Her Majesty the Queen v. Sie-Mac Pipeline Contractors Ltd., [1992] 1 CTC 341

Linden, J.A.:—The issue in this appeal is whether expenses incurred to entertain clients at a fishing lodge are deductible. The Associate Chief Justice, in the decision being appealed, held that they were deductible, approving the decision to the same effect by Brulé, J. of the Tax Court of Canada.

In 1984, Sie-Mac Pipeline Contractors Ltd. hosted some of its customers at a fishing lodge in a wilderness area in British Columbia known as the "Hoeya Hilton". Fourteen people, including seven customers, five employees and two from a related company, attended from May 11 to 14, 1984. There were no other guests at the lodge during this period. The aim of the visit was for the respondent to show its appreciation to its customers and to inform them of new equipment and techniques. Business meetings could be held for one-two hours per day but the main activity was recreation, namely fishing. The guests travelled by commercial airline from Edmonton to Vancouver, where the lodge's Twin Otter airplane transported them to the lodge. The total cost of the trip was $12,800.65, which included room, food, transportation, fishing and the canning of fish, licences, alcohol and tobacco.

The appellant contends that this amount is not deductible as an expense because it is caught by subparagraph 18(1)(l)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"). The relevant parts of section 18 are as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property. ....

(I) an outlay or expense made or incurred by the taxpayer after 1971,

(i) for the use or maintenance of property that is a yacht, a camp, a lodge or a golf course or facility, unless the taxpayer made or incurred the outlay or expense in the ordinary course of his business of providing the property for hire or reward, or

(ii) as membership fees or dues (whether initiation fees or otherwise) in any club the main purpose of which is to provide dining, recreational or sporting facilities for its members; . . . .

The respondent argues, however, that the expenses were deductible since they were not incurred for the “use or maintenance of property that is. . . a lodge” as outlined in subparagraph 18(1)(l)(i) of the Income Tax Act. Counsel suggested that the Associate Chief Justice and Brulé, J. had properly interpreted the law in allowing the expense.

I am of the view that this expense is not deductible, even though it may have been incurred for the purpose of producing income, because it falls within the language of subparagraph 18(1)(l)(i). In 1971 Parliament decided to exclude as deductible expenses certain types of costs that had been allowed before that time. It was apparently felt that certain taxpayers may have been taking unfair advantage of the law, as it then stood, to provide recreational activities to its customers where the direct business purpose of the meeting may have been only marginal. Parliament, as a matter of policy, prepared a list of recreational sites that were prone to this type of perceived abuse and prohibited the deduction of the costs of their use and maintenance. Certainly, anyone who owned a yacht, camp, lodge or golf course could not deduct the cost of their maintenance as an expense, but, so too, a taxpayer who used" any one of these facilities to entertain customers was precluded from deducting the cost. It is my view that this has already been decided by this Court in The Queen v. Jaddco Anderson Ltd., [1984] C.T.C. 137,84 D.T.C. 6135 (F.C.A.), which reversed the Associate Chief Justice who had come to a similar conclusion to the one he reached in this case. (See [1981] C.T.C. 11, 81 D.T.C. 5002 (F.C.T.D.).) The way that Jaddco was distinguished by Brulé, J. and adopted by the Associate Chief Justice is, in my view, not convincing.

In my view, in enacting subparagraph 18(1)(I), Parliament wanted to deny the deduction of expenses at certain recreational facilities, as well as certain club dues, but that it was not going so far as to disallow all entertainment expenses at social clubs. Parliament was certainly entitled to draw the distinctions it chose to draw, and it is not for this Court to second-guess Parliament.

In this case there is no dispute that the “ Hoeya Hilton” is a lodge within the meaning of subparagraph 18(1)(l)(i). The payments made on behalf of the customers were for the use of the lodge, in the sense of "utilisation" or "availing oneself of" or to“ employ”. (See Black's Law Dictionary, 6th Edition.) There is no need for the property to be "owned" or "rented" or “ exclusively controlled” in order for it to be "used", as that word is employed here. If that were the meaning intended, Parliament could easily have shown that intention, which it did not.

The anomaly of allowing deductions for entertainment of customers in restaurants or hotels, but not on yachts or in lodges is obvious, but it is within the authority of Parliament to make these distinctions if it so chooses. The fact that some may view these distinctions as unfair does not permit the Court to rectify that injustice.

