Les Soudures Chagnon Ltée v. Minister of National Revenue, [1990] 1 CTC 2365, 90 DTC 1203

Rip, T.CJ.:—On May 4, 1979 a meeting of the directors of Soudures Chagnon Ltée, the appellant, adopted a resolution providing inter alia as follows:

(TRANSLATION)

. . . in view of the many duties performed by Mr. Camille Chagnon, the many hours of work given by Mr. Chagnon to the company and the results obtained by the company, be it resolved that the sum of $240,000 be laid to him as a bonus when the company’s banking position permits it.

In its tax return for the 1979 taxation year, the appellant deducted the sum of $240,000 as a bonus in accordance with paragraph 18(1)(a) [1] of the Income Tax Act ("the Act”). This deduction was not allowed by the Minister of National Revenue, the respondent, since it was a reserve within the meaning of paragraph 18(1)(e) of the Act [2] and the Minister reassessed the appellant for the 1979 taxation year. The appellant filed a notice of appeal against this reassessment.

The appellant never paid the $240,000 to Mr. Chagnon. The bonus was subsequently cancelled by Mr. Chagnon. In 1980, he cancelled $40,000 of the bonus, and in 1981 he cancelled the remainder, that is $200,000. When the Minister assessed the appellant by adding the sum of $240,000 to the calculation of its income for the 1979 taxation year, he assessed the appellant for its 1980 and 1981 taxation years, excluding from the calculation of the appellant's income sums of $40,000 and $200,000 respectively. The appellant also appeals from the Minister's decision to exclude the sum of $200,000 from its income for the 1981 taxation year; it relies on subsection 78(3) of the Act.

The appellant company was incorporated in 1971. Its fiscal year ends on September 30. The company builds in its plant and installs on the site steel construction equipment such as elevator cages and garbage containers. It repairs trucks, agricultural equipment and cranes, for example. Mr. Chagnon began the business in 1961. He was the appellant's sole shareholder during the years at issue. The company directors were his wife, his father and himself.

The evidence indicated that Mr. Chagnon was a hard worker. He testified that he frequently worked at the plant from 6:00 a.m. to 10:00 p.m. or even until midnight, seven days a week. Mr. Chagnon was responsible for the entire business. He sold and leased the products, he was in charge of quality control and he estimated the cost of contracts. His wife also worked for the appellant.

The company grew in size considerably over the years. In 1971, it had only 20 employees while in 1978, it had about 100. The nature of its customers also changed. It began doing work for the large Canadian corporations—Hydro- Québec, Stelco, Alcan, Dorco and Dow Chemical. During 1980 the company expanded its plant, from 82,000 to 500,000 square feet.

Under a contract which the company received from Hydro-Quebec at the end of calendar year 1979, Mr. Chagnon negotiated a new line of credit for the appellant company in 1980 with the Royal Bank. One of the conditions for obtaining this new line of credit was that the appellant would reduce the bonus; Mr. Chagnon and the appellant agreed that the bonus would be reduced by $40,000.

It was the appellant's accountants who had advised the appellant's directors to award Mr. Chagnon the bonus. The auditors who began working for the appellant in 1978 told Mr. Chagnon that the salary he had received since he set up the business was much too small. His annual salary between 1974 and 1979 varied between $15,600 and $19,000. Mr. Chagnon received no dividends. The company paid his wife between $12,000 and $13,000 salary per year. The salaries of Mr. and Mrs. Chagnon were their sole respective sources of income. Before 1979, the company had never declared or paid a bonus. During his examination, Mr. Chagnon said that he thought others who owned companies in the same industry earned more than he did and lived more comfortably. However, no evidence was presented as to the profitability of these other companies.

The auditors explained to Mr. Chagnon that he and the company were two separate persons and that the assets of the company were not his property. They told him that a salary of $16,000 to $18,000 was not sufficient and suggested that the appellant’s directors award him a bonus of $240,000. Mr. Chagnon said that the bonus represented a “salary catch-up”. Mr. Emile Male- tte, C.A., a partner of Samson, Belair, chartered accountants, who were the appellant's auditors, confirmed this testimony to [sic] Mr. Chagnon. In Mr. Malette's opinion, an annual salary of $50,000 was reasonable for Mr. Chagnon. There was no evidence as to how the amount of $240,000 was arrived at.

Mr. Chagnon said that the company's financial position on May 4,1979 was "very good" and that the company's liquidity made payment of the bonus possible. The company's profits had exceeded expectations. Mr. Chagnon said that his father wanted him to invest in real estate so he did not insist on payment of the bonus. Despite the company's good financial position, Mr. Chagnon admitted, in cross-examination that the amount of accounts receivable prevented the company from paying the bonus on May 4. The bank manager warned Mr. Chagnon that the accounts receivable were too high. According to Mr. Chagnon, the company’s working capital was poor.

