the time of
the reorganization but, for whatever reason, was not. He personally remained a
shareholder.
[9]
For the first four
months of 2002, the Appellant had a fractional interest in a turbo prop
airplane, but in March of 2002 it traded it in for a similar interest in a jet.
[10]
The reasons given by
Mr. Mullen as to why the Appellant would buy a plane rather than rely on
commercially scheduled flights was that his windows of opportunity for working
on the Appellant’s business was very limited, given his huge time commitment to
the Mullen Group. As he put it, his work for Lyncorp only started late on
Friday afternoon. The ownership of the plane guaranteed availability of
transport and it was reliable. In representations from his accounting agent,
KPMG, to the Canada Revenue Agency ("CRA") in March 2008, KPMG
described the reasons for the acquisition of the plane as follows:
…
·
Absolute time savings by spending less time at
airports checking-in, going through long security line-ups, making
connections, risking potential commercial flight delays, waiting for luggage,
clearing US Customs, etc.
·
Ability to respond quickly to urgent matters
that required David’s personal attention and intervention. There were instances
where return trips were required that could not have been accommodated
commercially. Since David also had responsibilities that required him to be
back in Calgary, he needed to
adhere to a very strict travel schedule.
·
The ability to conduct business meetings and
discuss confidential business matters on route with others and, conversely, the
ability for David to have uninterrupted quiet time to spend this time
strategizing business plans on the many flights he took alone.
·
An effective and more convenient way to
transport Lyncorp’s potential suppliers, other investors and consultants to
business sites by eliminating time spent making alternate travel arrangements
on commercial flights and then coordinating their arrival with David’s.
·
There are times when the nature of the
information and goods that David travels with, such as drilling and core
samples, would be too sensitive, confidential and difficult to check in
personal baggage and too large for carryon on a commercial flight.
·
The timing and often short notice period made
the use of scheduled commercial flights unfeasible. Airsprint was able to
accommodate David to get him to his destinations quickly and on short notice.
·
Reduced and better control over exposure to
air-borne sickness so prevalent on commercial flights. David was very busy and
couldn’t afford to increase his chances of becoming ill and missing time and
opportunities.
[11]
Mr. Mullen handled the
aircraft invoices from Airsprint by identifying on the invoice itself whether
the flights referred to in the invoice were personal, for a third party account
(e.g. for the Mullen Group), in which case costs would be invoiced to that
third party, or for the Appellant’s own account. The Appellant in fact earned
$121,000 and $54,000 respectively from third parties’ use of the aircraft in
the years in question. Mr. Mullen acknowledged that this system of allocating
costs was imperfect and that he might occasionally mischaracterize a flight.
[12]
Before turning to a
review of the business ventures in which the Appellant had an equity or debt
interest, that specifically relate to the disputed flight expenses, I want to
provide a brief review of any direct business activity carried on by the
Appellant, in particular mining exploration and drilling services.
[13]
With respect to mining
exploration, Mr. Mullen testified that Lyncorp held some mining interests in
Saskatchewan and incurred some exploration expenses there as well as in
southern British Columbia. The Appellant’s financial statements,
however, show no expenses, salary or otherwise that might relate to exploration
in 2002 or 2003. Certainly, there was no such activity in Alaska. Apart from holding some claims, I find there was
little, if any, direct exploration activity in 2002 or 2003 by the Appellant,
though there was some evidence of some future activity.
[14]
With respect to a
drilling services business, the Appellant did acquire a drilling rig for
$35,000 USD in July 2002. The rig was located at Shulin Lake, Alaska.
The Appellant made the rig available to Shulin Mining for no charge, to
continue drilling in the area. Mr. Mullen explained that having the rig
operating there allowed him to learn a lot about the drilling business.
Although the rig was acquired by the Appellant, it was accounted for in the
books of Shulin Mining, rather than in the books of the Appellant. The rig was
moved to Saskatchewan in the fall of 2003. There was
correspondence in 2004 from Golconda Resources Ltd. ("Golconda") to Mr. Mullen at Mullen Transportation, as
well as a mineral sample submittal form from ALS Chemex ("ALS")
indicating samples were submitted by the Appellant from Saskatchewan in 2004.
[15]
Mr. Mullen testified
that the Appellant continuously carried on a drilling business up to 2007. From
a review of the Appellant’s financial information, it is clear it was, in the
latter years (2004 to 2007), incurring costs, and in 2006, 2007 and 2008 it was
actually earning some income from drilling. In 2007, a new drilling company,
Lyncorp Drilling Services Inc. commenced operations and carried on the
drilling services.
[16]
I will now turn to a
review of the following business ventures associated with many of the disputed
flight expenses:
a) Shulin Lake Mining
Co. Inc., Golconda Resources Ltd. and Shear Minerals Ltd.
("Shear");
b) Shulin Lake Lodge Inc.