The case of Duramould Ltd. v. M.N.R., [1984] C.T.C. 2571, 84 D.T.C. 1498 (T.C.C.) followed Jaddco Anderson in a situation not dissimilar to this one, where a company convened a shareholders meeting at a lodge. The expense of the meeting was not allowed, Taylor, T.C.C.J. explaining as follows at page 2572 (D.T.C. 1499):

. . .counsel for the appellants, nevertheless stressed that the section should not be so narrowly interpreted as to exclude a deduction (which by inference would be otherwise deductible) merely on the grounds that the location was a “fishing lodge". The recent judgment in Her Majesty the Queen v. Jaddco Anderson, [1984] C.T.C. 137, 84 D.T.C. 6135, cited by counsel for the Minister, leaves no such flexibility to taxpayers. An expenditure made under the circumstances as described to the Court in this instance does not qualify for any exception, and the Minister’s treatment of the amount as a non-deductible item is correct whether or not it had a business purpose.

The respondent made some sophisticated arguments in relation to section 67.1, subsection 212(13) and paragraph 12(1)(g), but, in my view, they are not of any assistance in resolving the matter on issue here.

It was also argued by the respondent, in the alternative, that if all the costs were not deductible at least some of them might be. He suggested that the expense associated with the “use” of rooms at the lodge might be forbidden, but the other costs such as food, transportation, etc. might be deducted. In my view, there is no merit in this contention. None of the costs incurred are deductible in this case. Had the customers been taken to dinner in Edmonton to discuss business the costs would have been deductible; if they had been flown to Vancouver, for a meeting at a hotel, those expenses too would have been allowable; however, the expense of flying up to a lodge for three days, even for a business purpose, is expressly made non-deductible. This was the very kind of thing the subparagraph was meant to stop.

The respondent is of course, at liberty to promote its business in this way, if it chooses, but, if it does so, the other taxpayers of Canada are not required to subsidize it for its generosity to its customers.

This appeal will, therefore, be allowed with costs.

Appeal allowed.

594872 Ontario Inc., Jacob Salamon, Salamon Bros. (Canada) Inc.

[Indexed as: 594872 Ontario Inc. v. Canada (No. 2)]

Federal Court—Trial Division (Reed, J.), March 26, 1992 (Court File No. 89-T-649) on a motion for directions.

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63)—231, 232(3.1), (4), (10)—Federal Court Rules—332.1—Solicitor-client privilege— Res judicata—Cross-examination on affidavit.

After the Minister served a requirement to provide information and documents on the applicants’ solicitors, the applicants applied pursuant to subsection 232(4) to determine whether solicitor-client privilege applied to any of the documents. The privilege question was not decided and two and one-half years later the Minister applied for directions pursuant to subsection 232(10). The Minister had brought a similar motion three weeks earlier and that motion had been dismissed. The taxpayer therefore submitted that res judicata applied and that the Minister's motion should be dismissed. In a related matter, an issue arose as to which party was responsible for producing an affiant whose affidavit was attached to the affidavit filed by the Minister.

HELD:

Res judicata did not apply in this instance because a decision on a motion for directions is not the kind of issue which is final so as to make any further decision with respect thereto res judicata. Accordingly, the proper course for the Minister to take was to bring forward for disposition, on seven days notice, the subsection 232(4) application which had been adjourned on August 29, 1989.

As to the related issue, the affidavit which was produced as an attachment to the Minister's affidavit had the same status as any other attachment to an affidavit. It did not have an independent status as an affidavit which had been served in the sense in which that term was used in Rule 332.1 of the Federal Court Rules. Accordingly, there was no obligation on the Minister to produce the affiant for cross-examination. Order accordingly.

Franklyn E. Capped for the applicants.

Kevin Wilson for the respondent.

Cases referred to:

Diamond v. Western Realty Co., [1924] 2 D.L.R. 922;

Scotia Construction Company Ltd. v. The City of Halifax, [1935] S.C.R. 124;

Leier v. Shumiatcher and Luboff (1962), 32 D.L.R. (2d) 584;

Lloyd v. Milton & Derkson, [1939] 3 D.L.R. 155;

Stamper v. Finnigan (1984), 1 C.P.C. (2nd) 175;

Talbot v. Pan Ocean Oil Corporation (1977), 4 C.P.C. 107;

Musqueam Indian Band v. Canada (Minister of Indian and Northern Affairs),

[1990] 2 F.C. 351;

Rans Construction (1966) Ltd. v. Canada, [1987] 2 C.T.C. 206, 87 D.T.C. 5415;

Hillsdale Golf & Country Club Inc. v. The Queen, [1979] 1 F.C. 809;

Glaxo Canada Inc. v. Minister of National Health & Welfare, (1988) 19 C.P.R.

