[OFFICIAL ENGLISH TRANSLATION]
Date: 20020221
Docket: 2000-1696(IT)G
BETWEEN:
MÉPALEX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
and
Docket: 2000-1702(IT)G
BETWEEN:
AGRIDANAX INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard on common
evidence. The taxation years in issue in the case of
Mépalex Inc. ("Mépalex") are 1995, 1996
and 1997 and, in the case of Agridanax Inc.
("Agridanax"), 1995 and 1997.
[2] The point at issue differs
depending on the appellant's and the respondent's
approach. In the respondent's view, it must be determined
whether the amounts paid by the appellants as bonuses to the
children of the shareholder-managers constitute reasonable
expenses within the meaning of section 67 of the Income
Tax Act (the "Act"). The appellants admit
that those expenses were not reasonable but contend that this was
a case of income splitting and that the bonuses must be added to
the salaries of the shareholder-managers under either
subsection 56(2) or subsection 74.1(2) of the
Act. They claim the managers' salaries are reasonable
within the meaning of section 67 of the Act and are
thus deductible by the appellants. This is in fact a request for
a change in tax planning to make it consistent with the
Act.
[3] Daniel Paul-Hus and
Monique Fontaine testified for the appellants;
Chantale Yelle testified for the respondent.
[4] Mr. Paul-Hus explained
that Monique Fontaine is his spouse. She is the majority
shareholder of the common shares of Mépalex. The preferred
shares are held by Fiducie Paul-Hus, the beneficiaries of
which are the children of the spouses. Mr. Paul-Hus is
the principal shareholder and manager of Agridanax. The fiscal
year of Mépalex ends on December 31 and that of
Agridanax on August 31.
[5] Mr. Paul-Hus explained
that Agridanax held auction sales of herds and agricultural
equipment and machinery in the Quebec farm market.
Mr. Paul-Hus met with farmers wanting to part with
their property, and he proceeded with the catalogue preparation
and necessary advertising and organized and held the auctions.
There was also the preparation and delivery of animals. In this
area, Agridanax engaged the services of persons specialized in
that type of business. The same was true of agricultural
equipment and machinery: persons cleaned and prepared them for
the auction sales.
[6] Agridanax can hold 100 or
125 auctions a year. It uses the services of auctioneers and
secretaries for those sales. The auctioneers are paid $150 a day
and the secretaries, $100 to $150 a day.
[7] The parents said that
Mélanie was born on February 1, 1978, Patrick on
June 1, 1982, and Alexandre on November 28, 1983. In
1995, Mélanie received a bonus of $50,835, that is,
$15,000 from Agridanax and $35,835 from Mépalex; and in
1996, she received a bonus of $34,000, that is, $18,700 from
Agridanax and $15,300 from Mépalex. In 1995, Patrick
received a bonus of $40,835, that is, $5,000 from Agridanax and
$35,835 from Mépalex; in 1996, he received a bonus of
$22,500, that is, $7,200 from Agridanax and $15,300 from
Mépalex. In 1995, Alexandre received $35,380, all from
Mépalex, and, in 1996, a bonus of $19,185, that is, $4,785
from Agridanax and $14,440 from Mépalex.
[8] The parents explained that their
children cooperate in certain activities such as catalogue
preparation and the auction sale. Mélanie assists her
mother in the secretarial work during the sales. Patrick
regularly maintains the Web site, and Alexandre provides much
assistance during the sales. No time log is kept for the
children.
[9] To take advantage of the lower tax
rate granted under section 125 of the Act to small
businesses whose business limit does not exceed $200,000, in
previous years, Agridanax had paid the senior manager a bonus to
reduce the income to the prescribed limit. According to
Mr. Paul-Hus, an accountant had suggested that they
pay a certain portion of the bonus to their children for tax
planning purposes.
[10] In 1995, salary and benefits, including
bonuses, amounted to $139,235 and, in 1996, to $153,636, as
appears in the financial statements of Agridanax, filed as
Exhibit A-1. Mr. Paul-Hus submitted that
this was not an exhorbitant salary for a senior manager and that
the bonuses or salaries paid to the children were in fact
indirect payments within the meaning of subsection 56(2) of
the Act. Mr. Paul-Hus said that what he had
wanted was that the payments made to his children be included in
computing his income and that he pay the tax on them. He felt
that, otherwise, there would be double taxation because his
children had paid taxes on those salaries and the corporation
would no longer be entitled either to those deductions or to the
benefit conferred on small businesses. He also stated that he and
his spouse had always intended to comply with the Act. Mr.
Paul-Hus thought his tax planning was consistent with the
Act. What he was requesting was the privilege of
retracting.
[11] Marie Fontaine testified for
Mépalex. She explained that the purpose of Mépalex
was to buy and resell farms. The farms may be resold together as
a unit but, most of the time, Mépalex uses the services of
Agridanax to auction properties, with the exception of the
buildings and land themselves, which are sold in the
supply-demand market. Marie Fontaine is the sole director and
employee of the appellant. She and her children take part in the
activities of Agridanax during sales.