("Shulin Lake Lodge");
c) Campbell River Boatland (1982) Ltd. ("C.R. Boatland")
Shulin Mining, Golconda and Shear
[17]
Shulin Mining was an
Alaskan company incorporated in 1997 with David Mullen and his father
owning two-thirds of the shares: the remaining one‑third of the shares
were held by Carl and Mike Tatlow. Shulin Mining had 152 claims. It
granted Shear, a public company, an option in 1999 to acquire a 50% interest in
the claims, that was later reduced to 24% interest. Mr. Mullen was a director
of Shear. The Appellant held approximately 2.7 million shares in Shear representing
a seven to ten percent interest. In 2005, Shear spun out shares in Kaminak Gold
Corporation ("Kaminak") worth $50,000 which the Appellant later sold
for $230,000.
[18]
In February 2001,
Shulin Mining granted an option to 885301 Alberta Ltd. ("885301") for
a 40% interest in the claims. In May 2001, the Appellant transferred its shares
in 885301 to Golconda for shares in Golconda. The Appellant already owned substantial shares in Golconda, and by the end of 2003 owned close to 1.7 million
shares at a cost of approximately $700,000. Golconda was engaged in the drilling services business.
[19]
In February 2002,
Shulin Mining bought some more claims from a third party for $36,500. Mr.
Mullen maintains this purchase was financed by the Appellant. By December 31,
2002 the Appellant had outstanding advances to Shulin Mining of $255,110 which
increased to $442,000 by the end of December 2003. Such loans were demand
non-interest bearing loans.
[20]
So what were these
companies doing in Shulin Lake? A newspaper article of August 1,
2002 described activity as follows:
…
Tatlow switched his focus, and he and Shulin Lake Mining Inc.
partners Dave and Rowland Mullen found Canadian backers.
Alberta-based Golconda Resources Ltd. holds 51 percent of the
project and Shear Minerals Ltd. of Edmonton holds about 14 percent.
The team began using airborne geophysical technology and samples of
deposits from streams and glaciers to narrow the search.
They began drilling last February, to the scepticism of some
geologists.
…
To many, Tatlow busy camp of ATCO trailers caterpillars tractors, a
lumber mill and miscellaneous heavy equipment must seem out of place.
…
[21]
A release from Golconda dated January 3, 2002 referred to a 2002 drilling
program at a cost of $200,000, $43,000 of which was for Shulin Mining’s
account. In summary, some drilling was taking place on some form of joint
venture basis amongst Shulin Mining, Golconda and Shear in
the relevant years. Lyncorp held an equity interest in Shear and Golconda and a debt interest in Shulin Mining.
Shulin Lake Lodge
[22]
Shulin Lake Lodge was
incorporated in 2001 with the Appellant owning 50% of the shares and Carl
Tatlow owning 50%. Mr. Mullen testified that it was his idea for the lodge to
evolve from a trailer used as accommodation for those working on a well site to
accommodation for workers in a mining camp, and if no mining was going on, then
to a permanent lodge for fishing and hunting. Construction commenced in August
2002. It was necessary to rely on a winter road to get materials in during the
winter of 2002 – 2003. Mr. Mullen anticipated guests in June 2004. The company
had income of $40,203 in 2003 being the charge to Shulin Mining for
accommodation, while in 2004 the income of $164,000 was mainly attributable to
fishing guests.
[23]
By the end of 2003, the
Appellant had advanced approximately $1.5 million to Shulin Lake Lodge, again
on a demand non-interest bearing basis.
C.R. Boatland
[24]
C. R. Boatland was in
the business of the sales and servicing of boats, ATV’s etc. in Campbell River, B.C.. The Appellant and Daniel Telosky acquired the
shares of C.R. Boatland and assigned them to 622535 BC Ltd.
("622535"), a company in which the Appellant and Mr. Telosky had a
50/50 interest. In November 2003, Mr. Telosky transferred his interest to the Appellant.
Mr. Telosky was to serve as manager of C.R. Boatland, though Mr. Mullen
testified that he provided the ideas to take the company from a losing position
to a profitable one, by adding some new businesses to the company, properly
capitalizing it and generally cleaning up the operations. As he put it, he made
the important decisions, though, similar to Shulin Mining and Shulin Lake
Lodge, he was not paid by C.R. Boatland for any of these services. He was also
a director of C.R. Boatland.
[25]
Mr. Mullen owned a home
40 kilometres outside of Campbell
River since 1996.
Flights
[26]
The deductibility of
about $400,000 in flight costs, representing about 40 round trip flights,
is in dispute. Attached as Appendix A to these Reasons is a list of the
disputed aircraft expenses. There is no question that it was Lyncorp who paid
for the cost of all these flights and that Mr. Mullen was the primary passenger
on all flights. Mr. Mullen, in examination-in-chief and on cross-examination
went through all the flights indicating, as best as he could remember, for what
purpose he took the flight, and what he did at his destination.
