Duramould Limited, Klaus Max Kachel, Donald E Holter v. Minister of National Revenue, [1984] CTC 2571, 84 DTC 1498

Taylor, TCJ:—These are appeals heard on common evidence in Toronto, Ontario on April 30, 1984 against income tax assessments with respect to the years 1978 and 1979 for Duramould, and the year 1978 for Holter and Kachel. For the 1978 year of Duramould, the respondent denied the deduction of $6,300 as being an expense incurred for the use of a property that is a camp within the meaning of subparagraph 18(l)(l)(i) of the Income Tax Act. For the 1979 year of Duramould the respondent included as income, the total of $93,000 (less appropriate direct costs) as received or receivable, pursuant to paragraphs 12(l)(a) and 12( l)(b) of the Income Tax Act. In the 1978 year, the respondent under the provisions of sections 15(l)(c) and 56(2) of the Act added back to the personal taxable income of each of Holter and Kachel amounts of $1,575 (25 per cent of $6,300) with regard to the use of the camp (noted above). There were four shareholders of Duramould who used the facility, Holter and Kachel being two of them, and the Court was made aware that the same income tax reassessment had been issued for the four shareholders. The bases for the appeals were summarized as follows:

Item 1

Our company manufactures injection moulds. Since moulds have no resale value, we insist on customer deposits. These deposits are refundable to our customers if we cannot deliver the mould as specified. Due to the highly technical nature of our products it is impossible to determine profit until we have produced the final tested mould according to our customer’s specification. We normally obtain the customer’s written approval. We inventory the cost for uncompleted moulds. When we obtain the customer’s approval, we expense the cost and recognize revenue in accordance with generally accepted accounting principles.

Item 2

The $6,300.00 deduction claimed with respect to the company’s shareholders and directors meeting held at Eaton Canyon Club only covers the cost of meals, transportation and rooms for the five directors, shareholders and key employees who attended the meetings. The Club has guides and facilities for fishing which was paid directly by the persons availing themselves of these facilities. [sic]

For the respondent, the assessments were founded on the following:

(a) in addition to the sales declared in its 1979 taxation year, the Appellant made sales of $93,000.00, of which amount $78,333.33 was received in the said year for moulds which had been delivered but not yet approved by its customers and $14,666.67 were amounts receivable for moulds delivered in the 1979 taxation year and which had not yet been approved by its customers;

(c) the Appellant incurred additional costs in the amounts of $36,735.00 in its 1979 taxation year;

(d) the amounts of $6,300.00 expended by the Appellant in the 1978 taxation year with respect to the Eaton Canyon Club was for the use of a camp and such outlay was not in the ordinary course of a business of providing the camp for hire or reward.

Mr Thomas Haar, chartered accountant, auditor of the corporation, and Mr Klaus Kachel, president, informed the Court that the trip to Eaton Canyon had been arranged so that the four shareholders and the principal employee could be alone for a few days, in an isolated location, not merely for the purpose of fishing, but also to discuss and agree upon serious and pressing business and financial matters. Previous efforts with the same objective had not been successful due to interruption for personal and business commitments, when they had been held near or at the corporation’s factory. In addition, the procedure by which Duramould obtained contracts, and completed the work of making moulds for customers was described to the Court in detail.

On the first part at issue, the thrust of the appellants’ evidence and the argument of counsel for the appellants was that the $6,300 amount was an expense just as deductible as any other reasonable expense in the circumstances. Noting the Minister’s reliance on subparagraph 18( l)(l)(i) of the Income Tax Act, 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 The Queen v Jaddco, [1984] CTC 137; 84 DTC 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. To address the question of the inclusion of the amount (proportionally) as taxable income to the personal taxpayers is another issue. I do not see that because the amount is not deductible as an expense for income tax purposes to the corporation, it automatically follows that a benefit has been conferred on the shareholders by the corporation. To reach such a conclusion (automatic benefit) in this matter would require the acceptance of the fact that there was no purpose at all in the “fishing trip”, other than for the pleasure of the shareholders — axiomatically therefore no business purpose whatsoever. I doubt that the testimony and evidence supports that extreme conclusion, particularly in view of the fact that the expenses for a senior employee (not a shareholder) who went on the trip, are also included in the proportionate distribution to the shareholders. It can well be argued that some business purpose, objective, and accomplishment were directly related to the trip. At the same time, I am satisfied that the same results might have been obtained in other locations or by other means. I am not aware of jurisprudence which would restrict the rights of parties to hold legitimate business meetings at any place and at any time, as long as the expense is “reasonable”. Therefore as I see it, the Minister is actually relying on section 67 of the Act, to disallow the deductions, and is doing so on the basis that none of the amount was “reasonable”. However for the Court, this part of the problem comes down to the fact that no basis was put forward by the appellants to support an amount which would be reasonable, and it is not the function of this Court to make such a calculation. Since there is no doubt in my mind that some part of the trip was a benefit to the shareholders — a personal advantage, the assessment must also be upheld as it pertains to the individual shareholders.