[12] The financial statements of
Mépalex were filed as Exhibit A-2. Under
salaries and benefits, they show total amounts of $259,457 for
1995; $130,607 for 1996; and $224,739 for 1997.
[13] Chantal Yelle, an objections
officer, testified and confirmed the assessment on the grounds
that, in view of the ages of the children, the fact that they
were attending school on a full-time basis, the amounts in
question and the duties performed, the salaries paid to the three
children were not a reasonable amount. There was no relationship
between the duties and the amounts paid. There was no record of
the hours worked. The children were at school and Melanie had
worked at Wal-Mart 24 hours a week.
[14] The auditor admitted that she had read
letters from the appellants' lawyers dated December 4,
1998, and filed jointly as Exhibit A-3. They were
contained proposals to have the matter settled by allocating
91 percent of the salaries and benefits to
Mr. Paul-Hus and Ms. Fontaine. The lawyers
concluded by saying: [translation] "We suggest that the
salaries and benefits expense, which would have been valid for
the same amount had it been paid in full to the principal
shareholder-managers, be allowed and that the tax payable by them
and tax payable by the children be reviewed
accordingly." This proposal was rejected by the auditor
because choices made in previous years, which, moreover, affected
various taxpayers in this case, cannot be changed
retroactively.
[15] At the request of counsel for the
appellants, the auditor filed as Exhibit I-3 an
analysis made by the auditor during the investigation concerning
the children's work and what might have been reasonable
remuneration. That analysis had been done for settlement
purposes.
Arguments
[16] Counsel for the appellants referred to
the Report of Proceedings of the Thirty-Third Tax
Conference, 1981, Canadian Tax Foundation, at page 757,
question 42, concerning the reasonable nature of salaries
and bonuses:
. . .
3) Large
bonuses are often paid in order to reduce the taxable income of a
CCPC to $150,000. These bonuses are then reviewed in the light of
section 67. Could you please comment?
Department's Position
. . .
3) Subject to
the bounds of reasonableness with respect to both the level of
salary and bonuses for services performed and the rate of return
on investment in shares, the Department generally accepts that a
principal shareholder-manager is entitled to determine a
mix of salary and dividend that he considers appropriate....
[17] Counsel referred to this Court's
decision in Safety Boss Ltd. v. The Queen,
2000 T.C.J. No. 18 (Q.L.), more particularly to the
following passages:
27
"Reasonable" in section 67 is a somewhat
open-ended concept requiring the judgement and common sense of an
objective and knowledgeable observer. . . .
. . .
52 There have been
numerous cases on the question of the reasonableness of expenses.
Essentially the determination is one of fact. I shall refer to
only one that sets out the principle and that has been frequently
cited: Gabco Ltd. v. M.N.R., 68 D.T.C.
5210. At page 5216 Cattanach J. 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. I do not think that in making the
arrangement he did with his brother Robert that Jules would be
restricted to the consideration of the service of Robert to the
appellant in his first three months of employment being strictly
commensurate with the pay he would receive. I do think that Jules
was entitled to have other considerations present in his mind at
the time of Robert's engagement such as future benefits to
the appellant which he obviously did.
53 It has in my view
been overwhelmingly established that the bonus paid to
Mr. Miller in 1991 and the fees paid in 1992 to his company
SBIL were fully commensurate with the services rendered by
Mr. Miller and were not in excess of the amounts that it
would have been reasonable to pay had the parties been at
arm's length.
[18] He also referred to the following
passages from the decision by the Federal Court, Trial Division,
in Murphy v. Canada, [1980] F.C.J. No. 706
(Q.L.), in which the Minister had included in the appellant's
income amounts received by his spouse, in accordance with
subsection 56(2) or subsection 74.1(1) (formerly
subsection 74(1)) of the Act:
37 Under
subsection 56(2), the transfer must be for the
taxpayer's own benefit or for the benefit of some other
person upon whom the taxpayer wished to confer a benefit. Such a
requirement is not included in subsection 74(1). Under
subsection 74(1) the transferee must be the spouse of the
transferor and there is no mention of the conference of a benefit
on the other spouse or upon the spouse who transfers. Further in
subsection 74(1) when property is transferred it is any
income therefrom or loss thereon that is deemed to remain vested
in the transferring spouse.
38 As I appreciate
this difference in language between the two subsections it
follows from the purpose to be accomplished by each.
Subsection 56(2) is to impute receipt of income to the
taxpayer that was diverted at his instance to some one else. It
is to cover cases where the taxpayer seeks to avoid the receipt
of what in his hands would be income by arranging to transfer
that amount to some other person he wishes to benefit or for his
own benefit in doing so. Apart from any moral satisfaction the
practical benefit to the taxpayer is the reduction in his income
tax.
[19] Counsel for the appellants referred the
Court to the decision by the Supreme Court of Canada in
Neuman v. Canada (Minister of National Revenue),
[1998] 1 S.C.J. No. 37:
32 In order for
s. 56(2) to apply, four preconditions, each of which is
detailed in the language of the s. 56(2) itself, must be
present:
(1) the payment must
be to a person other than the reassessed taxpayer;
(2) the allocation
must be at the direction or with the concurrence of the
reassessed taxpayer;
(3) the payment must
be for the benefit of the reassessed taxpayer or for the benefit
of another person whom the reassessed taxpayer wished to benefit;
and
(4) the payment
would have been included in the reassessed taxpayer's income
if it had been received by him or her.
