Impenco Ltd. — Impenco Ltee v. Minister of National Revenue, [1988] 1 CTC 2339, 88 DTC 1242

Couture, C.J.T.C.:—The appellant appeals an assessment for its 1984 taxation year whereby the respondent disallowed as a deduction in computing its income an amount of $122,604 claimed as an outlay or expense incurred for the purpose of earning income within the meaning of the provisions of paragraph 18(1)(a) of the Income Tax Act (the Act).

Mr. Ralph Herzog who gave evidence on behalf of the appellant provided the following information regarding its operations and its reasons for the appeal. He is the vice-president of the appellant, a manufacturer of boxes for the jewellery, watches, cosmetic and gift trade. Its main customers are manufacturers, importers and wholesalers of jewellery and watches and also department and chain stores. Its competitors are mainly in Montreal, Toronto, the Orient and in Europe. It has approximately 100 employees.

Its financial statements indicate that for the 1983 and 1984 taxation years, its sales totalled $6,436,017 and $4,577,312 respectively. The substantial decrease in sales in 1984 compared with 1983 was explained by the witness as resulting from the drop in the price of digital watches. These watches were very popular in 1983 and prior years and were packaged in boxes. Their price dropped so drastically that in subsequent years it became unprofitable to market them in that fashion and since 1984 they have been sold in what the witness referred to as blister packs. The witness also contended that the reduction in sales would have been substantially larger if it had not been that new customers were recruited in 1984.

In filing its 1984 income tax return the appellant claimed contributions to various charitable organizations in the amount of $178,097 as selling expenses. No sum was claimed as gifts to these organizations within the provisions of paragraph, 110(1)(a). In assessing the return the respondent allowed a deduction in computing the appellant's taxable income equal to 20 per cent of its net income or $55,593.60 under paragraph 110(1)(a) and disallowed the remainder $122,603.40. It was the first year that the appellant's aggregate contributions exceeded the maximum amount permitted as a deduction under paragraph 110(1)(a).

Asked by Counsel to account for such large contributions the witness replied: "We felt that it's considering it like a promotion. We are selling the same product as our competitors. We're selling the same price, approximately, as our competitors and service, hopefully, is a little better, but our real sales pitch is that we are dealing with a large per cent of clientele that are Jewish and we couldn't get them to go along with us, only if we made some kind of impact to them and we're no different than our competitors are and we believe that through giving these donations, they would appreciate the work that we do, the involvement that we have. That’s why they would consider us a little bit of a higher priority as they would others.”

A substantial portion of the appellant's contributions, $140,000 out of $178,097, was to an organization named Belz. The witness explained that Belz is mainly a synagogue that operates a co-educational school and provides other services to young people who have just left school such as interest-free loans. It is a worldwide organization with a Canadian chapter registered as a charitable organization for the purpose of the Act.

The witness testified that 70 per cent of the appellant's clientele is Jewish and is part of a very closely knit community that meets often and in which everybody knows what the others do. He stated that the appellant does no promotion in the form of entertainment. Customers are not wined and dined as is customary in the trade, but the appellant relies on supporting certain charitable organizations to make its presence known in the trade and try to impress and attract certain customers who cannot be reached by conventional advertising methods.

It was established in cross-examination that between 1981 and 1986 the appellant had the following gross and net income and made these contributions to charitable organizations:

Mr. Myer Wenger also gave evidence on behalf of the appellant. He is the president of Wenger's Limited, a company that has approximately $24 million in annual sales, $21 million to $22 million of which is from the sale of watches. The company operates three other divisions besides watches; one is called "Swank" that is men's jewellery, a clock division and a division of watch straps and bracelets.

The witness said that he, his wife and his brother are deeply involved in supporting a number of charitable organizations. For instance he and his wife are working on a project to raise funds for a children's village in Israel. His brother, who is also his business partner, was the chairman of the Combined Jewish Appeal. In fact charity plays an important part in their personal and business lives. He admitted that he was well aware of the generosity of the appellant and its principals and that they are very religious persons who support a number of religious institutions.

Counsel for the appellant asked this question and received this reply:

Q. Would you say that this (generosity of the appellant) influenced your decision in a large measure to deal with Impenco, Mr. Wenger?

A. I think you'd have to say that, everything being equal, we would always lean towards any organization that did something for charity. We would not go out of our way to support somebody or buy from somebody only because they were charitable, but if the product was equal to the next ones, certainly the way we are, we would respect these people and would give them the edge over somebody who did not.

Wenger testified that four or five years ago they were doing $10,000 to $20,000 worth of business with the appellant and about three years ago it became Wenger's Limited principal supplier of boxes and purchases increased to $180,000 in 1985 and reached $275,000 in 1986.

Counsel for the appellant also called Mr. Mickey Gesdetner as a witness. He is president of Sperry Group International Inc. of Toronto, a company that was in the watch importing business. It started doing business with the appellant in 1984 and it has since become its largest supplier of boxes. The witness was well aware of the appellant's support of various Jewish charities and that this is also known in the Toronto community as well. He asserted that this was the motivating consideration for Sperry Group International Inc. dealing with the appellant. The witness said that he is actively engaged in different charitable organizations, one called Bobov, another Yeshivas and also with hospitals. He said that his suppliers’ involvement with charitable organizations was a motivating factor in his dealings with them. In 1985 and 1986 he purchased some $56,025 and $86,770 worth of merchandise from the appellant.

The next witness called by counsel for the appellant was Mr. Joseph Chesir. He is vice president of a company named Carmen Jewellery that manufactures gold and custom jewellery and also imports custom jewellery. Carmen Jewellery has been a customer of the appellant since at least 1983 and its purchases have grown from $30,000 to $170,000 over the years. While the witness admitted that they have other box suppliers in Montreal, the appellant was their largest supplier.