[27]
Over half of the
flights involved travel to Campbell River, in connection with C.R. Boatland,
somewhat less number of flights to Alaska, in connection
with Shulin Mining or Shulin Lake Lodge and a few flights to other destinations
(Cranbrook, Rankin Inlet, Vancouver and Kelowna).
[28]
With respect to trips
to Campbell River, Mr. Mullen described them as being for
the purpose of working on C.R. Boatland business. His typical trip would be to
leave Calgary Friday afternoon, meet with Mr. Telosky
Friday evening, review the condition of the operations, attend the business
Saturday morning to either serve customers or simply help out, spend Saturday
afternoon with the family, have a Sunday morning breakfast meeting with Mr.
Telosky and have the rest of the day with the family. Often, his wife and
daughter would travel with him to their home in Campbell River for these weekends.
[29]
On one such trip to
Campbell River (April 25 to 28, 2002), Mr. Mullen returned via Vancouver to attend a mining trade show. On another (November
17 to 20, 2002) he travelled through Vancouver to meet
representatives from Yamaha to discuss the possibility of C.R. Boatland picking
up the Yamaha line. Mr. Mullen indicated several of the Campbell River trips involved working on the Yamaha file in 2002 and
2003.
[30]
Mr. Mullen also
described one trip to Campbell
River due to problems with
the boiler on the premises.
[31]
Finally, in connection
with the C.R. Boatland business, Mr. Mullen had a trip to Vancouver in late 2001 for the purposes of securing containers
for ice machines, a new business he was introducing to C.R. Boatland. On the
same trip, he checked into the availability and suitability of ocean
containers. It was unclear to me whether this was intended to be a business for
C.R. Boatland or for the Appellant directly.
[32]
To reiterate, Mr.
Mullen held no paid position with C.R. Boatland, though he was a director.
[33]
Several of the flights
were to Alaska, where Mr. Mullen attended to both the
business of Shulin Mining (including Shear and Golconda) and Shulin Lake Lodge. Exactly what he did could have been made
clearer. For example, he would indicate that he would be in Shulin Lake because Shulin Mining was putting in drill
sites, or because Shulin Mining required ice roads and he needed to know how to
build ice bridges. This type of response did not elaborate in any great detail
on his personal involvement. He said he would check the hauling of loads (materials
for building the lodge) on the ice roads, or check on the drill sites. I was
not clear exactly what this all meant. With respect to the lodge, he would get
as involved as tapping trees in readying the site for construction. He also
stated there would be some helicopter work and he would look into getting
helicopter transportation information.
[34]
On one trip to Shulin Lake in late August 2002, he wanted to ensure
everything in connection with the drilling operation was safe due to some
recent flooding problems. He would occasionally bring back core samples with
him from Shulin Mining’s drilling. He described another trip in his
written summary as follows: “travel to site to assess equipment and needs”.
[35]
One trip (June 16 to
19, 2003) appeared to be primarily to attend the cleanup and landscaping of the
lodge. Mr. Mullen did acknowledge that after work, he may go fishing until late
in the evening.
[36]
Mr. Mullen also
described another trip to Shulin
Lake (September 2 to 5, 2003)
as a networking trip, connecting with future employees, business associates and
partners. This is the trip on which he stopped in Kelowna
to drop off a couple of business associates.
[37]
In May 2002, Mr. Mullen
had a one-day trip to Cranbrook to check out potential mine sites for the
Appellant.
[38]
In June 2003, Mr.
Mullen travelled to Rankin Inlet to visit a site where Shear was drilling. He
returned with some core samples.
[39]
Mr. Mullen maintained
that all the disputed flights were for commercial purposes tied in with either
the Appellant’s direct business activity or in connection with the business
ventures, Shulin Mining, Shulin Lake Lodge, C.R. Boatland or Shear. The Crown
took Mr. Mullen through some of his timesheets from the Mullen Group, which
suggested that on days where he was shown to be in Campbell River or Alaska on
the Appellant’s or its’ business ventures’ businesses, he was recording eight
or 10 hours towards his full-time employment with the Mullen Group.
Mr. Mullen explained that his timesheets only represented minimum hours
actively worked. He left the impression that if he put in a 14-hour day, he
might only record 10 and reflect the extra hours on another day – the
timesheets were imperfect. He admitted that they were not completed daily but
only every month or two. Asked directly how he would account for 10 hours to
the Mullen Group on a day that his flight data showed he was in Alaska purportedly on the Appellant’s, Shulin Mining’s or
Shulin Lake Lodge’s business, he answered: “I can’t tell you”.
[40]
A review of Lyncorp’s
revenue from 2002 forward shows some aircraft charter income from 2002 to 2005
and some drilling income from 2006 to 2008, with little other active income.
With respect to investment income, it shows no investment income in 2002,
dividend income from the Mullen Group in 2003, dividend income of $168,000 in
2004, $165,000 of which was from the Mullen Group and $5.9 million of
dividend income in 2005, all from the Mullen Group.
