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Citation: 2006TCC215
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Date: 20060331
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Docket: 2005-1297(IT)I
2005-1299(IT)I
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BETWEEN:
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TRUCKBASE CORPORATION
and TOM GRABOWSKI,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
McArthur J.
[1] These appeals were heard together on common evidence, and concern reassessments by the Minister of National Revenue ("the Minister") as to the deductibility of legal and accounting fees paid by the Appellants, Tom Grabowski and Truckbase Corporation. With respect to Tom Grabowski, the issue is whether the amounts of $22,213 and $30,260 are to be included in his income on account of shareholder benefits in the 2000 and 2001 taxation years, respectively. With respect to Truckbase Corporation, the issue is whether the Corporation is entitled to deduct the amount of $16,942 in professional fees in the 2001 taxation year, and also is entitled to claim eligible capital expenditures for the 2001 and 2002 taxation years.
[2] Mr. Grabowski was the Appellant's primary witness. He is a well-educated intelligent entrepreneur. Together with his friend, Robert Morton, he commenced a business in the early 1980s, providing technological services to the forestry industry primarily in north-western Canada. Over the years, their endeavours have continued to grow. There are now seven corporations and over 40 employees. Mr. Grabowski is a meticulous person who has a strong desire to see the business grow and continue operating after his death or retirement, and that of Mr. Morton.
[3] In the 1990s, he was contemplating expanding into the United States market. He was anxious to protect the Canadian corporate and personal assets from creditors and from litigants in general. He also felt at this time that their corporations' structure had been seriously neglected. It was with this frame of mind that he approached Michelle Simpson, an able Edmonton lawyer with a corporate commercial practice. Mr. Grabowski retained her to review his and his corporations' paperwork that had been overlooked for many years. Ms. Simpson, together with Mr. Grabowski, his accountants and staff immersed themselves in updating and restructuring the Corporations' operating documentation to assist in making them more profitable and ensuring continuance of the business over the long term.
[4] Incorporated in 1990, Truckbase Corporation is one of seven corporations that comprise the Silvacom Group of Corporations. Silvacom Ltd. was incorporated in 1983 and since then, has been controlled by permanent directors, Tom Grabowski and Robert Morton. Generally, all of the Silvacom Group companies carry on business in the forestry and transportation industries. Truckbase Corporation is involved in the design, production and sales of satellite-based information producing devices for tractor-trailer trucks and other heavy equipment. All of the corporations of Silvacom Group use a fiscal year end of November 30.
[5] For the 2000 and 2001 taxation years, Silvacom Group incurred general legal and accounting fees pertaining to business reorganization and for work of a general nature. As stated, the Silvacom Group had retained the services of various legal and accounting firms, in particular the legal services of Michelle Simpson, general counsel for the Silvacom Group, who was responsible for the corporate restructuring. I accept that the Appellants incurred fees for the following services as outlined in their arguments:
(a) General legal and accounting fees of a general, ongoing nature;
(b) The reconstructing and updating of minute books for the seven corporations under the Silvacom Group;
(c) A comprehensive review of pre-existing Unanimous Shareholder Agreements ("USA's");
(d) Meetings to review the different legal and business climate in the US and the protections necessary to reduce the risk of the corporate veil being pierced;
(e) Meetings and/or discussions to review what should be contained in new USA's;
(f) Meetings and discussions to determine which business operational matters required unanimous shareholder consent;
(g) The redrafting of all of the USA's to make them consistent with one another;
(h) The review of income tax provisions, including the section 122 grandfathering rules on corporate owned life insurance;
(i) The review of options for holding key employee disability insurance;
(j) Incorporating the proposal for Mr. Grabowski to hold and pay for disability insurance on Mr. Morton and vice versa into the various new USAs;
(k) The amendment of the authorized share capital for Truckbase; and
(l) The conversion of Common Shares in Truckbase owned by Robert Morton and Tom Grabowski to Preferred Shares followed by the creation of family trusts and the issuance of new Common Shares of Truckbase Corp. to each of the Grabowski Family trust and the Morton Family Trust.
[6] Corporate accounts for legal and accounting fees during the fiscal year of December 1, 2000 to November 30, 2001 equalled $15,316.75 for accounting fees and $59,168.30 for legal fees, for a total of $74,485.05.[1] Accounting fees in the amount of $2,729.38 and legal fees in the amount of $25,507.24 were allocated to Truckbase, totalling $28,236.62. Truckbase deducted $16,942.62 as a current expense and treated the balance of $11,294 as eligible capital expenses. Also, Truckbase deducted a further $593 and $553 in the 2001 and 2002 taxation years, respectively, with respect to the $11,294.
