Grace Babcock, Grant Babcock, Grant Babcock Limited v. Minister of National Revenue, [1985] 2 CTC 2181, 85 DTC 518

Brulé, TCJ:—

Issue

At the outset counsel for the appellants, addressed the Court to advise that the appeals would be presented on common evidence. The company is a Canadian Tire Dealership and the other appellants are Mr and Mrs Babcock, the principals involved in the company. In his summary, counsel outlined claims for rental expenses by Mr and Mrs Babcock as well as farm losses by both these appellants. These two matters however were not argued during the hearing and only passing reference was made to them. The appeal for farm losses by the company was withdrawn, leaving three main issues to be considered. One involved Mr and Mrs Babcock claiming expenses for a trip they took in 1981 which was disallowed by the Minister. A second issue involved Grant Babcock Limited leasing warehouse space from Mr and Mrs Babcock in the years 1978, 1979, 1980 and 1981 on their farm and the third issue is whether or not moneys paid to Mrs Babcock by the company in the years 1979, 1980 and 1981 were proper.

I would like to deal first with the travel expenses of Grant Babcock in 1981. He attended a meeting sponsored by the Newfoundland Dealers Association of Canadian Tire in the Canary Islands. An invitation was forwarded by the sponsoring group to have him speak on the subject of human relations. Grant Babcock Limited paid the expenses for both the individual appellants in the amount of $4,060.90. The disallowance of this expense for Mrs Babcock was not argued. With respect to Mr Babcock it was reported in the minutes of the meeting as shown in Exhibit R-2 that he did speak at the convention and reported on a meeting held in Halifax. There were many other topics discussed which would have been useful to Mr Babcock in his business, and therefore the payment of his expenses in the amount of $2,035.45 is justified. As to the payment of a similar amount on behalf of Mrs Babcock, this is not allowed. As Mrs Babcock attended the meeting with her husband, this was for the convenience of her husband and her expenses may not be deducted. See Maning Harold Roebuck v MNR, 26 Tax ABC 11; 61 DTC 72 and William George Shambrook v MNR, 40 Tax ABC 28; 66 DTC 20. There was no suggestion that a benefit was conferred upon Mrs Babcock who was the holder of one share in the company, but there was a benefit to Mr Babcock.

The second issue involves the rental by the company of warehouse space from Mr and Mrs Babcock on their farm. In his notice of appeal the appellant Grant Babcock stated:

As the Company's business accommodation became overcrowded during the years preceding the taxation year 1978, the Company required warehouse space for the storage of merchandise. During each of the taxation years 1978, 1979, 1980 and 1981 the Taxpayer and Mrs Babcock rented warehouse space to the Company on property owned by the Taxpayer and Mrs Babcock at rental rates which were less than rental rates which would have been payable had the Company rented equivalent useable space from unrelated third parties. During each of the said taxation years, the Company used the rental warehouse for the storage of merchandise to be sold in its retail business.

In reply to this the Minister stated that the rent paid by the limited company to the Babcocks was in excess of the estimated fair market rent for that rural area of Nova Scotia.

Both Mr Babcock and the respondent brought forward expert testimony as to the values of warehouse space both in Bedford, Nova Scotia, the location of the Canadian Tire store, and in the surrounding area.

The rental agreed upon orally by the company and the Babcocks was in the sum of $12,500 for 5,000 square feet at $2.50 per square foot. This was reflected in a meeting of the directors of the company on December 19, 1976.

The individual appellants submitted a cost comparison chart (Exhibit A-3) to show that the rental paid plus a mileage allowance resulted in a saving over rental space in Bedford. The chart neglected to include the salary or wages of the person transporting the goods to the distant warehouse location. Mr Babcock’s brother lived on the property for security reasons and the company paid his salary. This also was not included in the comparison chart.

The expert for the appellants concluded that there was 7,643.5 square feet available for rental and he placed an annual value on this of $6,715 or $0.88 per square foot. Given that 5,000 square feet was the amount of space the company agreed to lease the value of this would be $4,400.

Expert testimony by the respondent indicated possible rental value for this space, based on a comparison with other storage facilities in the area, to be in the neighbourhood of $2,000 per annum for 5,000 square feet. In view of the fact that the warehouse rented was on the Babcocks’ property and presented some degree of flexibility and proximity to surveillance by the family, I believe that the value of $2,000 is low. I am prepared to accept the proper rental as being in accordance with the calculation made above, based on the appellants’ expert's figure.

The third issue appealed by Grant Babcock Limited is the propriety of the amounts paid to Grace Babcock during the years 1979, 1980 and 1981. In 1979, Mrs Babcock was paid a salary of $50,000. In 1980 a salary of $44,980 was paid plus a deferred bonus of $5,000 for a total of $49,980. In 1981 the salary was $40,040 plus a deferred bonus of $45,000 for a total of $85,040.

The respondent submitted that the amounts disallowed as salary and bonuses payable to Grace Babcock by the appellant, Grant Babcock Limited, were not outlays or expenses made or incurred by the appellant for the purpose of gaining or producing income within the meaning of paragraph 18(1)(a) of the Income Tax Act.

In the alternative the respondent submitted that if the amounts disallowed as salary and bonus payable to Grace Babcock were outlays or expenses within the meaning of paragraph 18(1)(a) of the Income Tax Act, then they were not reasonable in the circumstances and therefore not deductible pursuant to section 67 of the Act.

