ISBA Construction Inc. v. MNR, 90 DTC 1940, [1990] 2 CTC 2491 (TCC)

Lamarre Proulx, T.C.J. [Translation]:—The appellant is appealing the reassessment made with respect to its 1981 taxation year by the respondent, the Minister of National Revenue.

The point at issue is whether the appellant may deduct a bonus that was reported during its 1981 taxation year, in calculating its earnings for that taxation year, as provided for in subsection 9(1) and paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). This bonus of $180,000 was not paid, apart from an amount of $30,000.

The appellant's shares were held equally by two corporations, whose shareholders were, in turn, the appellant's two directors. The appellant, which operates in the field of construction, enjoyed a particularly good year in 1981. Its earnings exceeded the limit established in section 125 of the Act for exclusive application of the small business deduction. As it was a good year, the appellant invested massively in another corporation, A.C.H.Q. Construction Inc. (A.C.H.Q.), which owned rental apartment buildings. The management corporations of the two directors each held 50 per cent of the shares of A.C.H.Q. These apartment buildings were to be transformed into undivided co-ownership units, and then largely resold towards late December 1981, or January 1982.

Mr. Lucien Roy, one of the appellant’s two directors, and Mr. Carol Lapointe, the appellant's accountant, testified on the appellant's behalf. According to their testimony, the appellant’s practice was to vote shareholder bonuses at the end of its fiscal year, which concluded September 31. Bonuses were usually paid from October through December. No copies of the resolutions were provided as evidence of prior bonuses having been voted.

From 1976 to 1983, the following system of remuneration was employed:

From 1976 through 1983, the management fees were paid to the appellant's shareholder corporations. The administrative salaries were salaries paid to the two directors for the years 1976,1977 and 1978. For 1980, this heading includes salaries paid to wives, who were the appellant's employees. For 1981, the administrative salary heading consists of $22,000 in salaries to wives, and the $180,000 bonus which is at issue.

According to the accountant's testimony, management fees paid in 1977 were exclusively bonuses. In subsequent years, a portion was paid for management services and a portion as bonuses. The amount given for management fees for 1978 includes a $52,500 bonus. The $95,900 in management fees for 1979 includes a $40,000 bonus. The $121,067 appearing as management fees for 1980 includes a $70,000 bonus. In 1981, the year in question, the bonus was included under the heading of administrative salaries.

Under the heading of “profits before other earnings or taxes", the amount of $104,396 was listed for 1980, and $200,893 was listed for 1981. These amounts obviously include the above-mentioned management fees and administrative salaries.

The resolution approving the bonus was dated September 29, 1981. The relevant portion reads as follows:

It is unanimously resolved to vote a bonus of $180,000. This bonus shall be paid and distributed as follows:

An amount of $30,000 was paid to the wives in 1981. Under the resolution, the bonus was payable in two instalments: an amount of $105,000 in 1981, and an amount of $75,000 in 1982.

In considering the witnesses' version of events, to the effect that it was the appellant's practice to pay bonuses. I am obliged to note, on the one hand, that I was presented with no resolution approving bonuses supposedly included under the management fees heading and that, on the other hand, in prior years bonuses were paid as management fees to the appellant's shareholder corporations and not directly to the directors, and that this was the first time a bonus was accorded to the wives. I can only conclude, therefore, that the $180,000 bonus voted in 1981 did not follow appellant’s normal practices. No real explanation was provided as to why bonuses appeared under the heading of administrative salaries and not under that of management fees, as was the case in previous years.

The evidence demonstrates that, at the time of the resolution, the appellant lacked the liquid assets to pay the bonus. Its credit line at the bank was exhausted and the appellant had invested half a million dollars in A.C.H.Q. appellant nonetheless contended that it was justified in believing that this cash would become available when the apartments, transformed into undivided co- ownership units were sold. The following is an excerpt from Mr. Roy's testimony:

Q. Could you tell the Court, Mr. Roy, why the bonus that was voted in the year one thousand nine hundred and eighty-one (1981) was not paid in the year one thousand nine hundred and eighty-one (1981)?

A. Because Isba Construction had made a loan to A.C.H.Q Construction of half a million (500 000), nearly half a million (500 000); then during that year, one thousand nine hundred eighty-one (1981), we thought that this was for a very short term; however it was longer than we believed, which is why the bonus was not paid in eighty-one (‘81).

Q. Am I to understand that, other than the loan to A.C.H.Q., Isba did not have any funds available to pay a bonus of one hundred eighty thousand (180 000)?

A. No, there was a cash-flow problem.

Q. It paid thirty thousand (30 000), and there remained one hundred fifty thousand (150 000) to be paid; of the one hundred eighty thousand (180 000), thirty thousand (30 000) was paid to the respective wives.

Q. And what about the difference of one hundred fifty thousand (150 000)? Was it payable, conditional on reimbursement by A.C.H.Q.?

A.

It was payable, no, it was payable in the year that we thought Isba would make money and A.C.H.Q. would repay its advances.

According to the appellant, a Quebec law which made it difficult to transform rental housing into undivided co-ownership units, as well as the increase in interest rates, deprived it of the liquidity required to pay the bonuses in question.

It is possible that, at the time the appellant invested in A.C.H.Q., which owned the apartment buildings, a rapid influx of funds was expected. However, the date on which the bonus resolution was passed, September 29, 1981, came after the date on which the Act to amend the Civil Code and certain Legislation in respect of Housing, S.Q. 1981, c. 16 had been assented to, coming into force on the same day, namely June 18, 1981, As for the alleged increase in interest rates at the end of 1981 and throughout 1982, according to a Bank of Canada report, filed as Exhibit 1-3, interest rates were higher in 1981 than in 1982. The basic rate applied by banks for loans to businesses for the last Wednesday of each month were:

Counsel for the appellant contended that the resolution approving the bonus of $180,000 was not a conditional one. It is true that the resolution is not worded in a conditional manner but, in actual fact, it is necessarily conditional. At the time of the vote, there was no cash available: the line of credit had been exhausted; the directors knew that the resale of the rental buildings as undivided co-ownership units would occur slowly, given the June 1981 sanction of the previously mentioned Quebec legislation, thereby precluding any rapid influx of funds. As for the increase in interest rates, this had begun at least as early as January of 1981.

The same principles which served as the basis for the judgments of this Court in Samuel F. Investments Ltd. v. M.N.R., [1988] 1 C.T.C. 2181; 88 D.T.C. 1106 and 257324 Ontario Ltd. v. M.N.R., [1988] 2 C.T.C. 2300; 88 D.T.C. 1670 apply in this appeal, namely, that an expense may not be deducted in calculating a company's earnings unless the expense is a definite one. The company's normal practices, the relationship between the directors and the recipients of the bonus, the company's cash on hand, and the certainty of an influx of funds, are all elements to consider in determining if a bonus that had been voted constitutes or may constitute a definite expense.

In the present case, these elements lead me to conclude that the bonus that was approved was not a definite expense of the company.

For these reasons, the appeal is dismissed.

Appeal dismissed.