Chesir is a member of the same Orthodox community as the Herzogs and their involvement with Belz is well-known within those circles.

To this question:

Q. Is this knowledge of their involvement a motivating factor in your doing business with them?

he answered:

A. It's not only motivating, it's one of the key factors.

He added that he was personally interested in a number of charitable organizations in Montreal, the United States and Israel and that while he shares the same sentiments and attitude as the Herzogs in charity-giving, his own contribution was not at the same level as theirs.

His closing comment was:

It's fair to say that the main reason why I do business with them is because I know that the money is going to be used for charity rather than on fancy cars.

Counsel for the respondent called Mr. Alain Ducharme, an employee of Revenue Canada. This witness was responsible for the appellant's file after the notice of objection was filed. His evidence disclosed that prior to the appellant's 1984 taxation year it had claimed its contributions to charitable organizations as gifts, that is as a deduction in computing its taxable income pursuant to the provisions of paragraph 110(1)(a).

As previously noted the appellant's position is that the amount of $178,097 contributed by it to charitable organizations during its 1984 taxation year constituted an expense incurred for the purpose of earning income under the provisions of paragraph 18(1)(a). It is the contention of counsel for the respondent that these contributions were charitable donations and deductible and subject to the limitations in paragraph 110(1)(a). He adds:

It has not been shown that the contributions made to charitable organizations in 1984 have increased the sales of the Appellant.

In his argument the latter submitted that the evidence establishes that the principals of the appellant are very generous individuals and that the true motivation in making contributions in 1984 was charitable and not business reasons.

In Olympia Floor & Wall Tile v. M.N.R., [1970] C.T.C. 99; 70 D.T.C. 6085 Jackett, P. (as he then was) held that even though outlays in that case took the form of contributions to charitable organizations they were not “gifts” within the meaning of that word in section 27(1)(a) [now 110(1)(a)] of the Act, but were made for the purpose of earning income. The headnote reads:

In each of the years under appeal the appellant contributed between $8,000 and $10,000 to various charitable organizations and sought to deduct these sums not as charitable donations under Section 27(1)(a) (the 10% maximum under which was exceeded) but as business promotion expense under Section 12(1)(a). The appellant contended that over 25% of its sales were gained as a result of goodwill generated in the business community as a result of the appellant's contributions to these organizations and evidence of the appellant’s immediate expectation of business as a result of making these payments was introduced. In the Minister's view a full deduction of these amounts was prohibited by Section 12(1)(a), (b), (2) and they were deductible only to the extent allowed by Section 27(1)(a).

HELD:

The amounts in question fell clearly within the authority of the Riedle Brewery Ltd. case, in which ‘treating’ expense was held by the Supreme Court of Canada to be deductible as a necessary business expense. Moreover, there was no inherent incompatibility between an outlay for the purpose of producing income and a gift to a charitable organization. Where, however, such an outlay took the form of a gift to a charitable organization it was not to be regarded as a “gift” within the meaning of Section 27(1)(a).

From the point of view of Section 12(1)(b) [prohibiting capital expenditures] the amounts were not distinguishable from advertising expense.

Having been shown to be “necessary”, the expenses in question could not be said to be not “reasonable” within Section 12(2).

The appeal was allowed.

Regarding the respondent's argument that the deduction of the contributions should not be allowed because it has not been shown that in 1984 sales had increased as a result of them having been made, I observe that there is nothing in the legislation that requires a taxpayer to prove an increase in sales in order that an expense be deductible. In Olympia, Jackett, P. deals with this at page 101 (D.T.C. 6086):

I am of opinion that the amounts in question (after eliminating those that were not over $100), if one puts aside the fact that they were gifts to charitable organizations, fall clearly within the authority of Riedle Brewery Limited v. M.N.R., [1939] S.C.R. 253; [1938-39] C.T.C. 312, where amounts were held to be deductible when they were spent by breweries in following a practice of "treating" potential customers because it was found that, if the practice was followed consistently, their sales would either be maintained or increased "whereas when the practice was discontinued, their sales would materially decrease".

[Emphasis added.]

It is quite possible that a portion of these contributions or all of it for that matter may have been made for reasons other than pure business reasons, but these other reasons would have been subordinate in my estimation to the purpose alleged by the appellant and which was confirmed by the evidence.

Furthermore, to claim that these contributions were in reality charitable gifts within the provision of paragraph 110(1)(a) and only because they exceeded the maximum deductible limit in 1984 had they become expenses is not supported by the evidence.

When the appellant's contributions to charitable organizations for 1982 to 1986 are considered they do not bear any relation to the maximum allowable for charitable gifts prescribed by the Act, with the exception maybe of 1982 in which year there is a differential of roughly $5,000 between the amount contributed and the amount that could have been deducted.

In addition throughout the 1984 fiscal period which ended on April 30, the appellant had contributed $78,000 as of April 25, an amount that was already in excess of 20 per cent of its income for the year, a situation which by that time had to be known to its principals, and on April 25 the appellant donated $100,000 to the Belz organization. I believe that this gesture on its part was consistent with its alleged purpose in making contributions and that the provisions of paragraph 110(1)(a) with its limitation was not of its concern.

For these reasons I am satisfied that for the 1984 taxation year the contributions of the appellant amounting to $178,097 to various charitable organizations were expenses incurred for the purpose of earning its income within the meaning of paragraph 18(1)(a) of the Act and the appeal is accordingly allowed.

The appellant is entitled to its costs on a party-party basis.

Appeal allowed.