Another reason why the company did not pay the bonus, Mr. Chagnon said, was that he thought the company would buy a property and so would need money.

During its 1981 financial year, the company received dividends amounting to $217,000 from an associated management company. During the same financial year, the company stood security for a bank loan of $150,000 for a new affiliated company. The working capital which had been $83,427 in 1980 increased by $198,622 in 1981 to $282,049.

According to Mr. Malette, the company was able to pay the bonus in 1979, but Mr. Chagnon decided that it should not be paid. The company's profits increased from $82,000 in the nine months ending September 30, 1978 to $239,000 for the period ending September 30, 1979. He also said that the quotient of short-term assets to short-term liabilities was 1:1, which he regarded as "very good". The short-term assets were $1,423,030 and the shortterm liabilities were $1,279,904. The short-term assets consisted of customer accounts and other debtors amounting to $904,175, inventory amounting to $492,590 and services receivable of $26,265. The short-term liabilities consisted of a bank loan of $363,537, suppliers and accrued liabilities of $752,168, taxes of $68,321, deferred taxes of $13,538 and portion of long-term debt payable within the year, amounting to $82,340. Mr. Malette testified that Mr. Chagnon decided that the bonus should not be paid because he had to pay tax on the bonus. It was also difficult to convince him that the company's money was not his own.

Mr. Malette said that the working capital was good. Nevertheless, he admitted that the company did not have the cash available to pay the bonus; it would have had to borrow on its line of credit to make such a payment. He admitted that he had no idea how the Bank would have reacted if the company had paid the bonus with its line of credit, but he said that the Bank did not indicate disapproval. Mr. Malette suggested that the company could speed up collection of the accounts receivable and sell stock to obtain the necessary liquid funds to pay the bonus.

One of the appellant's debts in 1979 was an advance from Mr. Chagnon of $71,679. Mr. Malette testified that the Bank would be prejudiced if this amount were repaid; the Bank did not want the company to repay the advance to Mr. Chagnon. Everyone regarded the $71,679 as necessary for liquidity. He added that when the company's capital increased from $348,000 to $522,000 in 1980, the company repaid the advance. The sum of $71,679 was in fact converted into preferred shares of the company.

For the appeal brought against a 1979 tax assessment to be allowed, the declaration of the bonus by the appellant's directors must be an obligation for the latter to pay Mr. Chagnon the amount of the said bonus: that obligation once established must not depend on any future and uncertain event. The directors must also have intended the appellant to pay the bonus.

By appealing from its assessment for 1981, the appellant is asking that its income, and accordingly its taxes, be increased. The appeal procedure provided by the Act is, however, intended to alleviate taxpayers' tax burdens. The Court can only consider an appeal brought from a tax assessment if the taxpayer is asking for a reduction of tax for the year at issue: No. 526 v. M.N.R., 20 Tax A.B.C. 114; 58 D.T.C. 497, Neil L. Boyko et al. v. M.N.R., [1984] C.T.C. 2233 at 2238, 84 D.T.C. 1233 at 1237; Steven Cooper v. M.N.R., [1987] 1 C.T.C. 2287 at 2301; 87 D.T.C. 194 at 205, and Paul Cohen v. M.N.R., [1988] 2 C.T.C. 2021 at 2023; 88 D.T.C. 1404 at 1406. For this reason, the appeal brought from a tax assessment for 1981 will be dismissed.

As regards the assessment made for 1979, counsel for the appellant contended that Mr. Chagnon had done too much for his client, which was only paying him a modest salary. He said that the appellant's success was due to Mr. Chagnon's efforts. The latter, he went on, is a simple man who regarded his property and that of the appellant company as one and accordingly saw no reason to be paid a reasonable salary. The appellant's auditors recommended that it pay the bonus as a means of correcting this iniquity [sic] and to compensate for the low salary received in previous years. He said that on May 4, 1979 the company's financial position was good and it was able to pay the bonus at that time. He added that the appellant's bank manager was in favour of this payment.

According to counsel for the appellant, the non-payment of the bonus was due to Mr. Chagnon's attitude, as he could not distinguish his own property from that of the company. Added to this was the possibility of investing money in property. In any case, counsel argued, there was nothing in the Act to prevent the company from paying the bonus immediately. Once October came, Hydro-Québec gave the appellant a contract and it needed money to increase its capital. The Bank increased the appellant's credit line on condition that the bonus be altered to $200,000. The appellant's receipts later decreased and the bonus could no longer be paid. Counsel emphasized that declaring the bonus was not part of any tax reduction plan.