[7] Mr. Grabowski was reassessed to include in his income, benefits of $22,213 and $30,260 for his 2000 and 2001 taxation years. These funds relate to certain accounting and legal fees paid by Silvacom Group and were considered shareholder benefits because they were incurred for personal estate planning purposes. Truckbase was disallowed the $16,942.62 deducted as professional fees.
[8] The relevant provisions of the Income Tax Act are as follows:
9(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property for the year.
15(1) Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by
...
18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;
(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part;
...
(h) personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer's business;
Appellants' position
[9] The Appellants argue that the corporate reorganization was a necessary business expense and not a personal shareholder benefit. The $1,500 legal fees for each of the two family trusts which were prepared should be considered a shareholder benefit to the trust and not to Mr. Grabowski.
[10]The Appellants also contend that the costs incurred for the Unanimous Shareholder Agreements are currently deductible under subsection 9(1) of the Income Tax Act, and as such, they do not constitute shareholder benefits under subsection 15(1). The Appellants relied on the Supreme Court of Canada decision in Duha Printers (Western) Ltd. v. R.[2]where Iacobucci J. commented on the vital role that Shareholder Agreements play in the management of corporations. He states that these Agreements are the means by which shareholders limit the powers of company directors as they set forth fundamental "rules" by which a corporation is to be governed. The interests of the shareholders are the dominant factor, they are provided with certain rights and powers and this cannot be equated with a conferral of a benefit. The Appellants conclude that the existing Shareholder Agreements in effect prior to the re-organization were inconsistent and contained many errors, and that the cost of drafting new Agreements should be deductible as current expenses. They likened the situation to current expenditures to fix a leaky roof as opposed to capital expenditures for the initial installation of a roof.
[11]The Appellants also relied on BJ Services Co. Canada v. R.,[3]a decision by Campbell J. of this Court, which involved a hostile takeover bid by BJ Services to acquire all of the shares of Nowsco Well Services Ltd. Nowsco's board of directors caused the corporation to incur substantial expenditures. BJ Services was successful in acquiring the shares of Nowsco and subsequently sought to deduct the professional fees on a current basis. Campbell J. held that the professional fees were deductible and incurred for shareholder relations in order to maximize shareholder value. The expenses were not considered capital in nature as they were incurred for the purpose of gaining or producing income and not for obtaining any enduring benefit. Campbell J. discussed the necessity of public corporations incurring expenses in takeover bid situations. The Appellants argued that her comments were directly applicable to the Shareholder Agreements as they are business costs and not personal in nature.
Respondent's position
[12]Counsel for the Respondent argued that the professional fees related to the reorganization of the Silvacom Group and represented shareholder benefits to Mr. Grabowski and Mr. Morton. Furthermore he was of the opinion that these professional fees should not be deductible to any corporation in the Silvacom Group, and not added to the eligible capital expenditure pool for any of these corporations.
[13]The Respondent believes that the benefits conferred on Mr. Grabowski in the form of the costs of legal and accounting advice and paid for by Truckbase should be considered personal shareholder benefits under subsection 15(1) of the Act. Counsel contends that the purpose of producing the Shareholder Agreements was to preserve the business structure. The preservation of a business structure is not the sort of effort that would assist a company to earn income. The preservation of a company upon the death of a shareholder or director is too remote to be linked to the test found at paragraph 18(1)(a) of the Act which asks whether an expense was incurred for the purpose of gaining or producing income. Moreover, as the purpose of the expenditure was not to earn income, no capital deduction should be available.
[14]The Respondent argued further that should I find that a benefit had been conferred on Mr. Grabowski, then Truckbase should not be entitled to a corresponding deduction for the payment of that benefit. Counsel referred to John Chopp v. The Queen[4] to support this position.
[15]Further, counsel for the Respondent disagreed with the Appellants as to the applicability of the BJ Services decision. He distinguished this case on the fact that BJ Services Ltd. had conducted a hostile takeover of Nowsco and had an obligation by the directors to expend resources of the company to protect the interests of the shareholders during the hostile takeover. Counsel also sought to restrict the application of other decisions where professional fees were deductible as situations in which companies owed an obligation to their shareholders, or where they were experiencing economic challenges. The Respondent referred to two decisions, The Queen v. Jager Homes Ltd. and Jager Holdings (Calgary) Ltd.[5] and Rona Inc. v. The Queen[6] in which professional fees were held to be capital expenses. In both decisions, the professional fees were held to have been incurred for the purpose of preserving the business structure.