[20] Counsel for the appellants argued that
the portion of the bonuses paid to the children that may be
considered unreasonable must be attributed to the managers of the
appellants in accordance with subsection 56(2) of the
Act. That additional share would not render the salaries
or bonuses received by the managers unreasonable. The salaries or
bonuses could be deducted in computing the appellants'
income.
[21] Counsel further contended that the
total amount of salaries and benefits that should have been
included in the salaries of the appellants' managers could be
deducted in computing the appellants' incomes since those
expenses, even if attributed to the children, were in fact
incurred for the purpose of earning the appellants'
income.
[22] As a final argument, he submitted that
during the investigation, the auditor had considered that the
children might be entitled to a certain remuneration, even a
minimal one. He therefore asked that it be granted.
[23] Counsel for the respondent stated that
the actual issue was the unreasonable nature of the bonuses paid
to the children. It was on this basis that the appellants were
reassessed. On this point, she referred to the decision by the
Federal Court of Appeal in Mohammad v. Canada, [1998]
1 F.C. 165.
[24] She argued that the Court must consider
what the taxpayer actually did, not what he might have done. She
relied on this point on a decision by the Federal Court of Appeal
in Friedberg v. Canada (F.C.A.), [1991] F.C.J.
No. 1255 (Q.L.), more particularly to the following
passage:
In tax law, form matters. A mere subjective intention, here as
elsewhere in the tax field, is not by itself sufficient to alter
the characterization of a transaction for tax purposes. If a
taxpayer arranges his affairs in certain formal ways, enormous
tax advantages can be obtained, even though the main reason for
these arrangements may be to save tax (see The Queen v.
Irving Oil, 91 DTC 5106, per Mahoney J.A.). If a
taxpayer fails to take the correct formal steps, however, tax may
have to be paid. If this were not so, Revenue Canada and the
courts would be engaged in endless exercises to determine the
true intentions behind certain transactions. Taxpayers and the
Crown would seek to restructure dealings after the fact so as to
take advantage of the tax law or to make taxpayers pay tax that
they might otherwise not have to pay. While evidence of intention
may be used by the Courts on occasion to clarify dealings, it is
rarely determinative. In sum, evidence of subjective intention
cannot be used to 'correct' documents which clearly point
in a particular direction.
Conclusion
[25] I will start with this last aspect.
There are indeed various ways in which a taxpayer may organize
his affairs, and each way entails specific tax treatment. It is
well-settled in tax matters that the Court must consider what the
taxpayer has done.
[26] There is in fact the decision of the
Ontario Court of Appeal in A.G. of Canada v. Juliar et
al., 2000 DTC 6589 (affirming the decision of the
Ontario Superior Court, 99 DTC 5743), in which the parties
to an agreement had obtained an order rectifying an agreement.
The common intention of the parties was to take part in a
rollover under section 85 of the Act, and that was
not what the wording of the agreement had reflected. It was not a
transaction that had been designed to obtain a certain result, a
result which subsequently proved to be a mistake from a tax
standpoint.
[27] That case was not argued before me. An
application for rectification of legal transactions is not the
path that was taken. Could it have been taken? I prefer not to
comment since, the decision being relatively recent and case law
not yet being settled, a legal debate is necessary.
[28] Counsel for the appellants asks the
Court to force the Minister to exercise his authority under
subsection 56(2) to attribute to the appellants'
managers the indirect payments made with their concurrence to
their children. Counsel for the appellants did not refer me to
any decision supporting what he chose to propose and enabling me
to do what he wishes.
[29] He argued that, if those amounts were
attributed to the managers of the appellants, that would not
result in unreasonable amounts of salary. However, the question
arises as to whether assessment of the managers under
subsection 56(2) of the Act would make it possible to
increase the businesses' expenses retroactively? Moreover,
and most importantly, this is not what is at issue in the instant
appeals. It is not the managers who are appealing. The
assessments in appeal before me are those of the
corporations.
[30] The appellants were reassessed because
the bonuses or salaries paid to the managers' children were
unreasonable, and it is those assessments that are in appeal
here. The Minister was entitled to find those bonuses
unreasonable. Even the appellants agreed with him, but they are
asking that the salaries paid to the parents and children be
amended by increasing the salaries of the parents and reducing
those of the children. The Court cannot restructure what has been
done.
[31] The salaries and bonuses paid to the
children were clearly unreasonable. Some services were rendered
by the children and might deserve remuneration. I find the
analysis conducted by the auditor and filed as
Exhibit I-3 reasonable. No evidence was adduced to
suggest that this remuneration might have been increased and by
how much. It is therefore my view that the amounts that were
apparently attributed to the children according to that analysis
are reasonable and may be deducted in computing the
appellants' income.
[32] The appeals are allowed on that basis
only. The respondent is awarded her costs.
Signed at Ottawa, Canada, this 21st day of February 2002.
J.T.C.C.
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