(3d) 374.

Motion for directions

Reed, J.:—The respondent, Her Majesty the Queen, brings a motion seeking directions pursuant to subsection 232(10) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). This is not the first time this matter has been before the Court. Mr. Justice Muldoon issued an order on March 4, 1992, dismissing a similar motion dated February 26, 1992. The applicants argue that the present motion should be dismissed because it is res judicata as a result of the decision of Mr. Justice Muldoon.

The matter which underlies both the present motion and the earlier motion originated in July 1989 when the respondent requested that Messrs. Fleischer and Kochberg relinquish certain documents relating to their clients, the applicants. This request was made pursuant to section 231 of the Income Tax Act. The applicants objected to relinquishing the documents on the ground that they are covered by solicitor-client privilege. An application dated July 14, 1989, was filed by the applicants, pursuant to subsection 232(4) of the Income Tax Act. That application seeks a determination by the Court as to whether the documents are covered by solicitor-client privilege.

A motion seeking the setting of a date and place for disposition of that application was adjourned on August 8, 1989, to August 29, 1989, by the Associate Chief Justice. On August 29, 1989, he dealt with the motion as follows:

Order of this court dated August 8/89 is amended nunc pro tunc to read, Order to go in terms of Notice of Motion herein, adjourned for hearing to August 29/89.”

Further, applicant having been served August 28/89 with the affidavit of David J. Kimball, this motion is adjourned indefinitely, to be brought on upon seven days' notice by either party.

The affidavit of David J. Kimball alleged that the documents in the possession of Messrs. Fleischer and Kochberg were required in order to trace funds which were part of a fraudulent scheme relating to scientific research designations under section 194 of the Income Tax Act. Counsel for the respondent intended to argue on the return of the subsection 232(4) application that any solicitor-client privilege which might exist was nullified because fraud was involved.

Counsel for the applicants has been cross-examining Mr. Kimball on his affidavit and is still in the process of doing so. The respondent clearly has found this frustrating and counsel states that the lengthy cross-examination is protracting the proceedings excessively. Consequently, the respondent, under what appears to be a rubber stamped signature of G.E. Taylor, Director- Taxation, Toronto District Office of the Department of National Revenue, sent Mr. Kochberg a letter dated January 23, 1992, stating that the request for the disclosure of the documents which underlie the claim for privilege was withdrawn. At the same time, the letter advised Mr. Kochberg:

This withdrawal expressly does not constitute an admission of any kind in respect either of the privilege claim or of the potential evidentiary value of the said documents in any proceeding.

Accordingly, to the extent that the said documents belong to you, you are advised to retain them, inter alia, since they may be required as evidence in legal proceedings. In respect of such documents belonging to other parties, any such parties to whom you turn over control of such documents should be advised to retain them, inter alia, because they may be required asevidence in legal proceedings. In the event that such documents were to become required in evidence in any proceeding, their intervening loss, disposal or destruction may, of course, have significant civil or criminal consequences.

Counsel for the respondent then sought directions, as has been noted from this Court, as to the status of the applicants’ subsection 232(4) application. The respondent claims that that issue is now moot. Counsel for the respondent indicated that the respondent wishes to put an end to the cross-examination process. In the respondent's view it has turned into a discovery process by the applicants with a view to use in other proceedings and which the respondent considers to be delaying substantive procedures bein taken. Counsel for the applicants argues that his clients are entitled to have the privilege issue determined or to have the respondent relinquish her request for the documents.

I will deal first with the argument that Mr. Justice Muldoon’s decision of March 4, 1992, renders the respondent's motion res judicata. Counsel cited a number of cases which deal with the issue of res judicata [1] . After reading those decisions, I am not convinced that a decision on a motion for directions is the kind of issue which is final so as to make any further decision with respect thereto res judicata. In addition, in this case it seems clear from Mr. Justice Muldoon's reasons that he considered the respondent's motion a request for a substantive determination (as to whether or not the applicants’ motion pursuant to subsection 232(4) was moot) and not merely an order for directions. As I indicated to counsel, I also had this difficulty. As framed the motion seems to seek a substantive determination in the context of a motion asking for directions.