Issues
[41]
The income tax issue is
whether the disputed flight expenses were incurred, in accordance with
paragraph 18(1)(a) of the Act, for the purpose of earning or
producing income from Lyncorp’s business or property. Specifically, the
following questions need to be answered:
a) did the Appellant incur the
expenses?
b) were the expenses of a personal nature?
c) if not, were they
incurred for the purposes of earning or producing income from a business or
property of the Appellant?
[42]
The Goods and Services
Tax (“GST”) issue is whether the Appellant was entitled to claim Input Tax Credits
of $11,396 in 2002 and $21,499 in 2003, arising from the disputed flight
expenses. The question to be answered specifically is whether the disputed
flight expenses were incurred by the Appellant in the course of the Appellant’s
commercial activities.
Parties’ Positions
[43]
The Appellant’s
position is that the Appellant was directly engaged in carrying on active
businesses, thereby having a source of income from business, as well as having
a source of income (dividends or interest) from property (shares and debt in
other companies). The Appellant’s strategy was to provide support services to
all of the business ventures, without adding to their cost, for the purpose of
ultimately benefiting the Appellant in the form of future dividend income. The
Appellant argues that it also held debt in the business ventures as a source of
interest income, as, if the business ventures proved successful, the Appellant
could then charge interest.
[44]
The Appellant further
argues that access to the airplane allowed Mr. Mullen the flexibility to
devote valuable limited time to the Appellant’s direct business activities, as
well as to providing the support services to the business ventures. The
Appellant points to the turnaround in C.R. Boatland’s profits as due to
Mr. Mullen’s, and therefore the Appellant’s, involvement, thus creating an
“opportunity” to pay dividends at some point. Finally, the Appellant maintains
that it made a business decision to use the airplane and it is not for the
Government to substitute its business judgment for that of the Appellant’s.
[45]
The Respondent’s
position is simply that the flight expenses were incurred solely for the
benefit of Mr. Mullen, not for the Appellant. It was a convenience to Mr.
Mullen personally. To the extent there was any commercial purpose, it was the
business of the business ventures, not the Appellant and, therefore, flight
costs are not deductible to the Appellant.
Analysis (Income Tax Act)
[46]
This is a unique case
in that a company, Lyncorp, incurs costs (ignoring any personal element for the
time being) that I would describe as operational expenses for the operations of
other companies (Shulin Mining, Shulin Lake Lodge, C.R. Boatland, Shear),
in which it has a debt or equity interest, without passing those costs onto
those operating companies. The Appellant can rightfully declare that its equity
interest could yield income from property; that is, there is a source of
income. Yet, equally clear is that Shulin Mining, Shulin Lake Lodge, C.R. Boatland
and Shear, had they been charged for these operational expenses, could have and
should have claimed them, as they would have gone to producing income from
their operations; that is, they had a business source of income. The fact is,
only one company incurred the costs, Lyncorp. I will return to this.
a) Did Lyncorp incur the costs?
Yes.
b) Were the costs of a personal nature?
[47]
Paragraph 18(1)(h)
of the Act prohibits a deduction for personal or living expenses. The
Respondent argues that the flight expenses are commuting expenses and, therefore,
personal and not deductible. Further, she argues that the flights were simply
for Mr. Mullen’s convenience to take him wherever he wanted to go,
whenever he wanted to go to increase his own efficiency in dealing with his
many companies.
[48]
Dealing with the
commute argument first, while it is certainly recognized that commuting to work
is a personal expense, I would not describe Mr. Mullen’s flights as simply
commuting to work. Is a business person, with several business interests across
Canada, to be denied the cost of getting to those interests
as that is simply commuting to work? No, there must be a recognition that some
businesses are located in multiple locations, though there would most likely be
one predominant place of business. The further twist in this case is that Mr. Mullen’s
flights can, for the most part, be viewed as costs incurred in connection with
the property source of income, as opposed to business income. It is too broad a
view of “commute” to suggest that in the context of holding properties,
travelling to check on those properties in several locations is commuting to
work. No, I do not accept the argument that Mr. Mullen was simply commuting to
his place of business. He, and therefore the Appellant, were incurring costs to
check on far flung investments, as well as carrying on some direct business
activity.
[49]
With respect to the
trips to Campbell River, however, Mr. Mullen had the added
attraction of having a home there; very much a personal reason for taking the plane
to Campbell River. His family would often accompany him.
This creates a chicken and egg scenario: which came first; the Appellant’s
decision to check on their investment in Campbell River, so let’s have some
personal time while we are there anyway or, the decision to spend a family
weekend at the Vancouver
island property, so let’s
check on our investment while we are there anyway. I conclude from Mr. Mullen’s
description, that the time in Campbell River was quite evenly split, so too
then should the cost of any flights to and from Campbell River, between personal and commercial.