Counsel for the appellant contended that declaration of the dividend was not “contingent”. Counsel preferred the word "contingent", which is used in the English version of paragraph 18(1)(e), to the word "prévoyant", used in the French version of this enactment. He referred the Court to definitions of the word "contingent" in French and English dictionaries; in French, the Dictionnaire Robert defines the word "contingent" as meaning, inter alia, ”. . . eventual, fortuitous, accidental, uncertain . . . conditional", the Dictionnaire Bélisle gives the following definition "What may or may not happen, v. accidental, casual, conditional, eventual, fortuitous, uncertain, chance . . .”.

Counsel for the appellant also referred to article 1079 of the Quebec Civil Code, which reads as follows:

An obligation is conditional when it is made to depend upon an event future and uncertain, either by suspending it until the event happens, or by dissolving it accordingly as the event does or does not happen.

When an obligation depends upon an event which has actually happened, but is unknown to the parties, it is not conditional. It takes effect or is defeated from the time at which it is contracted.

In the submission of counsel, the condition contemplated in the directors’ resolution according to which the bonus would be paid "when the company's banking position permits it" was met in the appellant's 1979 financial year as it was in a position to pay the bonus in 1979. He argued that on the very day the resolution was adopted, May 4, 1979, the company was in a favourable financial position as a result of which it could pay the bonus.

The appellant referred the Court to several published decisions which, its counsel said, supported the appeal. In my opinion, however, none of these cases is directly relevant. In The Queen v. V. & R. Enterprises Ltd., [1979] C.T.C. 465; 79 D.T.C. 5399, the services rendered by the employees were rendered for several years without immediate payment on condition that the final remuneration was determined at the end of the year. Salaries receivable were earned during the taxation year in which they were listed as disbursements. In Carling Realty Company Ltd. et al. v. M.N.R., [1982] C.T.C. 2323; 82 D.T.C. 1283, it appears that the resolution itself authorizing payment of the salary and bonus was not subject to any condition, but following the resolution, the Bank insisted that the current bonus be repaid before the shareholders received any part of their bonus receivable. The obligation created by declaration of the bonus did not depend on the Bank's approval. In McClain Industries of Canada Inc. v. The Queen, [1978] C.T.C. 511; 78 D.T.C. 6356, Brazolot Construction Ltd. v. M.N.R., [1981] C.T.C. 2468, 81 D.T.C. 449 and Earlscourt Sheet Metal Mechanical Ltd. v. M.N.R., [1988] 1 C.T.C. 2045; 88 D.T.C. 1029, each appellant had followed a practice over a period of years of accumulating the annual salary of managers and the salaries receivable related to services performed during the year, their payment had to be made during the following year. Each company had undertaken an obligation during the year to pay these employees for the services rendered. The member of the Tax Review Board hearing the appeals in Toronto Heel Ltd. v. M.N.R., [1980] C.T.C. 2277; 80 D.T.C. 1250 and Len Singleton Ltd. v. M.N.R., [1983] C.T.C. 2196; 83 D.T.C. 141, held that the facts of this first case did not differ significantly from those in McClain, and in the second appeal, he ruled in the appellant's favour because of the particular facts of the case.

Counsel for the respondent contended that, although according to the testimony of Messrs. Chagnon and Malette the discussions on payment of a bonus took place during 1979, it was not clear when the question of the bonus was settled, in May 1979 or in October 1979, once the year's figures were known and more capital was needed. Further, he said, it appeared from the evidence that the possibility of investing in real estate first arose in December 1979, not in May of that year.

Counsel questioned whether the bonus could have been paid during 1979, especially in view of the fact that the Bank would not allow the appellant to repay its debt of $71,000 to Mr. Chagnon in 1979.

Counsel also argued that the appellant was in no way required to pay Mr. Chagnon a bonus.

The respondent relied on the reasons for judgment of the Federal Court in The Queen v. Ken and Ray's Collins Bay Supermarket Ltd., [1975] C.T.C. 504; 75 D.T.C. 5346. The [D.T.C.] headnote reads as follows:

The defendant taxpayer company operated grocery supermarkets. In the relevant years, the issued shares of the company were beneficially owned two-thirds by E and one-third by K. Each of them worked every day and long hours operating the two stores owned by the company. They were full-time employees and officers of the company, made all corporate decisions on behalf of the company and determined management policy. In 1968, their accountants introduced a computerized accounting system for the company, which provided cumulative profit and loss and trial balance figures at the end of each month. The trial balance statement up to the end of October 1968 showed a profit of $151,366 for the first nine months of the company's fiscal year ending February 28, 1969. Having regard to the excellent prospects of higher earnings, the level of salaries they had been taking and the long hours they had devoted to the business, E and K decided to have bonuses of about $25,000 to $30,000 each provided funds were available. The bonuses were to be paid out in the next fiscal year when the exact amount was determined after the year-end results were known. In April or May 1969 they decided that the bonuses for the year ended February 28, 1969 would be $58,590 divided equally between them. For its 1969 fiscal year, the company's income before taxes was $34,997 after deducting $58,590 for bonuses as an expense. The bonuses were, however, not paid out. The sum of $58,590 was carried as a “deferred management bonus" under current liabilities. In 1969 the company faced severe competition and a price war, with the result that the bonuses could not be paid. The unpaid bonus was brought back into income and a new bonus of $17,000 was set up to be paid out in the next year. For its 1970 year, after deducting the new bonuses of $17,000, the company's income was $34,258. The new bonuses were also not paid out, and were returned to income in the following year. The Minister disallowed the deductions in both years. The Minister contended (1) that the management bonuses were not an outlay or expense made or incurred for the purpose of gaining or producing income from a business; (2) that the deductions had the effect of setting up a reserve that was not expressly provided for under the Act; and (3) that the bonuses would unduly or artificially reduce income. The company appealed, contending that the management bonuses were bona fide and reasonable in all the circumstances. The Tax Review Board (74 D.T.C. 1192) ruled that the bonuses were a proper deduction and allowed the appeal. The Minister appealed further.