In any event, in my view the proper course of action is for the respondent to bring on, on seven days’ notice, the motion which was instituted by the applicants in July 1989 and adjourned by the Associate Chief Justice on August 29, 1989. The order of the Associate Chief Justice specifically accords both parties the right to bring the subsection 232(4) application on for a hearing on seven days' notice. It is open to the respondent then to bring that motion on for a hearing and to argue that it should be disposed of even though the cross- examination of Mr. Kimball has not been completed. It is open to the respondent to argue that the application should be dismissed because it is now moot since the attempted seizure of documents to which it relates has been abandoned. If the respondent is successful, I do not think the applicants can legitimately fear an immediate re-seizure of the documents by the respondent pursuant to the investigative provisions of the Income Tax Act. A court would surely prevent such abusive conduct. In addition, counsel for the respondent has given an undertaking on behalf of his client that no such subsequent attempt to obtain the documents for investigative purposes under the Income Tax Act will be made. Whether or not the respondent will in any other proceeding (for example in the context of any future trial) attempt to subpoena such documents and what would be the result of such action is not a matter which this Court need be concerned about for present purposes.

Production of Mr. Sebold for cross-examination

Counsel raised an additional point. If I am wrong in suggesting that the correct procedure is for the respondent to bring forward for disposition the original subsection 232(4) application or if on the hearing of that application the respondent is not successful, then, it will be necessary to know which of the two parties has an obligation to produce Mr. Otto Sebold for cross- examination.

The evidence on which Mr. Kimball based his affidavit dated August 28, 1989, alleging fraud on the part of the applicant taxpayers, was in part based on an affidavit by Mr. Sebold. That affidavit was attached as an exhibit to the affidavit of Mr. Kimball. Mr. Sebold is a resident of the United States. In response to Mr. Kimball's affidavit the applicants filed two additional affidavits by Mr. Sebold dated October 5 and October 25, 1989.

As has been noted, the applicants have been examining Mr. Kimball on his affidavit of August 28, 1989. Counsel for the applicants indicates that when he has finished, he may also wish to cross-examine Mr. Sebold on the affidavit which is appended as an attachment to Mr. Kimball's affidavit. If he determines that such course of action is advisable, he argues that the respondent has an obligation to produce Mr. Sebold for cross-examination. Counsel for the respondent on the other hand argues that the Sebold affidavit upon which he relies has only the status of an attachment to Mr. Kimball's affidavit and as such it is not an affidavit which has been served in the sense in which that term is used in Rule 332.1 of the Federal Court Rules. Counsel for the respondent argues that if the subsection 232(4) application is still extant, however, he will wish to cross-examine Mr. Sebold on the two October 1989 affidavits filed by him in support of the applicants’ position and it is the applicants' responsibility to produce Mr. Sebold for cross-examination on those affidavits.

Counsel for the applicants suggests that the underlying cause of this dispute between the parties is that if the applicants have the obligation to produce Mr. Sebold, this will require him to come to Canada or force the applicants to relinquish their reliance on his affidavits. Counsel for the applicants suggests that the respondent would very much like to see Mr. Sebold come into the jurisdiction perhaps to enable independent proceedings to be taken against him.

In any event, I find counsel for the respondent's argument persuasive. The Sebold affidavit which is produced as an attachment to Mr. Kimball's affidavit has the same status as any other attachment to an affidavit. It does not have an independent status as an affidavit served in these proceedings on which cross- examination pursuant to Rule 332.1 applies. Counsel for the applicants argues that if there is no obligation on the respondent to produce Mr. Sebold then a party could always shield an affiant from cross-examination by placing the affidavit in evidence as an attachment to a purely formal affidavit which says nothing and is signed by someone having minimal real knowledge of the issues. In my view, this argument is not persuasive. If such a practice were adopted it would clearly result in an affidavit which had little or no weight. In the present case Mr. Kimball was the investigating official; his affidavit contains his findings from reviewing various tax returns, bank documents, business records etc He interviewed Mr. Sebold in company with an Internal Revenue Officer of the United States Department of Internal Revenue. Mr. Kimball's affidavit is more than just a cover for Mr. Sebold’s affidavit. The fact that Mr. Sebold is not produced by the respondent for cross-examination is a matter which a judge hearing the 232(4) application on the merits, if such a hearing is held, would take into account in weighing the affidavit evidence of Mr. Kimball but there is no obligation on the respondent to produce Mr. Sebold for cross-examination.

There is however an obligation on the applicants, if they wish to rely on the two October 1989 affidavits of Mr. Sebold which they have served in these proceedings to produce Mr. Sebold for cross-examination.

Order

1. With respect to the respondents motion for directions it is open to the respondent to bring forward for disposition, on seven days' notice, the 232(4) application adjourned by the Associate Chief Justice on August 29, 1989;

2.There is no obligation on the respondent to produce Otto Sebold for cross- examination on his affidavit which was filed as an attachment to the affidavit of David J. Kimball dated August 28, 1989.

Order accordingly.