REASONS
FOR JUDGMENT
D'Arcy J.
[1]
The Appellant has appealed a reassessment in
respect of its taxation year ending on December 31, 2010 (the “2010 taxation year”).
The sole issue before the Court is the amount of salary or wages paid to the
two shareholders of the Appellant that constitutes an expenditure on or in
respect of scientific research and experimental development (“SR&ED”).
[2]
The parties filed a partial agreed statement of
facts (“PASF”). I
heard from three witnesses: Mr. Tom McCrea who, together with his brother,
owned the Appellant during the relevant period; Mr. Dennis Kowal, the
Appellant’s accountant; and Mr. Glenn Schur, a Canada Revenue Agency (“CRA”) auditor.
I. Facts
[3]
Unless otherwise noted, the following facts are
taken from the PASF. A copy of the PASF is attached as Appendix A to these
reasons for judgment.
[4]
Since 1984, the Appellant has been engaged in
the business of researching, designing and manufacturing agricultural
implements. Since 1993, it has filed SR&ED claims under the relevant
provisions of the Income Tax Act (the “Act”).
[5]
Tom McCrea and his brother, Gary McCrea, each
own 50% of the shares of the Appellant. They are the only officers and
directors of the Appellant.
[6]
Tom McCrea testified that, during the relevant
period, he was the general manager of the Appellant responsible for employees,
production and new product development. Gary McCrea was in charge of marketing
and sales.
[7]
In the 2010 taxation year, the Appellant claimed
SR&ED expenditures in relation to eight projects.
[8]
Tom McCrea was directly engaged in SR&ED
activities for 1094.5 hours and in non-SR&ED activities for 1,905.5 hours.
Gary McCrea was directly engaged in SR&ED activities for 201.5 hours and in
non-SR&ED activities for 2,798.5 hours.
[9]
In summary, the parties agree that Tom McCrea
worked 3,000 hours in 2010, of which 1094.5 were spent on SR&ED activities,
and Gary McCrea worked 3,000 hours, of which 201.5 were spent on SR&ED
activities.
[10]
The Appellant paid Tom McCrea wages of $26,940
and Gary McCrea wages of $11,940.
[11]
As noted on page 12 of Exhibit A/R-3, the
Appellant paid dividends of $62,400 in the 2010 Taxation Year. As 50%
shareholders, Tom McCrea and Gary McCrea each received $31,200 of such
dividends.
[12]
Tom McCrea explained that he and his brother had
agreed to receive relatively low compensation from the Appellant and to look to
the increased value of the company as their retirement program. He stated the
following:
We’re both going to come to work. Work diligently to
the best of our abilities all year long and at the end of the year we pray the
company is worth more.
[13]
He explained that, on the basis of advice they
had received from Mr. Kowal, the Appellant paid them salary and wages for
their time spent doing SR&ED, and any other amounts removed from the
Appellant were paid as dividends. Normally the salary and wages were split
equally between the two brothers.
[14]
Mr. Kowal explained his advice as follows:
The advice that I gave them was that pursuant to the Income Tax
Act, the Income Tax Act says that specified shareholder -- specified
employees, which they are as shareholders, could be paid for SR&ED work and
as such if they were paid for SR&ED work, that constituted a valid input
tax credit pursuant to the Tax Act. That's what I advised.
. . .
. . . the only wages that we accrued for them were for those hours
that pertain to SR&ED work. They were not compensated for any other work
that they performed for the company because essentially they were -- they --
they took a draw from the company, if I can get into that? They took a draw
from the company and that draw was simply something they needed for their own
livelihood.
And at the end of the year, those drawings were then put through as
dividend income. No different than any other shareholder of a corporation would
receive to offset his drawings.
[15]
Tom McCrea testified that he and his brother
determined that the Appellant should pay them $30 per hour for the SR&ED
work. They based that hourly rate on the hourly rate the Appellant paid third
parties who performed similar SR&ED work for the Appellant.
[16]
Tom McCrea testified to the effect that the
Appellant paid to him and his brother salary and wages for the 2010 taxation year
calculated as follows:
Total hours Tom and Gary McCrea worked on SR&ED – 1,296
(1094.5+201.5)
Times $30 hourly rate
Equalled total salary and wages of $38,880.[4]
[17]
Tom McCrea testified that for the 2010 taxation
year it was determined that the salary and wages would not be split 50/50 but
rather would “be skewed some to recognize that
I’d made a different level of contribution”. Exhibit A/R-2 evidences what
occurred: the Appellant paid the first $15,000 of salary and wages to Tom
McCrea and split the remaining $23,880 equally between Tom McCrea and Gary
McCrea, i.e., $11,940 each.
[18]
As noted in the PASF, this resulted in Tom
McCrea receiving $26,940 of salary and wages and Gary McCrea receiving $11,940
of salary and wages.
[19]
In reporting its income for the 2010 taxation year,
the Appellant claimed qualified SR&ED expenditures in the amount of
$297,968, which included 100% of the salary and wages paid by the Appellant to
Tom McCrea and Gary McCrea.
