Maduke Foods Ltd. v. The Queen, 89 DTC 5458, [1989] 2 CTC 284 (FCTD)

Strayer, J.: —

Relief Requested

This is an appeal against the reassessments made by the Minister of National Revenue of the plaintiff's income tax for taxation years 1981, 1982, 1983, 1984 and 1985.

Facts

During the period in question the plaintiff Maduke Foods Ltd. was owned by members of the Maduke family of Leduc, Alberta. Gordon Maduke, the senior member of the family, had 70 per cent of the shares; his brother Bernard (“Bernie”) had 10 per cent, his sister Audrey Cleveland had 10 per cent, and his sister Ruby, now deceased, had another 10 per cent. The company was operating (and its successor company continues to operate) a modest sized supermarket of 9,000 square feet in Leduc.

Gordon and Audrey live in Leduc and work in the store full time. Bernie lives in Toronto with his wife Peggy and, during the years in question, their four children were all at home: Merritt, born in 1966; Sandra, born in 1968; Pamela, born in 1969; and Murray, born in 1971. Bernie and his family assisted during these years in the operation of the store by means which will be discussed more fully later. The reassessments in issue here relate to amounts accrued as salaries or "bonuses" for Peggy and the four children during the taxation years 1982-85, together with certain other amounts paid by the plaintiff corporation on behalf of Peggy. These amounts were fixed each year by Gordon and Bernie in consultation and were deducted as operating expenses by the plaintiff. The Minister disallowed most of these expenses on the basis that they were not incurred for the purpose of gaining or producing income or that they were not reasonable in the circumstances, thus invoking both paragraph 18(1)(a) and section 67 of the Income Tax Act. I am informed by counsel that the reassessment of the plaintiff's 1981 taxation year is dependent on the determination in this appeal, as the operating losses resulting from the payment of the salaries or bonuses in question were carried back in part to the 1981 taxation year.

According to the evidence the store in question was opened in 1972, although the family had had prior stores in Leduc. It is wholly managed by the family and they provide much of the labour involved in its operation. The store normally has only five or six other employees apart from the members of the family. The store is open seven days a week, every day of the year except Christmas and Easter. It is open from about 7:30 a.m. to 9:00 p.m. on weekdays, closing at 8:00 p.m. on Saturday and Sunday night. Gordon is the manager and he is in the store about 14 hours a day. Audrey, his sister, is in the store 10 to 12 hours a day, although she did mention that occasionally she takes a few holidays. The non-family employees normally work 8 hours a day, 40 hours a week. Bernie, although he lives in Toronto, was the secretary-treasurer of the plaintiff company in 1982-85 and did the bookkeeping. This was and is effected by means of Gordon regularly mailing to Bernie all necessary documents such as invoices, bank records, payroll records, etc. Bernie issues most of the cheques as well. Gordon and Bernie discuss by telephone, several times a week, current affairs of the store and Bernie gives his advice. Bernie also spends six to seven weeks during the summer working in the store, in part relieving Gordon of some of his management responsibilities. Bernie has other business experience and is a Master of Business Administration. The evidence generally indicates that he has a major role in the management policies of the company and with respect to financial planning and controls.

The evidence is clear that during the period in question Peggy and the children worked in the store for certain periods during the summer. Peggy worked there two weeks per summer and the children worked there for an average of 31 days each, except for Merritt who in 1985 went to Europe during the summer and only worked in the store for two weeks. The children were rotated from Toronto so that only one or two would be in the store at a time during the summer.

Family witnesses did not concede that they ever had any time off on working days, even for eating. They did admit to leaving the store on Sunday morning long enough to attend church.

Apart from her actual work in the store, Peggy is credited by members of the family with providing ideas for innovations in the store. These innovations are really based on her observations in supermarkets in Toronto, and occasionally in the United States. She is particularly credited with having invented the motto of the store back in the early '70s, namely “Our Motto — Your Satisfaction”, which she says she read on the side of a truck while in traffic on the Gardiner Expressway in Toronto. With respect to actual operations, she is credited by all of the other family members who testified with having suggested two important innovations: prepackaging and pre-pricing of all produce, and a return to the sale of “hung meat" in lieu of “block ready" meat (prepackaged by the suppliers). Family witnesses were rather uncertain as to when these innovations had been adopted. Those who seemed the most positive estimated anywhere from 1980 to 1982, while Peggy herself was only reasonably certain it was sometime during the taxation years in question. Apart from contributions in those years, Bernie and Peggy are credited with some ideas in the planning of the store in 1972 and the conversion of the store after the 1985 taxation year into a “Tom-Boy” chain supermarket.

