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Date: 20030116
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Docket:2000-4052(IT)G
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BETWEEN:
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LOU FERRO,
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Appellant,
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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
Teskey, J.
[1] The Appellant appeals his
reassessments of income tax for the years 1992 and 1995, which
includes two 12-month periods, first period ending
January 31, 1992 and the second period ending
January 31, 1995, as well as the stub period from
February 1, 1995 to December 31, 1995.
Issues
[2] The Appellant, in his Notice of
Appeal, states that there were four issues, namely, whether the
Minister of National Revenue (the "Minister")
erred in adding the amounts of $341,428 and $721,698 to the
Appellant's income in 1992 and 1995 and in particular:
(a) even if the Minister was
correct that amounts in respect of unbilled disbursements were
not deductible by Ferro, whether such justified only a denial of
the deductions (in the amounts of $126,239 and $222,049 in 1992
and 1995 respectively) rather than an addition of greater amounts
to income;
(b) whether the Minister erred in any
event by seeking to deny the deduction of disbursements incurred
by Ferro and not billable to his clients during the period;
and
(c) whether the Minister erred in
denying Ferro the reserve to which he was entitled under
section 34.2 of the Income Tax Act
(the "Act").
[3] The Respondent in her second
Amended Reply to the Notice of Appeal
(the "Reply"), which was filed on consent at the
opening of the hearing, stated that there was only one issue,
namely:
The issue to be decided is whether or not the Appellant
improperly calculated his gross revenues by deducting amounts
that were already excluded from the computation of income by
virtue of the Appellant's section 34 election.
Facts
[4] The Appellant is a lawyer
practicing exclusively for persons who have suffered personal
injury from a motor vehicle related accident.
[5] When a prospective client attends
on the Appellant for the first time, the Appellant talks about
the case in an attempt to instil confidence and to make the
prospective client comfortable and then he discusses what can be
done for the client.
[6] The terms of each and every
contract that the Appellant enters into with his various clients
are identical.
[7] The contract is a contingency
contract with no risk to the client. The Appellant advises the
client that he does not require a monetary retainer and that he
does not keep time dockets. He also advises that he will finance
the file and the final bill will be remitted only when the file
is finished and will be entirely based on the results. He advises
the client of the usual formula but states that it will be
adjusted up or down depending on the results.
[8] The client has no risk or
obligation to the Appellant. If costs are awarded against the
client by a court, those costs are paid by the Appellant
personally and not charged at any time to the client.
[9] If a client's claim should be
dismissed, there is no bill rendered by the Appellant for a fee
or any disbursements.
[10] There are many different ways that a
client's claim could end up unsuccessful or the quantum being
greatly reduced due to no fault of the Appellant or his
client.
[11] When a settlement is being proposed,
the client usually will authorize the Appellant to settle on the
basis that he or she will receive a set net amount. The Appellant
will then attempt to calculate his costs of the file and what a
fair fee would be, and then attempt to settle on a gross amount
that will pay the client his or her set net amount and pay him
his costs and fee. If the Appellant cannot get quite the fee he
is seeking or overlooks some cost that he has incurred, that is
his responsibility. The client gets the agreed upon set amount.
If the settlement is a lump sum plus party and party costs, again
the client gets his or her agreed upon amount and the Appellant
gets what he can negotiate or tax, whatever that amount might
turn out to be.
[12] When the Appellant enters into a
contract with a client, he first looks at the no fault benefits
under the automobile insurance policy and then, at any employment
insurance that may be available through policies with such
companies as Canada Life or Great West Life, or through the
client's employer. If the injury is serious or permanent,
then the Appellant takes a much more aggressive approach and
information is gathered.
[13] The information-gathering process is
done by staff and outside contractors such as Golden Horseshoe,
which is a firm of former police officers who go out, take
pictures of the site of the accident, interview all possible
witnesses and attempt to get written statements from all
witnesses. The staff obtains reports from all treating doctors,
the hospital, OHIP and an ambulance report. Certificate of
ownership of the various vehicles is also obtained. These costs
of getting the file to this point are paid in full by the
Appellant.
[14] The next step taken by the Appellant is
the retaining of Future Health Inc., in which he has a
33 percent interest. The nurse, Ellen Helden
("Helden"), who also holds 33 percent interest,
does a five-point assessment of the client. Although the
Appellant and Helden have a personal relationship, it is
immaterial to this appeal.