The Minister by reassessment disallowed from the above noted amounts the following: In 1979 — $32,761, in 1980 — $30,776, and in 1981 — $58,823. By these amounts the Minister was prepared to allow a salary to Mrs Babcock equal to that paid during the years in question to a Graham Rafuse who appeared to be, from the evidence, the in-store manager. The result would be to allow Mrs Babcock these amounts: 1979 — $17,239, 1980 — $19,204, 1981 — $26,217.

A great deal of evidence was presented to the Court by Mr Babcock, Mrs Babcock and by Wayne McMahon, who was the auditor. All of these people testified that Mrs Babcock worked at times in the store, outside the store doing such things as comparison shopping, and also discussed at home with her husband, the auditor, and at times the corporate solicitor, various Corporate matters. She was on the board of directors but held only one of 10,000 common shares.

There is no question that the contribution of Mrs Babcock in her various endeavours qualified her for compensation, and a corporate deduction under the provision of paragraph 18(1)(a) of the Income Tax Act.

It then becomes necessary to consider the provision of section 67 which reads:

67. In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

This section provides a test which is simply what is “‘reasonable in the circumstances". The word “reasonable” would appear to apply to the amount of the deduction claimed, here the salary of Mrs Babcock. The section is designed to prevent the avoidance of corporation tax by means of such deductions as large salaries and bonuses and has particular application to closely-held corporations.

When one considers whether a deduction is reasonable there must be taken into consideration whether the deduction is reasonable in itself, ie reasonable in relation to the services performed and also reasonable in relation to other expenses incurred by the business.

In the present case, Mrs Babcock was paid by the company some $27,750 in 1978 and over $85,000 in 1981, triple the amount in three years. Mr Babcock acknowledged that his wife's greatest contribution was when he was a sole proprietor but that she still contributed during the years in question without going through any laborious work. Mrs Babcock testified that she often worked at home looking over statements and discussing matters with her husband. She had nothing to do with the staff except on social occasions, yet said that she helped with staff decisions including bonuses.

During 1979 and 1980 Mrs Babcock spent some time in hospital and convalescing at home, and she admitted doing less than in previous years.

The evidence pointed out that the actual store related work was not of a nature that merited a large salary and bonus. It then must be considered whether or not her assistance in the decision-making process was worth this large amount to the company.

The reported cases are not too helpful in this matter. In Mulder Bros Sand & Gravel Ltd v MNR, [1967] Tax ABC 761; 67 DTC 475, a decision of the Tax Appeal Board, the Board awarded the wife of one of the principals, who was a full-time employee, an amount less than the company had paid, but more than the Minister was prepared to allow.

In Roymac Mobile Homes Limited v MNR, 77 DTC 204 the Board held that salaries of $10,000 paid to the wives of two directors of the corporation were considered just and reasonable in relation to the services performed.

A similar conclusion was reached in Fred & Ted's Construction Ltd v MNR, [1984] CTC 2549; 84 DTC 1530.

An opposite finding that the input of the wife of a company's president did not justify the payment of a substantial bonus is found in Doug Burns Excavation Contracting Limited v MNR, [1983] CTC 2566; 83 DTC 528. Here all the bonuses over a normal salary for the work performed were denied.

In Gabco Limited v MNR, [1968] CTC 313; 68 DTC 5210 Mr Justice Cattan- ach in the Exchequer Court of Canada said at 320 (DTC 5214):

The ultimate test as to when a payment is intra vires a company is when what is done is done bona tides, within the ordinary scope of the company’s business and reasonably incidental to the carrying on of the company’s business for the company’s benefit and advantage.

At 323 (DTC 5216) the Court said:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind.

I do not find it too difficult to determine that no reasonable businessman would have paid a similar amount for the services rendered by Mrs Babcock. The clerical functions did not warrant a large salary and I am sure Mr Babcock could have handled all the decision-making without the part-time services of a highly-paid third party who was only occasionally on the scene. Many directors of large corporations assist in decision-making matters of great consequence for remuneration at meetings for far less than the amount paid to Mrs Babcock.

It seems that Mrs Babcock contributed less during the years in question yet was compensated to a greater extent than before, perhaps because the profitability of the company increased rapidly. She could not benefit as a shareholder because of her small holding and as a director the amount per meeting was set at $350. The company then attempted to pay a large salary and bonus.

I am quite sure that Mrs Babcock assisted her husband to a great extent and therefore merited compensation greater than clerical or non-decisionmaking staff. At the same time, I find the amounts paid to her to be too high and not reasonable in accordance with good business considerations as envisaged by section 67 of the Act. I believe there is justified salary and bonuses higher than those which the Minister has allowed and accordingly I allow to Mrs Babcock in 1979 the amount of $30,000, in 1980 $35,000 and in 1981 $40,000.

In conclusion, these matters are referred back to the Minister for reconsideration and reassessment on the basis that

(1) conference expenses to Mr Babcock and paid by the Company be limited to $2,035.45 for the 1981 taxation year,

(2) warehouse rental expenses claimed by the Company during the taxation years 1978, 1979, 1980 and 1981 be limited to $4,400 in each year,

and

(3) allowable salary by the Company to Mrs Babcock in 1979 be $30,000, in 1980 be $35,000 and in 1981 be $40,000.

The rental expenses and farm losses claimed by Mr and Mrs Babcock during the years 1978, 1979, 1980 and 1981 are disallowed as no evidence nor argument concerning these was presented to the Court, except reference made thereto in the opening statement by counsel for the appellants.

Appeal allowed in part.