According to family witnesses, during the periods when the children were at the store during the summer, as described above, they did the following types of work: they stocked shelves, helped clean coolers and refrigerator equipment, prepared signs for use within the store, packaged produce and priced it, packaged "barge orders" for shipment to the north, unloaded trucks bringing orders to the store, cleaned up the warehouse, and checked prices in the competitor's store across the street. In addition the girls worked as cashiers from the time they were 11 or 12 and were said to be good at "customer relations", i.e. talking to customers. Murray did not work as a cashier but he cleaned up the parking lot every summer. Apart from their work in Leduc, Bernie's family took back to Toronto the coupons collected by the store during the previous year, sorted them and mailed them to the relevant suppliers for reimbursement to the plaintiff. By their presence in the store Peggy and the children made it possible for non-family staff employed at the store to take their annual holidays. The evidence also indicates that the girls learned cashier work much faster than non-family employees and were more reliable in this post. Similarly they could be relied on more to do certain kinds of work with respect to prepackaging produce and assisting their aunt, Audrey, in cleaning the coolers and refrigerators once during the summer. They too were credited in a general way with innovative contributions to the operation of the store. The only examples of these that could be provided were that Merritt was good at making original signs advertising specials, etc., in the store, and Sandra was credited with the novel idea of adopting a policy not to accept cheques from people they did not know (this after they had accepted an endorsed cheque for $1,000 which, it turned out, did not belong to the person who presented it).

Apart from these specifics, Gordon Maduke in particular spoke enthusiastically of the "Toronto management team”. According to him this team which included Bernie, Peggy, and the four children, provided ongoing useful advice and ideas even during the ten months they were all in Toronto. This was done through the regular telephone conversations between Bernie and Gordon.

In the years in question the various members of the family were rewarded by the plaintiff as described in the following tables. These figures are taken from various exhibits filed by both the plaintiff and the defendant and there appears to be no dispute about them. Table 1 shows the amounts accrued as salaries (or "bonuses" as described by the plaintiff) for the respective taxation years and which were deducted by the plaintiff from its income as expenses during those years. Also shown, in parentheses, are the amounts actually allowed by Revenue Canada in respect of such salaries as were questioned. It may be noted that the accrued amounts were in each case actually paid to the respective family members in the calendar year following the taxation year in which they were accrued. Table 11 shows salaries and benefits actually paid to the family members, or paid on their behalf, during the year in which these salaries and benefits were earned. Again, where an amount was challenged by Revenue Canada the actual amount allowed in the reassessment is indicated in parentheses.

Table I

Management Salaries Accrued and (Amounts allowed as expenses by Revenue Canada where questioned)

Recipient		Taxation Year
	1982	1983	1984	1985
Gordon Maduke	50,000	70,000	60,000	55,000
Audrey Cleveland 70,000		60,000	60,000	50,000
Bernard Maduke	0	34,000	0	0
Peggy Maduke	50,000(4,200)	50,000(3, 000)	50,000(5, 000)	35,000 (4,000)
Merritt Maduke	12,500(nil)	14,000(nil)	20,000(nil)	15,500 (nil)
Sandra Maduke	12,500(nil)	14,000(nil)	15,000(nil)	8,500 (nil)
Pamela Maduke	12,500(nil)	14,000(nil)	15,000(nil)	8,500 (nil)
Murray Maduke	12,500(nil)	14,000(nil)	15,000(nil)	8,500 (nil)
		Table II

Salaries and benefits paid in year earned and (Amounts allowed as expenses by Revenue Canada where questioned)

Recipient		Taxation Year
1982		1983 1983	1984 1984	1985 1985
Gordon Maduke	0	12,817.30	20,338.40	7,379.80
Audrey Cleveland	0	4,998.80	1,446.70	941.92
Bernie Maduke	0	0	10,846.70	15,941.82
Peggy Maduke	0	761.04(nil)	10,846.70(nil)	941.92 (nil)
Merritt Maduke	0	4,200.00	3,000.00	5,000.00
Sandra Maduke	0	4,200.00	3,000.00	5,000.00
Pamela Maduke	0	4,200.00	3,000.00	5,000.00
Murray Maduke	0	4,200.00	3,000.00	5,000.00