Analysis
[16]I will deal first with the issue of subsection 15(1) and the benefit to Grabowski as a shareholder. I agree with the Appellants that the professional fees incurred for the preparation of Shareholder Agreements were not a shareholder benefit to Mr. Grabowski. I do not feel that BJ Services and the other decisions cited in that case, should only apply in situations involving hostile takeover bids or economically difficult circumstances. I agree that the amounts in question should be deductible to Truckbase under subsection 9(1) of the Act for the taxation years in question.
[17]Shareholder Agreements play a very significant role in protecting a corporation and its relationship, vis-à-vis its shareholders. As mentioned above, counsel for the Appellants relied on the Duha decision at paragraphs 61-71, wherein Iacobucci J. attests to the vital role and importance of Shareholder Agreements in the modern operation of business.
[18]Evidence was adduced at the hearing as to the importance of the Shareholder Agreements to the Silvacom Group. The revision of these agreements effectively took operational powers away from the shareholders and gave it to management. I agree with Ms. Simpson that the original shareholder agreements were poorly drafted, deficient and had inconsistencies. For instance, one problem was that should something happen to Mr. Grabowski or Mr. Morton, the old agreements would call for the mandatory winding up of Truckbase and the liquidation of Silvacom. This, from a business perspective, would obviously be unacceptable. Victor Wearden, the chief financial officer and controller for the Silvacom Group, testified that the newly drafted Shareholder Agreements succeeded in making the company more productive. I agree with this observation. The employees now have the motivation of being an integral part of the operation. This has evolved into an attractive bonus system in which all employees participate. Obviously, the corporate structures have made the business more profitable.
[19]I believe the costs incurred for the Shareholder Agreements were for the purpose of a bona fide business reorganization which facilitated effective management, good governance and protection for the Silvacom Group against any disruption due to the disability of key employee/shareholders. The fees were not personal or living expenses of Mr. Grabowski pursuant to paragraph 18(1)(h) of the Act. Since there was no shareholder benefit conferred on Mr. Grabowski, there is no need to consider whether Truckbase is automatically disentitled to a corresponding deduction.
[20]Therefore, I conclude that the professional fees were incurred to earn "income" as set out in paragraph 18(1)(a). These expenses were an integral part of Truckbase's business and were made for the purposes of gaining or producing income within in the meaning of the section.
[21]Alternatively, the Respondent submitted that the expenses were on account of capital and not tax deductible under paragraph 18(1)(b). As stated, the Respondent relied on the decisions in Rona and Jager. Both cases held that where legal fees were incurred to preserve the business entity, structure or organization, then these fees will be viewed as capital and not the kinds of expenditures which are made to earn profits.
[22]The Supreme Court of Canada, however, in John-Manville Can. Inc. v. The Queen,[7] established that the characterization of expenditures as current expenses or capital outlays is a question of both fact and law. There is no single definitive test to distinguish between a current expense or capital outlay. The basic distinction has been described by Viscount Cave, L.C. in British Insulated and Helsby Cables Ltd. v. I.R.C.[8] as follows:
...when an expenditure is made, not only once and for all, but with a view to bringing an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributed not to revenue but to capital.
The focus is on the purpose of the expenditure and not the result. I would liken the redrafting of the Shareholder Agreements as the maintaining of an asset and, subsequently, an expenditure that is a deductible current expense.[9]
[23]The Appellants drafted the initial shareholder agreements which were meant to outline which operational decisions required shareholder consent, restrict sales of shares, set out procedures to be followed in the event of the death or disability of a key shareholder, and provide dispute mechanisms, amongst other things, which were initially a capital expense. These initial agreements were not functioning properly and as such, were "repaired" through the incurring of various professional fees. The Appellants paid to have their shareholder agreements rectified and maintained so as to meet their initial goals of the original agreements. The Shareholder Agreements have not been improved to do more than before. It is amended to function as originally intended. The legal fees for the restoration of the Agreements can be viewed as current expenses and deductible under subsection 9(1) of the Act. The fees will not be subject to the restrictions with respect to the deductibility of capital expenses set out in paragraph 18(1)(b).
[24]In conclusion, I find that the professional fees incurred were not shareholder benefits conferred on Mr. Grabowski. As well, the amount deducted by Truckbase was appropriately deducted as a current expense. The remaining amount of professional fees capitalized to the Truckbase's cumulative eligible account which totalled $11,294, should be allowed with deductions of $593 and $551 for amortization of eligible capital expenditures as claimed under paragraph 20(1)(b) of the Act, for its 2001 and 2002 taxation years. The matter is referred back to the Minister for reassessment. The Appellants are entitled to one set of costs.
Signed at Ottawa, Canada, this 31st day of March, 2006.
McArthur J.
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