[50]
This only addresses one
element of the Respondent’s concern as to the personal nature of the flights;
the other element is an overriding concern that these were simply flights of
personal convenience. The Respondent points to the list of reasons cited by
KPMG (see paragraph 10 of these Reasons) for support of the position that the
flights were personal to Mr. Mullen and not for the benefit of the Appellant.
This is a difficult concept to grapple with when the corporate Appellant and
Mr. Mullen are, as he put it, one and the same. Legally, of course, the
Appellant is a separate entity, but practically it is people who conduct that
separate entity’s affairs; and where the corporate entity has effectively only
one person serving as shareholder, director, officer and employee, one must
closely scrutinize the nature of the activities before too hastily suggesting
those activities are only to the personal benefit of the individual. If Mr.
Mullen, as director of Lyncorp, determines it is in the best interest of
Lyncorp to actively oversee its’ business ventures’ activities, and to do so in
a time effective manner, knowing the Appellant has only the resources of one
person, whose time is limited, is the Government simply second guessing that
business decision by suggesting this can only be interpreted as a personal
convenience to Mr. Mullen? I believe that is exactly what the Government is
doing. Former Chief Justice Bowman addressed this matter of second guessing the
taxpayer’s business judgment in the case of Podlesny v. R. where
he stated:
[15] There is also the question of reasonableness
which was not pleaded but which appears to have been an important consideration
in the making of the assessments. It is obvious to me that Mr. Podlesny was
rather aggressive in claiming the cost of two cars in computing his employment
income. It is equally obvious that he liked cars. That, however, is his choice.
It is not for me or the Minister to second-guess his business judgement and say
that he cannot use two cars for business purposes even though he might have
been able to make do with only one, and a cheaper one at that. His work is
important and at times urgent. His decision to have two well maintained
automobiles is not so patently absurd that I would be justified in setting it
aside as irrational or capricious. (See, for example, Gabco Ltd. v. M.N.R.,
[1968] DTC 5210). To do so would require me
to substitute my business judgement for that of the taxpayer and that is not
something that I am entitled or prepared to do. Moreover, I would be to some
extent usurping the role of Parliament. If Parliament wants to say that you can
only use one car in your business it knows how to say so, just as it has put a
limit on how much CCA you can claim on a luxury car. I do not think that one
can, under the guise of “reasonableness” substitute the court’s judgement for
that of the taxpayer. …
[51]
The fact that Mr.
Mullen was convenienced by having a plane at the ready, does not make the cost
of flights on that plane personal, if the purpose of the flight was commercial
and the actions of Mr. Mullen fulfill that purpose. It seems the Respondent is
suggesting that if commercial flights were cheaper, though the schedules were
awkward for Mr. Mullen, causing considerable inconvenience, that such costs may
more likely not be considered to be of a personal nature. Or perhaps the
Respondent is suggesting that Mr. Mullen, as the moving force of Lyncorp,
should have decided that Lyncorp should hire a third party consultant to check
on the business ventures, rather than Mr. Mullen himself, as again it might
have been cheaper. These are business decisions. I realize it is difficult when
dealing with a one person company to readily determine when the individual is
conducting personal matters versus corporate business, but the facts in this
case support the conclusion that it was Lyncorp who was both in some active
business and also held investments. Mr. Mullen was Lyncorp’s sole mover and
shaker to get things done.
[52]
The Respondent did not
plead that the expenses were unreasonable, but simply that they were personal
to Mr. Mullen and did not produce income from the Appellant’s business or
property. I need not, therefore, address the question of reasonableness.
c) Were the costs incurred for the purpose of
gaining or producing income from business or property?
[53]
Having carved out 50%
of the disputed flight costs to Campbell River as being personal, were the remaining
disputed flight costs incurred for the purpose of earning or producing income
from business or property of the Appellant as required by paragraph 18(1)(a)
of the Act.
Business source
[54]
I will first address
whether any of the disputed flight expenses were incurred for purpose of
gaining or producing income from the Appellant’s business, as opposed to the
Appellant’s property.
[55]
The Appellant argues
that it was directly engaged in several businesses: active mining exploration,
drilling services, aircraft charters and, interestingly, the business of
providing a variety of technical, management and executive type services of Mr.
Mullen. I find that none of the disputed flight expenses were incurred in
pursuit of the Appellant’s mining exploration business. That business was not
carried on in any of the locations connected to the disputed flights. Also, the
aircraft charter business was not engaged in the disputed flights.
