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Citation: 2003TCC582
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Date: 20030922
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Docket: 2002-2971(IT)I
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BETWEEN:
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JOHN A. PROSNICK,
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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
McArthur J.
[1] These are appeals from assessments
for two taxation years, 1996 and 2000. The issue is whether
certain corporate advances made to the Appellant, the controlling
mind, are earned income under subsection 146(1) of the Income
Tax Act or shareholder benefits under subsection 15(1) of the
Act. It becomes important for the Appellant in the
determination of the amount of Registered Retirement Savings Plan
premiums deductible under subsection 146(5). "Earned
income" is defined in subsection 146(1) as income from an
office or employment.
[2] The facts include the following.
The Appellant is a professional engineer. He held a substantial
interest in two businesses, J.A. Prosnick & Associates Inc.
and Paul Davis Systems of the West Island of Montreal Inc. The
two corporations were audited for the taxation years 1992, 1993
and 1994.
[3] As a result of the audits, the
Minister of National Revenue added to the Appellant's income
$10,382 in 1992, $5,001 in 1993 and $5,600 in 1994 pursuant to
subsection 15(1) which deals with a personal benefit conferred on
a shareholder. The Appellant did not object to the Minister's
reassessments and paid the resulting tax.
[4] The question boils down to what
was the nature of the income. Was it earned income as submitted
by the Appellant?
[5] For the years 1992, 1993 and 1994,
the Appellant declared a total personal income of under $8,000
per year. I presume this modest amount triggered the audits. As
stated the Minister added an approximate total of $21,000 to the
Appellant's income for the three years. This was assessed as
a subsection 15(1) shareholder benefit which the Appellant did
not contest and he paid the resulting tax forthwith. Almost three
years later, he realized that he could benefit if the payments
were classified as earned income and not shareholder benefits and
he commenced these appeals.
[6] The Minister's auditor
demonstrated that the amounts in question were personal expenses
made by the corporations to pay for such things as cigarettes,
cable TV, home phone account, taxes, his wife's car and
similar expenses. The amounts for these expenses were paid to the
Appellant by the corporations to pay his personal expenses, or
paid directly. They were declared as expenses of carrying on
business by the corporations and not declared as income by the
Appellant until discovered in the Minister's audit.
[7] I have no difficulty in concluding
these expenses were of a personal nature and the Minister
correctly characterized them as shareholder's benefits under
subsection 15(1). The Appellant presented no evidence to the
contrary.
[8] The Appellant argued that the
amounts were earned income and not dividends . It is clear that
they were not received by the Appellant on account of dividends.
Both dividends and shareholder benefits are included in a
taxpayer's income as business income pursuant to paragraph
12(1)(j) and subsection 15(1).
[9] The question before us is whether
the shareholder benefits are excluded from the definition of
"earned income" under subsection 146(1).
[10] The two most relevant cases referred to
me are Goldstein v. Canada[1] and De Giorgio v. Canada.[2] In
Goldstein, Bowman J. was faced with the same issue. He
stated at paragraph 2:
The difference between the Minister and the
appellant lies in the computation of the appellant's
"earned income". Earned income, as defined
in paragraph 146(1)(c), is a factor in the formula used in
calculating the taxpayer's "RRSP deduction limit"
as defined in paragraph 146(1)(g.1), which in turn is a component
in the determination of the amount of RRSP premiums deductible
under subsection 146(5). If the taxpayer's earned income is
reduced this may reduce the amount of RRSP contributions that are
deductible.
Following a detailed analysis of the definition of
"earned income" with respect to partnerships (which
does not concern us here), Bowman J. stated at paragraph 18:
This interpretation fits more precisely with what appears to
me to be the scheme and object of the definition of "earned
income" in section 146. The purpose of that
definition appears to be to exclude from it certain types of
passive income such as interest and dividends, but not rental
income which may also be passive.
Although instructive insofar as to the object of the
definition is concerned, it does not answer whether "earned
income" excludes shareholder benefits. O'Connor J. of
this Court in De Giorgio, considered this question at
paragraphs 9 to 12:
9 The amount of $169,500
was taxed as income of some sort. It was not taxed as
a dividend. Counsel for the Minister however contends
that the $169,500 should be considered as a shareholder benefit
or appropriation as opposed to earned income.
10 After some
consideration I am satisfied that the $169,500 reported by the
Appellant in 1990 as income from R.E.D.G. qualifies as earned
income as defined in paragraph 146(1)(c) of the
Act. The Appellant held the office of president and was
sole director and sole shareholder. Appellant's counsel
acknowledged that the amount in question is large but the
Appellant was the president of R.E.D.G., which is certainly an
office. Given his relationship with R.E.D.G. he was
entitled to have R.E.D.G. pay him any amount and to categorize
the receipt as income from an office. The amount paid
may relate, as testified, to the profitability of the business
but that, in my opinion, does not necessarily characterize it as
a shareholder benefit.