It will be noted that Revenue Canada has not challenged the amounts accrued or paid to those most heavily occupied with the operation of the store, namely Gordon, Audrey, and Bernie. It should also be noted at this point that the Minister now concedes that he should have allowed an amount for accrued salaries (i.e. as described in Table I) for each of the four children in 1982. It will be noted in Table II that neither Peggy nor any of the children were actually paid any salary or benefits during 1982 although they were equally involved with the store that year. Accordingly the Minister did allow, as indicated in Table I, an accrued salary of $4,200 for Peggy in that year but overlooked making similar provision for the children. The witness for Revenue Canada took the position that the amount could be fixed as low as $1,120 for each of the four children in 1982. I will return to this question later.

It appears that store employees other than members of the family were paid very modest wages: according to the audit of the 1984 payroll records they were paid in the range of $4 to $6 per hour.

Issues

The Minister principally relies on two provisions in the Income Tax Act as follows :

18(1) In computing the income of a taxpayer from a business or property no deduction shall he 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. . . .

67 In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

Thus the potential issues are: (1) were these expenses incurred for the purpose of producing income; and (2) if so, were salaries of this magnitude reasonable in the circumstances? If either question is answered in the negative the plaintiff must fail. Counsel agreed that the case could be decided under either section and I will do so under section 67.

Conclusions

It is apparent from the jurisprudence that what is "reasonable in the circumstances” within the meaning of section 67 is essentially a question of fact. Therefore other decided cases are of limited assistance. Counsel for the plaintiff relied strongly on a statement of Cattanach, J. of this Court in Gabco Ltd. v. M.N.RA where he said:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind. . ..

Notwithstanding this general statement, it may be noted that Cattanach, J. in that case looked at all the facts and concluded that the remuneration in issue was reasonable. He also noted that the Minister was entitled (and by implication so was the Court) to consider salaries and bonuses paid to other employees to determine whether the salary or bonus paid to the family member of a closely held corporation is out of proportion to remuneration paid to others.

After considering all the evidence I am satisfied that the amounts originally accrued as salaries or bonuses for Peggy Maduke and her four children, as set out in Table I, together with the disallowed payments on behalf of Peggy as set out in Table II, were not reasonable in the circumstances. The evidence satisfies me that Peggy and her children took a strong interest in the welfare of the business and that while they were in Leduc they made a very useful contribution to its operation. It is obvious that the children are intelligent and conscientious and that the whole family works together in what is perhaps unusual harmony. I have no doubt that Gordon and Audrey feel considerable relief each summer when various members of the family come to assist in the store as they represent temporary help which is experienced and reliable. But the total amounts as set out in Table I and Table 11, paid to these members of the family, are completely out of propor-

[1968] C.T.C. 313; 68 D.T.C. 5210 at page 323 (D.T.C. 5216).

tion to what others receive for working in the store. For example Gordon Maduke, the president of the company and manager of the store, who says that he worked in the store 14 hours a day, 7 days a week, 363 days of the year, was paid a total of $82,817.30 in 1983. Peggy Maduke was paid or credited with a total of $54,200 for two weeks work in the store plus some advisory work which I will discuss later. Merritt Maduke at the age of approximately 18 in 1984 was paid a total of $23,000 for one month's work in the store while her uncle Gordon, for his full-time work and responsibilities 363 days of the year was paid $80,338.40. That same year the top pay for others working in the store — who, after all, must have been doing during the remaining ten months of the year most things that the children did in the summer — was $6 per hour or $240 per week assuming on the average a 40 hour week as the evidence indicated. This would amount to $12,480 a year. In 1983, at the age of approximately 12, Murray Maduke was paid $18,200. Like the other children he spent about 31 days at the store. In 1985 Merritt only spent two weeks at the store and she was paid $20,500.