[56]
I will address first then
the notion put forth by the Appellant that it was in the business of providing
support services to the business ventures. If it was, then the evidence is
clear that it was engaged in a not-for-profit business. Mr. Mullen was
straightforward in his testimony that the Appellant simply did not charge the
business ventures for the support services he provided. The Appellant did not
even charge Shulin Mining for the use of the rig. There is a commercial flavour
to Mr. Mullen’s work with the business ventures, but the Appellant cannot
rely on this consulting business for the purpose of claiming a deduction for the
distributed flight expenses as this “business” did not produce revenue nor was
it intended to produce revenue. According to Mr. Mullen, the business ventures
could not afford to pay for these services. I do not see how the Appellant can
now turn around and argue the costs were incurred for the purposes of producing
income from that business. This is not a matter of reincarnating any “reasonable
expectation of profit” test: this is a matter of the facts clearly establishing
this was an intentional non-income producing activity.
[57]
The Appellant also
cannot point to the possibility of dividend income as being income produced
from this consulting business. Dividend income is derived from the source of
income being property, and although neither party mentioned it, if the dividend
income is the income to be gained from the Appellant’s efforts, it would
necessarily be a specified investment business, with the result the income is
still to be considered income from property, not income from business. All to
say, I find the Appellant’s argument non-persuasive that this consulting
business justifies any deduction of the disputed flight expenses: if it is a
business, there is no income; if the Appellant points to the dividend income as
the income being produced, it is not income from business but income from
property.
[58]
With respect to the
Appellant’s drilling services business, that needs further review. I find the
flights to Alaska to check on the operations of Shulin
Mining had a twofold purpose. First and foremost, it was to assist Shulin
Mining (and also Shear and Golconda) with its operations. But second, it was
for the Appellant, through Mr. Mullen, to see firsthand how the Appellant’s
drilling rig, being used at no charge by Shulin Mining, was being operated. Mr.
Mullen acknowledged it provided a learning experience on which the Appellant
could rely for its ongoing and future drilling services. I am satisfied the
Appellant owned the rig and I am further convinced it was a legitimate business
reason to send its representative to check on the rig and to, more importantly,
determine how to best use the rig in its future drilling business. The rig was
later moved by the Appellant to work in Saskatchewan.
[59]
There is little
evidence to effectively determine how much of Mr. Mullen’s time and
effort, when visiting drill sites at Shulin Lake, was overseeing the activities
of one of its business ventures (Shulin Mining, Shear or Golconda) versus
checking on the Appellant’s rig and learning, from the use of the rig, the
effective operation of a drilling business. The flight costs of the Appellant
for the latter direct business activity are legitimate deductible business
expenses as they relate directly to the development of Lyncorp’s active
business. The cost incurred for the former, I will deal with when reviewing
income from property.
[60]
From Mr. Mullen’s
description of his involvement with Shulin Mining, I find that he was
there more to oversee the work of Shulin Mining, Shear and Golconda in
connection with the claims, than to check on Lyncorp’s rig and basically learn
the ropes for Lyncorp’s own drilling business. I considered sending this point
back to the Parties for further submission but instead have determined that a
75% - 25% allocation is appropriate. Therefore, one-quarter of the flight costs
to Alaska that relate to drilling should be
deductible. It is then necessary to allocate flights to Alaska between flights to check on the lodge versus flights
to check on the drilling versus flights where Mr. Mullen did both. I find the
following flights related only to drilling and, therefore, one-quarter of the
cost is deductible, as it pertains to Lyncorp’s direct business activity:
a) February 7 to 11, 2002 - $9,677
b) April 2 to 4, 2002 - $19,404
c)
August 3 to 6, 2002 -
$13,776 ($6,450 was already deducted as pertaining to the Campbell River portion of the trip)
d)
August 14 to 19, 2002 -
$15,943
e)
August 30 to September
3, 2002 - $16,472
f)
September 22 to 23,
2002 - $20,649
Total for 2002 - $95,921, 25% being
$23,980.
g)
February 5 to 7, 2003 -
$16,314
h)
March 14, 2003 -
$16,445
Total for 2003 - $32,759, one-quarter of
which is $8,189.
[61]
I find the following
flights related to both Shulin Lake Lodge and to the drilling. I have no
conclusive evidence as to how Mr. Mullen divided his time between the two, and
again am going to presume an equal split, which means one‑quarter of
one-half of the costs related to Lyncorp’s direct business activity of
developing a drilling business:
a) March 15 to 19, 2002 - $11,281
b) June 17 to 20, 2002 - $18,254
Total for 2002 - $29,535, of which $3,692 is
deductible.
c)
April 23 to 27, 2003 -
$18,081
d)
June 16 to 19, 2003 -
$16,657
e)
August 13 to 17, 2003 -
$15,569
f)
September 2 to 5, 2003
- $25,061
Total for 2003 - $75,368, of which $9,421
is deductible.
[62]
All other flights to Alaska, I conclude were non-drilling related, such as work
in connection with the lodge.
[63]
The only other flight
that I find relates directly to the Appellant’s business activity is the May
2002 flight to Cranbrook at a cost of $1,440.
Property source
[64]
I turn now to consider
whether any of the remaining disputed flight expenses were incurred for the
purpose of gaining or producing income from property. In this regard, the
Appellant argues it has two sources of property income – shares and debt.