11 Revenue Canada assessed
tax on the said amount of $169,500 and I am of the opinion that
the Appellant was entitled to claim it as earned income thus
justifying the RRSP premium deductions which he claimed in the
1990 and 1991 taxation years.
12 Consequently, on this
issue the appeals succeed.
[11] Counsel for the Minister attempted to
distinguish the facts in De Giorgio, from those in the
current situation, specifically in that the amount in that case
was "truly paid" by the company, meaning that the
amounts actually changed hands. In contrast, counsel argued that
the amounts in the case before the Court paid directly to the
creditors or paid to the Appellant upon his presenting receipts
were charged as an expense to the company. For the most part, it
appears the amounts were paid by the corporations directly to the
suppliers of the goods. They were personal expenses of the
Appellant and never declared by him. In De Giorgio, the
taxpayer included the amount in his income and it was declared as
paid to him by the corporations.
[12] The Appellant states that he was the
President and employee of both corporations and, as in De
Giorgio, he was entitled to have the corporations pay him any
amount and to categorize the receipt as earned income from an
office or employment. He cites Goldstein wherein the
Minister took a different position on assessing, after having
previously confirmed that its understanding of "earned
income" in section 146 was to exclude losses from a limited
partnership that owned rental properties. He adds that in
Goldstein, the taxpayer did not originally report the
partnership losses as "earned income" and the court was
in no way influenced by these circumstances in coming to its
decision in that authority.
[13] He continues in paragraphs 36 and 39:[3]
36. The two circumstances
or differences cited by the representative of the Respondent
were:
a) That the
Appellant had not originally reported the income which was
subsequently added by the Minister pursuant to an audit of three
corporations and two individual taxpayers and Notices of
Reassessment issued by the Minister more than five years after
the original filing date for taxation year 1992; and
b) That the
funds related to the acquisition of the goods and services
characterized by the Minister as personal expenses were never
paid by the company to the Appellant; but were always paid by the
Company directly to the supplier of the goods and services;
38. In response to 36 b),
the Appellant respectfully directs the court to the testimony of
the witness Mme Foucault who provided evidence regarding the
nature of the goods and services characterized by the Minister as
personal expenses. The Appellant submits that the testimony of
Mme Foucault does not support the affirmation made by the
representative of the Respondent. On the contrary, the Appellant
submits that the testimony of Mme Foucault reasonably leads the
court to infer that by their very nature the type of goods and
services acquired demonstrate a modality of cash disbursement
from two companies to the Appellant for which the Appellant
provided receipts or vouchers so that these transactions could be
recorded into the financial records of the two companies.
[14] I find no merit in this final
submission (paragraph 38) and no such inference is drawn. The
expenses were personal benefits to the Appellant and not
legitimate business expenses of the corporations.
[15] In attempting to clarify this
discrepancy, the Respondent cited a decision of Bell J. of this
Court in Ballegeer v. Canada[4] who concluded at paragraph 17:
Accordingly, the sums aforesaid were properly disallowed as
deductions to Ltd. and the remaining sums aforesaid were properly
included in the income of Arthur and Linda pursuant to the
provisions of subsection 15(1) which states that the amount or
value of a benefit conferred on a shareholder of a corporation
shall be included in computing the income of that shareholder
...
Ballegeer, and cases like it, however, do not assist us
in determining whether shareholder benefits fall into
"earned income", as it merely suggests that shareholder
benefits are to be included in the income of the taxpayer for the
year. Income includes both earned income as well as passive
income.
[16] In Chopp v. The Queen,[5] Mogan J.
stated the following which applies equally to the present
appeal:
The relationship between a corporation and those individuals
who work in the operation of the corporation's business is
one of employer/employee. That employment relationship is, of
course, incidental to and connected with the corporation's
business. If a shareholder is also an employee of the corporation
and receives a benefit in his capacity as employee, the value of
that benefit would be taxed under paragraph 6(1)(a) of the
Act. A corporation is ordinarily permitted to deduct as a
business expense the cost of a benefit received or enjoyed by an
employee qua employee. A corporation, however, is not
permitted to deduct any amount with respect to a benefit
conferred on a shareholder qua shareholder because the
corporate/shareholder relationship is not incidental to the
corporation's business. A shareholder benefit is more like a
dividend and less like a business expense. Therefore, a benefit
taxed under subsection 15(1) will usually result in some form of
double taxation because the shareholder will be taxed on an
amount which has not been deducted in computing the income of the
corporation. In appropriate circumstances, this will be a harsh
but necessary result.
[17] I find as a fact that the
Appellant's corporations conferred benefits on the Appellant
shareholder qua shareholder. These benefits were not
incidental to the corporations' business. The position that
the benefits are earned income was an afterthought of the
Appellant, years after the fact when it was too late.
[18] The appeals are dismissed.
Signed at Ottawa, Canada, this 22nd day of September,
2003.
McArthur J.
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