[20]
The Minister assessed the Appellant to reduce
the claimed SR&ED expenditures by a portion of the salary and wages paid to
Tom McCrea and Gary McCrea. When assessing the Appellant, the Minister
assumed that only a portion of such salary and wages was paid in respect of
SR&ED.
[21]
Mr. Schur testified that, when determining the
amount of salary and wages that qualified as an SR&ED expenditure, the
Minister took into account the total amount of time Tom McCrea and Gary McCrea
worked during the year.
[22]
He stated that, since Tom McCrea worked 1,094.5
hours on SR&ED and 3,000 hours in total, the Appellant was only entitled to
claim as an SR&ED expenditure 36.5% (1,094.5/3,000) of the $26,940 of
salary and wages paid to Tom McCrea. Similarly, since Gary McCrea worked 201.5
hours on SR&ED and 3,000 hours in total, the Appellant was only entitled to
claim as an SR&ED expenditure 6.7% (201.5/3,000) of the $11,940 of wages
paid to Gary McCrea.
[23]
As a result, the Court must determine if the
Appellant is entitled to claim 100% of the salary and wages paid to Tom McCrea and
Gary McCrea, or the lower percentages determined by the Minister.
II.
The Law
[24]
Paragraph 11 of the PASF states: “The Appellant used the proxy method of claiming
overhead costs for its SR&ED claim in the 2010 Taxation Year.” Counsel for the Appellant confirmed that the parties
are referring to the election that is made under clause 37(8)(a)(ii)(B) and
subsection 37(10) of the Act.
[25]
With respect to salary and wages, since the
Appellant made the so-called proxy election, it was only entitled, under
subclause 37(8)(a)(ii)(B)(IV), to include as an expenditure on or in respect of
scientific research and experimental development “that
portion of an expenditure made in respect of an expense incurred in the year
for salary or wages of an employee who is directly engaged in scientific
research and experimental development in Canada that can reasonably be
considered to relate to such work having regard to the time spent by the
employee thereon . . . ”.
III.
The Court’s decision
[26]
The Respondent does not accept that the $38,880
of wages that the Appellant paid Tom McCrea and Gary McCrea was only paid for
the time those two individuals spent performing SR&ED. As discussed
previously, it is the Respondent’s position that the salary and wages relate to
all of the work that Tom McCrea and Gary McCrea performed for the
Appellant. This would include the 1,905.5 hours Tom McCrea spent and the
2,798.5 hours Gary McCrea spent “performing
director or management activities” for the
Appellant.
[27]
I do not accept the Respondent’s position. It is
not consistent with the facts before the Court.
[28]
It is clear from the PASF and the argument of counsel
for the Respondent that the Respondent accepts that during the 2010 taxation
year:
-
The Appellant was engaged in SR&ED.
-
Tom McCrea and Gary McCrea were engaged directly
in SR&ED.
-
Tom McCrea spent 1094.5 hours and Gary McCrea
spent 201.5 hours carrying out SR&ED.
-
The Appellant paid Tom McCrea wages of $26,940
and Gary McCrea wages of $11,940.
-
The total wages of $38,880 ($26,940 + $11,940) paid
to Tom McCrea and Gary McCrea were calculated on the basis of the total hours
spent by Tom McCrea and Gary McCrea working on SR&ED, i.e., 1,296
times an hourly rate of $30.
[29]
Thus, the Respondent accepts that Gary McCrea
spent 1094.5 hours directly engaged in SR&ED and that Tom McCrea spent 201.5
hours directly engaged in SR&ED. In addition, the Respondent did not
present any evidence to challenge the reasonableness of the $30 per hour rate
the Appellant applied to these hours to determine the total salary and wages
that it paid to Gary McCrea and Tom McCrea.
[30]
The evidence before me was that the Appellant
based the $30 per hour rate on the hourly rate charged by arm’s length third
parties. I accept that it was a reasonable hourly rate for the work performed
by Gary McCrea and Tom McCrea. My conclusion does not change simply
because the $30 hourly rate was not used to split the $38,880 between Gary McCrea
and Tom McCrea. The method used to split the $38,880 did not result in the
Appellant paying Gary McCrea an unreasonable hourly rate.
[31]
In summary, the undisputed evidence before me is
that the Appellant paid Gary McCrea and Tom McCrea wages of $38,880 solely for
the work Gary McCrea and Tom McCrea performed conducting SR&ED. As a
result, 100% of those wages can reasonably be considered to relate to SR&ED
and they represent an expenditure on or in respect of SR&ED.
[32]
Counsel for the Respondent argued that, if I
accept that the Appellant paid the $38,880 of wages solely for SR&ED, then
Gary McCrea and Tom McCrea did not receive any compensation for the significant
time they spent “performing director or
management activities” for the Appellant.