[15] This five-point assessment covers the
following five areas:
(i) the physical health of the
client;
(ii) the emotional health of the
client;
(iii) changes, if any, in the
lifestyle of the client;
(iv) any job related financial
problems, such as loss of employment, diminished abilities,
etc.;
(v) changes, if any to social and
family life.
[16] Depending on the result of these five
point assessment reports, the Appellant may arrange for his
client to be examined by any number of medical specialists, such
as a neurologist, psychiatrist, psychologist or orthopaedic
surgeon. Any of these may order further X-rays, MRIs or cat
scans. Also, Future Health may be asked to do a further in-depth
assessment. All this work is ordered by the Appellant and it is
his responsibility to pay for these services. Because of cash
flow problems, they are not paid until a settlement is obtained.
Most of these people charge interest on their accounts, which is
also the Appellant's responsibility.
[17] Attached to the Appellant's 1992 T1
general tax return is form T2032, being a statement of
professional fees excluding work-in-progress and a
calculation that shows the amount of unpaid disbursements at the
start of the year and the amount at the end of the year. The
difference being the amount the Appellant incurred during the
1992 fiscal year, namely $314,428 - $215,189
= $126,229, which was expensed against income resulting in a
net professional income of $64,790. That is all of the 1992
incurred expenses in the fiscal period and expensed against
income to produce the net taxable income.
[18] The Minister, in his 1992 reassessment,
disallowed the deduction of the unbilled disbursements incurred
in 1992 in the amount of $126,229 and added to the income of
$64,790 the sum of $314,428, being the total disbursements
outstanding at the year-end of the 1992 fiscal period,
which figure included disbursements of $188,199 incurred prior to
the 1992 fiscal period, notwithstanding that the Appellant only
deducted from income those monies whose debt was incurred in 1992
of $126,229.
[19] As a result of amendments to the
Act that requires all professional individuals to have a
December 31 year-end, the Appellant's 1995 T2
general tax return contains two fiscal periods, namely the period
February 1, 1994 to January 31, 1995 and the stub
period of February 1, 1995 to December 31, 1995.
Attached to the return are two statements of professional
activities (T2032), one for each period. In both statements,
these costs are shown at the start of the period and at the end
of the period, giving the amount incurred for the period, namely
$117,869 for the first period and $104,180 for the second period,
which were both deducted from income.
[20] The Minister, in his reassessment,
added to the Appellant's calculated income the total amount
of outstanding disbursements as of December 31, 1995 of
$1,063,126 less the disallowed unbilled disbursements reassessed
for 1992, in the sum of $341,826, the calculation being
$1,063,126 - $341,826 = $721,698,
notwithstanding that the Appellant only deducted from income
those debts incurred in the two fiscal periods covered by the
return, namely the sum of
($117,869 + $104,180) $222,049.
[21] Certain questions and answers given on
the examination for discovery of Lou Zavagos
("Zavagos"), the auditor involved in the reassessments
demonstrates that several of the assumptions alleged to have been
made at the time of the assessment were in fact not made and, in
any event, they were irrelevant. Zavagos, when being questioned
on assumption Q, did not know how a figure of $478,896 was
arrived at or where it came from but, in any event, the evidence
of the Appellant demonstrates what the proper amount was. In
regard to the assumptions in subparagraphs N, O, P and R, Zavagos
relied upon any of the facts contained therein.
[22] This is all immaterial as the evidence
of the Appellant is accepted by me in full. He gave his evidence
in a straightforward manner without equivocation in-chief
and in cross-examination. His oral evidence was not
challenged in any way by counsel for the Respondent while he was
in the witness box.
Appellant's Position
[23] The expenses at issue are incurred by
the Appellant personally and not on behalf of a client, they are
to assist him to obtain a more favourable result. The client has
no risk for these services or for these costs. If and only if a
settlement is negotiated or an award is obtained at trial which
is sufficient to put these expenses back into the Appellant's
pocket. Will he recover the expenses incurred for that particular
file?
[24] These costs at the time they are
incurred are neither receivable from the clients nor payable by
the clients to the Appellant.
[25] The expenses are deductible in the year
in which they were incurred. The average client file can last
from two and a half years to four years. These expenses occur at
the outset and continue to settlement or arbitration and
settlement or to trial. The expenses are the absolute
responsibility of the Appellant, and they continuously occur,
some are paid in full at the time, and some payment is deferred.
These costs are incurred for the purpose of earning income and
are deductible in the year in which they are incurred. If a
successful conclusion is not reached, no fee is received and the
expense remains that of the Appellant.