[65]
I will first deal with
the issue of debt as a source of property income. The Appellant did indeed lend
considerable amounts to its business ventures in 2002 and 2003. It argues it
could benefit from such loans in two ways: first, if the ventures became
profitable enough, the Appellant could charge interest on the loans; second,
even if it chose not to charge interest on the loans, they could be viewed as
enhancing the business ventures’ ability to pay dividends.
[66]
The evidence was clear
that the loans were non-interest bearing. The Appellant’s position that it
could decide to charge interest at a point it believed the business ventures
could afford to pay it, is just not sufficient to find the existing contractual
debts owed to it were income producing. They were not. The disputed flight
costs were not incurred for the purpose of producing interest income, given the
debts were non-interest bearing. It is too remote a link to suggest that,
because the Appellant could have or perhaps should have charged interest, there
is a property source of income. Could haves or should haves, speculation
generally, is not enough.
[67]
The Appellant’s
argument that the loans are a source of income from property as they would
allow the debtors to ultimately pay dividends is imaginative, bold even, but it
too must fail. The property itself, the debt, produces no income. The debtor is
obliged to repay the principal: it has no contractual obligation to pay
interest. It may become profitable in the future, allowing it to repay that
debt. It may then be in a position to pay dividends. I fail though to see any
link, direct or otherwise, between the debt and the possibility of payment of
dividends, let alone any actual payment of dividend. The dividend income does
not arise from the debt. Put in tax terms, the debt is not the source of
dividend income.
[68]
This leads, finally, to
perhaps the most interesting issue: does the Appellant’s investment in shares
of the business ventures, with the possibility of dividends being declared on
those shares, support the deduction of the disputed flight expenses, claimed to
have been incurred for the purpose of producing that dividend income?
[69]
To recap, it was the
Appellant’s strategy to provide the support services of Mr. Mullen to the
business ventures at no charge, to help them succeed with an expectation of
future dividends. Therefore, the Appellant argues, the flight costs incurred in
enabling Mr. Mullen to provide those support services fits squarely within
paragraph 18(1)(a) of the Act, as they were incurred for the
purpose of producing income from a property, being the shares in the business
ventures. I note at this point that it was Mr. Mullen, not the Appellant, who
owned shares in Shulin Mining, notwithstanding Mr. Mullen’s view that those
shares should have been transferred to the Appellant. They were not. However,
the Appellant did own shares in both Shear and Golconda, which were intimately involved with Shulin Mining in the work in
Alaska.
[70]
The Respondent relies
on the recent decision of SLX Management Inc. v. R.
to support the proposition that expenses incurred to produce income from a
subsidiary company, are not deductible on the basis of being incurred for the
purpose of producing income from property (dividends). To be fair, SLX Management
does not appear to address this issue head on, but simply stated:
[55] Second, the aircraft was used in relation to a business other than
Management, SLX Aviation, which is a subsidiary of Management. A
distribution agreement being negotiated with Socata by Miller anticipated that
this other entity and not Management would be the distributor. Miller
stated that Management itself would never be the owner of anything in terms of
this venture with Socata. According to the principles enunciated in Stewart,
supra, any aircraft expenses incurred for the purpose of gaining
income for SLX Aviation are not deductible by Management.
[71]
It is not clear whether
the Appellant in SLX Management even argued for the deductibility based
on income from property. No, I am not prepared to attribute as broad an
interpretation to SLX Management as the Respondent suggests. The issue
requires further scrutiny.
[72]
In Stewart v. Canada,
the Supreme Court of Canada stated:
[57] It is clear from these provisions that the deductibility
of expenses presupposes the existence of a source of income, and thus should
not be confused with the preliminary source inquiry. If the deductibility of a
particular expense is in question, then it is not the existence of a source of
income which ought to be questioned, but the relationship between that expense
and the source to which it is purported to relate. The fact that an expense is
found to be a personal or living expense does not affect the characterization
of the source of income to which the taxpayer attempts to allocate the expense,
it simply means that the expense cannot be attributed to the source of income
in question. As well, if, in the circumstances, the expense is unreasonable in
relation to the source of income, then s. 67 of the Act provides a
mechanism to reduce or eliminate the amount of the expense. Again, however,
excessive or unreasonable expenses have no bearing on the characterization of a
particular activity as a source of income.
[73]
The dilemma before me
is which relationship triggers a possible deductible expense: the relationship
between the expense, being the disputed flight costs, and the business
income of the particular business ventures, or the relationship between the
expense and the property income (dividends) of the parent company
incurring the expense? I attempted to address the dilemma in argument by asking
the parties about a direct or indirect relationship. They did not appear
enthusiastic to take the bait. Yet, that is where, I believe, the resolution
lies. To which source of income does the expense purportedly relate? The fact
the Appellant incurred the expense has little impact on the answer to that
question. The Appellant argues the expense relates to the property source of
income. Indirectly, perhaps. But clearly, the remaining disputed flight expenses
relate directly to the business income of the business ventures. The expenses
were incurred to make the business ventures profitable. Yes, that might yield
at some future point dividend income, but the direct cause and effect link is
between the expenses and the business income of the business ventures, not the
relationship with any property source of income.