[33]
I do not accept this conclusion. The evidence
before me was that Gary McCrea and Tom McCrea received compensation for
such work in the form of dividends. As the controlling shareholders of the
Appellant, Gary McCrea and Tom McCrea could cause the Appellant to pay
them dividends, or remuneration in the form of salary and/or bonuses, for their
contributions with respect to directing and managing the Appellant. As the
controlling shareholders and managing directors of the Appellant, they chose to
receive dividends in lieu of salary and/or bonuses. This was their choice and
did not require a formal agreement.
[34]
The Respondent also relies on the decision of
this Court in Ergorecherche et Conseils Inc. v. The Queen. That appeal involved a
situation where the owners of a company performed SR&ED on six projects and
tried to allocate their salary and wages to three of the six projects. The three
projects chosen were the only ones eligible for investment tax credits.
[35]
That case can be distinguished from the current
appeal. The salary and wages paid to the two individuals in Ergorecherche were
not calculated on the basis of the hours the individuals spent on specific
SR&ED projects, rather “the salaries paid to
the two shareholders were based not on the hours they worked, but solely on the
appellant’s liquid assets at the end of the year.”
[36]
This is not the fact situation before the Court
here. In the current appeal, the Appellant based the total salary and wages
paid to Tom McCrea and Gary McCrea on the hours they worked on specific
SR&ED projects.
[37]
For the foregoing reasons, the appeal is allowed
and the reassessment is referred back to the Minister of National Revenue for reconsideration
and reassessment on the basis that the $38,880 of wages paid by the Appellant
to Tom McCrea and Gary McCrea constitute an expenditure on or in respect of
scientific research and experimental development.
[38]
Costs are awarded to the Appellant. The parties
shall have thirty days from the date of this judgment to make submissions with
respect to the costs awarded. Such representations shall not exceed 10 pages.
If no submissions are received, costs shall be awarded to the Appellant as set
out in the Tariff.
Signed at Ottawa, Canada,
this 27th day of April 2017.
“S. D’Arcy”
2014-4749(IT)G
TAX COURT OF CANADA
BETWEEN:
AG SHIELD CANADA LTD.,
Appellant,
-
and –
HER MAJESTY THE QUEEN,
Respondent.
AGREED STATEMENT OF FACTS
1. The Appellant, A.G. Shield Ltd. is a corporation existing under
the laws of the Province of Manitoba whose principal place of business is
located in the village of Benito in the Province of Manitoba.
2. Tom McCrea (“Tom”) and Gary McCrea (“Gary”) are two brothers,
each of whom owns 50% of the shares in the Appellant.
3. Tom and Gary are the only officers and directors of the
Appellant.
4. Since 1984, and at all material times, the Appellant has been engaged
in, inter alia, researching, designing and manufacturing agricultural
implements.
5. The
Appellant has filed scientific research and experiment development
(“SR&ED”) claims with the Respondent since 1993.
The Claims
6. In its taxation year ending December 31, 2010 (the “2010 Taxation
Year”), the Appellant claimed SR&ED expenditures in relation to eight
projects.
7. In the 2010 Taxation Year, Tom was directly engaged in SR&ED
Services for the Appellant for 1,094.5 hours, and Gary was directly engaged in
SR&ED Services for the Appellant for 201.5 hours.
8. In the 2010 Taxation Year, Tom was paid wages by the Appellant in
the amount of $26,940.00 and Gary was paid wages by the Appellant in the amount
of $11,940.00.
9. In addition to the 1094.5 hours Tom Spent on SR&ED
activities, Tom spent 1,905.5 hours performing director or management
activities for the Appellant, for a total of 3000 hours for the Appellant in
the 2010 Taxation Year.
10. Gary was in charge of marketing, sales representatives and customer
service on behalf of the appellant. In addition, to the 201.5 hours Gary spent
on SR&ED services, Gary spent 2,798.5 hours performing director or
management activities for the Appellant in the 2010 Taxation Year.
11. The Appellant used the proxy method of claiming overhead costs for
its SR&ED claim in the 2010 Taxation Year.
12. In reporting its income for the 2010 Taxation Year, the Appellant
claimed qualified SR&ED expenditures in the amount of $297,968.00 and
corresponding investment tax credits (“ITC’s”) of $122,852.00. The qualified
SR&ED expenditures claimed included 100% of the wages paid by the Appellant
to Tom and Gary in the 2010 Taxation Year.
13. The Minister of National Revenue assessed the Appellant with
respect to the 2010 Taxation Year, disallowing $21,119 of the claimed total
allowable SR&ED expenditures and corresponding ITCs of $7,391, as the
Minister’s position is that the wages received by each of Tom and Gary were
paid for all of the services Tom and Gary provided to the Appellant, not just
for SR&ED services provided by Tom and Gary.
October
18, 2016 PITBLADO LLP
Per: “David
E. Silver”
David E. Silver,
Counsel for the Appellant
October 18, 2016 William
F. Pentney, Q.C.
Deputy Attorney General of Canada
Solicitor for the Respondent
Per: “Julien
Bédard”
Julien Bédard
Counsel for the Respondent
Department of Justice Canada
Prairie Region
301 – 310 Broadway
Winnipeg, MB R3C 0S6
Telephone: (204) 983-0984
Facsimile: (204) 984-5434
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