[26] The Appellant's election under
section 34 of the Act allows him not to include work
in progress in the calculation of income. Paraphrased, this
provision reads: In computing the income of a lawyer, if he or
she elects in his or her return, there shall not be included any
amount in respect of work in progress at the end of the
year.
Respondent's Position
[27] The Respondent referred to
section 9 of the Act concerning profit and
paragraphs 12(1)(a), and (b), the inclusion
sections, and argues that these costs are receivables in the
hands of the Appellant even though they are contingent
receivables, that is they are client disbursements until the
Appellant forgives them. Thus, the Appellant should declare each
year as receivables, the year's expenses that he has incurred
for client files.
[28] This was argued notwithstanding the
only issue raised in the Reply was the deduction of these
costs.
[29] The first position of the Respondent is
that the 1992 assessment is correct even though the Minister
added to income the total outstanding costs of $341,418 and not
just the amount that was incurred in 1992 in the amount of
$126,428, being the amount the Appellant expensed. This position
is so obviously wrong it deserves no comment by me.
[30] The first alternative position would be
the example that a $300 expense is incurred in year one and a fee
of $1,000 is earned and billed in year two. The $300 should be
shown as a receivable and added to income in year one, and in
year two, the $300 is expensed, the fee of $1,000 declared as
income, thus tax is paid on the net amount of $700.
[31] The next alternative position is in
using the same $300 expense in year one and a fee of $1,000 in
year two. In year one, the $300 is not expensed, and in year two
the $300 is expensed and both the fee and the expense brought
into income with tax paid on the net amount of $700.
[32] The Respondent points to the wording in
the financial statements, such as: "Unbilled disbursement
receivable from clients."; "Disbursement made on
behalf of clients are recorded as unbilled disbursements pending
subsequent reimbursement" and argues this properly
characterized the monies in issue. The Appellant was not
cross-examined on this point.
The Law
[33] The Exchequer Court decision of
M.N.R. v. John Colford Contracting Company Limited,
dated June 16, 1960 ([1960] Ex., C.R. 433 (Q.L.)),
which was upheld on appeal to the Supreme Court of Canada, dealt
with a contract that required an architect's certificate of
completion before the taxpayer was entitled to any money.
[34] Kearney J., said in
paragraph 22 thereof :
22 As "amount
receivable" or "receivable" is not defined in the
Act, I think one should endeavour to find its ordinary
meaning in the field in which it is employed. If recourse is had
to a dictionary meaning, we find in the Shorter Oxford,
Third Edition, the word "receivable" defined as
something "capable of being received." This definition
is so wide that it contributes little towards a solution. It
envisages a receivable as anything that can be transmitted to
anyone capable of receiving it. It might be said to apply to a
legacy bestowed in the will of a living testator, but nobody
would regard such a legacy as an amount receivable in the hands
of a potential legatee. In the absence of a statutory definition
to the contrary, I think it is not enough that the so-called
recipient have a precarious right to receive the amount in
question, but he must have a clearly legal, though not
necessarily immediate, right to receive it. A second meaning, as
mentioned by Cameron J., is "to be received," and Eric
L. Kohler, in A Dictionary for Accountants, 1957 edition,
p. 408, defines it as "collectible, whether or not
due." These two definitions, I think, connote
entitlement.
and in paragraphs 29 and 30:
29 It is provided in
article 3 of the Dominion Bureau of Statistics contract that the
amount of the holdback is to be 15 per cent of the progress
payments, and the article concludes in these words:
Final payment to be made within 30 days after satisfactory
completion of the entire building and acceptance by the
architect.
Although it does not add that such completion and acceptance
by the architect are conditions precedent which must be fulfilled
before the taxpayer is entitled to final payment of the holdback,
in my opinion, under the jurisprudence such meaning is to be
implied. As a corollary, I consider that the holdback does not,
as far as the taxpayer is concerned, take on the quality of a
receivable until the work has been accepted by the architect.
This does not, however, dispose of the issue in regard to the
contract under consideration.