The Court allowed the appeal brought by the Minister. First, it held that the decision to grant the bonuses had been made gratuitously although the evidence indicated that in 1968 the company decided to pay bonuses for legitimate business reasons. Kerr, J. explained that the fact the company actually did intend to pay bonuses, provided funds were available, did not mean that it had contracted and legally undertaken to pay them. The trial judge found, at 510 (D.T.C. 5351) that even

if the bonuses had been paid when the decision to grant them was made . . . the grant of that benefit would have been gratuitous in that payment would not have been made pursuant to a legal obligation as payment for services received by the company or pursuant to a contract for services to be received . . . There was . . . no new contractual obligation or undertaking by the company to pay the bonuses in consideration of [the employees] continuing their efforts and services.

The bonus for each of the years covered by the appeal was not a deductible expense in calculating income pursuant to paragraph 18(1)(a). See also G.W. Dorman Pulp Chip Company v. M.N.R., [1981] C.T.C. 2005; 81 D.T.C. 21. Secondly, the Court held that the payment of the bonuses depended on whether the necessary funds were available. Claiming the expenses incurred for the bonuses amounted to establishing a reserve that was not expressly provided for by the Act. See also Samuel F. Investments Ltd. v. M.N.R., [1988] 1 C.T.C. 2181; 88 D.T.C. 1106.

The evidence submitted by the appellant at bar is quite clear: on the recommendation of its auditors, the company decided to pay Mr. Chagnon a bonus because he had worked long and hard for a very low salary in previous years and was responsible for the company's success. However, nothing required the appellant to declare or pay such a bonus, and though it may have had sound business reasons for declaring and paying the bonus, it was not established that the company had contracted and legally undertaken to pay it. In my view, any payment of the bonus would have been made gratuitously and not pursuant to a legal obligation such as payment for services received by the appellant company would have been. The reason for declaration of the bonus did not differ significantly from that at issue in Ken and Ray's Collins Bay Supermarket, cited above, and I adopt the reasons of Kerr, J.

I also consider that payment of the bonus depended on the appellant's position with the Bank. The words used in the French version of paragraph 18(1)(e) are "compte de prévoyance". When the legislator uses a word in one of the two official languages, it is for a good reason. One should not say that the words are correct in the other official language and then refer to the meaning of the word in bilingual dictionaries. The word "prévoyance" has a meaning, although the word "contingence" may be used by accountants in French. The Petit Robert defines "prévoyance" as follows:

(TRANSLATION)

. . . faculty or action of foreseeing . . . attitude of someone making the necessary provision to cope with an anticipated situation . . .

A "compte de prévoyance" is thus an account established with a future event in mind. An amount is transferred into or credited to an account for a later purpose. In the instant case, if the bonus was not a gratuitous benefit, its amount was transferred for the purpose of a payment to be made, that is, when the company’s position with the Bank permitted it.

I am not persuaded by the argument of counsel for the appellant that the company was in a position to pay the bonus in May 1979. The appellant had no liquid funds. Mr. Chagnon admitted that the appellant's accounts receivable at the time were high and that the Bank did not regard this favourably. Any payment of the bonus would have had to be made from the credit line which the Bank was giving the appellant at that time, and there is nothing to show that this was ever considered, still less that it was a valid option in 1979. I would note that no bank employee was called to testify about the alleged "banking position” in 1979 so far as the appellant was concerned, though I must admit that the words "banking position" do not require the Bank's authority for the bonus to be paid. While, as Mr. Malette indicated, the appellant could have asked its debtors to pay their debts so that the bonus could be paid, it is clear that its creditors, such as the Bank, would have asked to be paid before any payment of the bonus was made. I greatly doubt that the company's position with the Bank would have allowed the payment of the bonus in such circumstances during its 1979 taxation year.

For these reasons, the appeals are dismissed.

Appeals dismissed.