[74]
To allow the
Appellant’s deductibility of such expenses invites shareholders and corporate
taxpayers to effectively choose from which source of income (property or
business) to deduct expenses as best suits their purposes. I do not believe the
Act contemplates such an election.
[75]
The Appellant was, in
effect, giving its business ventures several hundred thousand dollars, neither
by way of debt or equity but simply by providing free services toward the
operation of the business ventures’ businesses, with the hope that this
generosity would help them get on their feet and maybe some day, in some
manner, repay them. This generosity was neither a loan nor an equity investment
by the Appellant. It might best be described as an agreement to pay someone
else’s expenses. Equity investments yield dividend income. Debt investments
yield interest income. Free services, with no obligation to repay, yield only
hope. This is not a deductible expense.
[76]
In summary, on the income
tax appeal, the appeal is allowed and referred back to the Minister for
National Revenue for reconsideration and reassessment on the basis the Appellant
is entitled to deduct flight expenses of $29,112 in the 2002 taxation year and
$17,610 in the 2003 taxation year.
GST
[77]
Generally, the
entitlement to Input Tax Credits (ITC’s) under the ETA arises when GST
was paid “for consumption, use or supply in the course of commercial activity”.
Subsection 123(1) of the ETA defines commercial activity generally, as “a
business carried on by the person…except to the extent to which the business
involves the making of exempt supplies by the person”. From this definition, it
is inferred that exempt supplies will not qualify as commercial activities, as
well as non-business activities, or activities of a personal nature. Further,
what is key from this description of commercial activity is that it is not
enough the activity be simply commercial in nature, but that it is a business carried
on by the taxpayer. This is the Appellant’s hurdle, as apart from the
direct flight expenses that I have found relate to the Appellant’s direct
business activity, the rest of the disputed flight expenses simply do not
relate to a business carried on by the Appellant.
[78]
In B.J. Services
Company Canada, the Successor to Nowsco Well Service
Ltd., v. Her Majesty the Queen, I determined the Court should look to the
following factors in determining the commerciality of the inputs:
a) the purpose for the input;
b)
for whose benefit was
the input incurred;
c)
the context within
which the input was incurred; and
d)
caselaw dealing with
what constitutes commercial activity.
[79]
In Sclerie
St.-Elzear Inc. v. Her Majesty the Queen the Court considered whether the
Appellant could claim ITC’s in relation to fees paid for the preparation of
financial statements of five related companies owned by the Registrant’s
members. The Tax Court upheld the Minister’s decision that the ITC’s were not
an integral part of the Registrant’s commercial activities, stating, as
follows:
…in the case at bar,
the professional services do not fulfil the Appellant’s obligations, but,
rather, the five management companies’ obligations to file tax returns and
financial statements. The five management companies are the ones that need
professional services like those rendered in the instant case, and, in my
opinion, they are the ones that should pay for them. The fact that the Appellant
has agreed to foot the bill for these services attests to its economic interest
in maintaining the management companies in existence, as opposed to pointing to
a need or legal duty on its part to ensure that its business operates soundly,
which need or duty would compel a finding that the payment is an integral part
of the Appellant’s commercial activities. The purpose and context of
the input are not related to the Appellant’s commercial activities, any more
than the fact that the Cooperative and its members are the ones that benefit
from the input by reason of the profit that will be distributed to the members
at age 60.
[80]
I conclude that the
purpose for, and the benefit of, the remaining disputed flight expenses (other
than the $29,112 in 2002 and $17,610 in 2003) relate to the businesses of the
business ventures and not any commercial activity of the Appellant. Likewise,
the context of the remaining disputed flight expenses was services provided in
the business ventures’ businesses, in their commercial activity, not any
commercial activity of the Appellant.
[81]
This is a unique
situation of a company incurring costs (inputs) to provide free services to its
business ventures. In such circumstances, the company can best be viewed as the
ultimate consumer – the end of the line: no ITC’s are available, as there is no
further commercial activity of the company.
[82]
In summary, the GST
Appeal for the period January 1, 2002 to December 31, 2003 by Notice of
Assessment No. 10CT0700344 dated July 26, 2006 is allowed and referred back to
the Minister of National Revenue for reconsideration and reassessment on the
basis the Appellant is entitled to ITC’s in connection with the flight expenses
of $29,112 in the 2002 taxation year and $17,610 in the 2003 taxation year.
[83]
Given the limited
success of the Appellant, I award one set of costs to the Respondent in
accordance with the tariff.
Signed at Ottawa, Canada, this
19th day of October 2010.
"Campbell J. Miller"
Appendix A
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