30 Ross, Patterson,
Townsend and Fish, as appears by the contract, had been named by
the owner as the "architect;" and on March 9, 1953, the
above-mentioned firm, per J.K. Ross, certified that all
the work in connection with the Dominion Bureau of Statistics,
which totalled some $6,000,000, had been completed by the prime
contractor according to plans and specifications; and that no
holdback was to be retained. The above-mentioned certificate, of
course, covered the work done by several sub-contractors,
including the taxpayer. It will thus be seen that the condition
precedent ceased to exist before the termination of the
taxpayer's fiscal year 1953 and the holdbacks payable under
it acquired the quality of a receivable as of the date of the
certificate. It is to be recalled that final payment was to fall
due thirty days after the issuance of the certificate which would
bring it into the taxpayer's subsequent fiscal year, and it
was in fact paid on April 11, 1953. I do not think that the
latter can rely on the delay allowed for payment as justification
for bringing the amount of the holdback into the fiscal year in
which it fell due. In my opinion, a term or instalment account
must be included in the taxation year in which it could be said
that it had the quality of a receivable since
Section 85B(1)(b) provides that it shall be thus included
"notwithstanding that the amount is not receivable until a
subsequent year."
[35] McDonald J.A., in Argus
Holdings Limited v. The Queen, 2000 DTC 6681, said in
paragraphs 14, 15, 23 and 24 :
[14] Moreover, there is well
established authority for the proposition that it is not the
accounting treatment of an amount which governs deductibility,
but rather the true nature of the amount deducted. The fact that
the Appellant's books of account do not describe the amounts
in question as a reserve does not mean that the Appellant did not
in fact take a reserve. See, for example, Dixie Lee
(Maritimes) Ltd. v. The Queen, 88 DTC 6108 (F.C.T.D.); Mr.
Muffler Ltd. v. The Queen, 74 DTC 6615 (F.C.T.D).
[15] In Mr. Muffler Ltd.,
Walsh, J. made the following comments with respect to the
significance of the designation assigned to an entry in the
financial statements:
The fact that the plaintiff in its financial statements refers
to the amounts set aside as (translated): "reserve for
merchandise sold and not delivered" when it is perhaps not
properly speaking a true reserve in the sense in which the use of
this term is recommended by accounting authorities is not too
significant. It is not the designation given to the amount which
is set aside but the purpose for which it was so set aside which
is important.
[emphasis added].
...
[23] It would be a gross
distortion of the Appellant's picture of income if the
balance remaining in the "Deferred Initiation Fee"
account were taxed in the 1992 taxation year. This is because
portions of that balance were earned in tax years prior to 1992.
The Appellant neither earned nor received the entire $441,154 in
question in its 1992 taxation year. Portions of that amount are
referable to taxation years other than 1992. In other words, the
amount in question does not represent profit from the 1992
commercial activities of the Appellant, but represents profit
from the 1982 to 1991 taxation years inclusively. Accordingly, it
would not yield an accurate picture of income if the entire
$441,154 were taxed in the hands of the Appellant in its 1992
taxation year.
[24] With the greatest respect,
the Tax Court Judge erred in seeking to rectify the
Appellant's under-reported income from 1982 to 1991 by adding
those amounts into the Appellant's income in its 1992
taxation year. The Tax Court Judge failed to consider whether, by
adding the entire $441,154 into income for the 1992 taxation
year, an accurate picture of income would result.
[36] MacGuigan J.A., in West
Kootenay Power and Light Company Limited and The Queen,
92 DTC 6023 said on page 9:
In my view, it would be undesirable to establish an absolute
requirement that there must always be conformity between
financial statements and tax returns, and I am satisfied that the
cases do not do so. The approved principle is that whichever
method presents the "truer picture" of a taxpayer's
revenue, which more fairly and accurately portrays income, and
which "matches" revenue and expenditure, if one method
does, is the one that must be followed.
Decision
[37] I am satisfied that the Appellant's
position in law and interpretation of the facts herein, is the
correct position.
[38] It appears in light of recent decisions
that the "matching" principle is no longer a
determinating factor.
[39] The arrangement the Appellant had with
each of his clients was a contingency arrangement until a
successful outcome was obtained. Until then, there was no
liability on the client and therefore cannot be a receivable
until the right to collect the amount occurs, that is a
negotiated settlement or a court judgment, and if a motion or
trial is lost with costs, the client still pays nothing and the
Appellant is out not only his costs but costs awarded against the
client.
[40] The monies in issue are exclusively
expenses of the Appellant, whether paid or not paid is immaterial
and should be expensed during the period in which they are
incurred and when the Appellant closes and bills the file, the
total recovery is included in income.
[41] The appeals are allowed with costs and
the two assessments are referred back to the Minister for
reconsideration and reassessment in accordance with the reasons
herein.
[42] Counsel for the Appellant shall prepare
a draft judgment, obtain the approval of counsel for the
Respondent and submit the same for a final judgment to be
issued.
Signed at Toronto, Ontario this 16th day of January 2003.
J.T.C.C.
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