In part the plaintiff seeks to justify these payments on the basis of the contribution of the "Toronto management team”, namely Bernie and Peggy Maduke and their four children. The contribution of this "team" was largely made from Toronto during the majority of the year when its members were not in Leduc. With every respect for the sincerity of the family witnesses on this subject, I am satisfied that their enthusiastic involvement with the family enterprise has deprived them of a certain sense of proportion. The strongest case was made for the contribution of Peggy, because of her innovative ideas. In the first place, it is clear even from her own evidence that these “innovations” were really all derivative from (in one case) a conference lecture or more commonly from her observations of other stores. Most of these stores are in the Toronto area where, presumably, she has to shop anyway. While she said that she had also looked at developments in U.S. supermarkets, she agreed that this was in association with trips taken for other purposes. When asked to be specific, family members could only identify a handful of such innovations inspired by Peggy's observations of other stores and it appears that most of them occurred either before or after the taxation years in question. As for the children, it was agreed by the witnesses that they did not engage in the regular telephone conversations with Gordon in educ; there was however some passing reference to discussions of the store, in which they would be involved, at the Bernie Maduke family dinner table in Toronto. Any innovations specifically attributed to one or more of the children were very few in number as noted above.

I am unable to conclude, therefore, that a reasonable business person having, as Cattanach, J. said in Gabco, "only the business consideration of the appellant in mind”, would in seeking to obtain such services as Peggy and the four children provided, pay to a group of workers such as this total salaries (those accrued in, plus those paid in, the respective taxation years) in amounts totalling as follows: 1982, $100,000; 1983, $123,561; 1984, $137,846; and 1985, $96,941. It is not without significance that during these same years Bernie Maduke, husband of Peggy and father of the four Maduke children in question, who by the evidence of everyone played a major and regular role in the operation of the store, was paid the following amounts: 1982, 0; 1983, $34,000; 1984, $10,846.70; and 1985, $15,941.82. I accept that it may be appropriate in a given taxation year to vary the amount of a bonus depending on the success of the business during that year, and also to build some factor of recognition of past service and future commitment into the amount of a bonus, (provided that one is not in fact specifically paying, in one year, expenses incurred for earning income in other years). But the plaintiff has not satisfied me that the amounts paid here are "reasonable in the circumstances".

The Revenue Canada auditor, Mr. Nowik, acknowledged in his evidence that his reassessment was based on an understanding which subsequently turned out to be wrong: namely that Peggy and the children worked in the store throughout the whole of the summer with more or less regular work days of eight hours a day. He calculated their entitlement at the average rate paid to non-family employees, namely $5 per hour, with the result that he thought that Peggy and the children should each have received $3,360 annually. He thus thought that the amounts shown in Table II paid to the children in the years 1983, 1984, and 1985 were sufficiently close to that amount that they should be accepted. After disallowing the amounts paid on behalf of Peggy Maduke he then allowed, as expense deductions by the plaintiff for remuneration to her, the amounts set out in parentheses in Table I, that are in the form of accrued salaries. He seemingly was trying to equate these to salaries paid to the children, it being his view that they should all be treated the same. The net result has been, however, that an accrued amount has been allowed in one taxation year in respect of Peggy equal to the amount actually paid in the following taxation year for work performed in that following year by the children. This anomaly should be corrected along with the one which the Minister has identified in his reassessment, by which the company was deprived of any deductible expenses for salaries for the children in 1982. Apart from correcting these anomalies, I believe it was reasonable for the plaintiff to recognize financially the special reliability, skills, and dedication of Peggy Maduke and her children and it is not reasonable to limit their remuneration to what was paid to non-family members. While it is impossible to say with precision what would have been the correct amount, I find for the purposes of section 67 that the following outlay would be reasonable in the circumstances as accrued management salaries, taking into account the amounts already paid to the children in various years as set out in Table II. 1982 — Peggy Maduke, $6,000 and each of the children $4,000; 1983 — Peggy Maduke $6,000 and each of the children $800; 1984 — Peggy Maduke $7,000 and each of the children $2,000; and 1985

— Peggy Maduke $7,000 and nothing for the children. I will therefore order the reassessment to be referred back to the Minister for adjustment accordingly.

Otherwise the appeal is dismissed.

Given the somewhat divided nature of the outcome, and given the fact that counsel for the defendant asked that he be given an opportunity to make a submission as to costs with particular reference to paragraph 344(1)(g) of the Federal Court Rules should there be any possibility of costs being awarded against the defendant, I will issue no formal judgment and make no finding as to costs at this time. Instead I am requesting counsel for the defendant to move for judgment, if possible in writing pursuant to Rule 324, making any submission he wishes as to costs. Needless to say if such an application can be made on consent or, failing that, by means of written submissions this would be preferable. Otherwise counsel will have to arrange to speak to the matter at an appropriate time.

Appeal allowed in part.