With regard to the larger item in dispute, the proper taxation year in which to credit to income the proceeds from certain Duramould contracts, it is the thrust of the evidence and argument presented on behalf of the corporation, that a policy decision taken in consultation with the firm’s auditors set out that “Generally Accepted Accounting Principles” (GAAP) permitted the inclusion as income of such proceeds at the date of final approval by the customer, rather than at an earlier point in time, ie payment, delivery, or some other transaction. According to the firm’s auditor Mr Haar, that policy was permitted by GAAP, and had always been followed with no repercussions. There would have been no problems in this taxation year in question, except for the fact that delivery of the goods had all been completed before the 1979 fiscal year end. According to Mr Haar, all invoicing may not have been completed by that 1979 year end, but perhaps extended into the 1980 taxation year, and a final payment had not been received on all relevant contracts (there were four in number totalling the $93,000) before the end of the 1979 fiscal year. Mr Haar termed this method of record-keeping the “completed contract method” of determining income, and regarded it as a completely acceptable practice. He did not proffer any indication of support for this “completed contract method” arising out of the provision of the Income Tax Act itself. According to the president of Duramould, Mr K Kachel, some work had been done after delivery, payment, and/or invoicing, but before final approval although he was unable to attribute any quantum to this work. With regard to any work on the contracts which might have been done after delivery, payment and/or invoicing (noted above) counsel for the respondent termed it as insignificant, and merely normal warranty work, which might be expected at any time. There was no indication of any “repayments” or “forfeiture” to customers by Duramould or any indication of a requirement to do so under the contracts.

It was evident to the Court that the “partial payment”, or “on account” method of payment used by some of the customers of Duramould was largely a convenience and aid for financial reasons to Duramould, and suited both parties. It appeared that in the event of dissatisfaction, rather than final approval (from a customer), that customer had only the normal legal processes available to recover any alleged over payments, but did not have any automatic right to them. Any refusal by Duramould to repay or rectify, could have disrupted otherwise peaceful business relationships with the customer, but that prospect in itself was not proposed as a reason for attributing to the “final approval” date some special accounting or income tax significance, and certainly in my view it could not warrant any such special treatment.

Counsel for the appellant did not assert that jurisprudence dealing with the subject of “generally accepted accounting principles” provided support for a view that such principles should be regarded as superior to, or even equivalent to relevant articles of law. As I understand it in situations where the tax law is unclear or ambiguous, one might assert that GAAP should be a factor, perhaps a major factor, in the interpretation and application of any particular transaction, or series of events. “Generally Accepted Accounting Principles” are by definition neither universal nor immutable, but only represent the accounting treatment regarded as best suited to reflect a transaction. If and when, the accounting treatment of a transaction is governed by some requirement of the Act or relevant jurisprudence, for income tax purposes, it is unnecessary to consider the relevance of any other novel or specific accounting treatment. Ultimately, therefore, the examination of this aspect of the instant appeal, leads first to a determination of whether there are requirements of the Income Tax Act to be met, and only secondly if the alleged “Generally Accepted Accounting Principles” fulfil these requirements.

In assessing the corporation Duramould, the Minister has relied upon paragraphs 12(l)(a) and 12(l)(b) of the Act (and I would add subsection 12(2)) which reads:

Interpretation. Paragraphs (1)(a) and (b) are enacted for greater certainty and shall not be construed as implying that any amount not referred to therein is not to be included in computing income from a business for a taxation year whether it is received or receivable in the year or not.

It is very difficult to comprehend in what manner any taxpayer or his professional advisors could reach the conclusion that the amount at issue in this part of the appeal could escape inclusion as income under those sections noted above. With regard to the amount at issue received during the year 1979, ($78,333.33) it must first be included in income, and then if appropriate the provisions of paragraph 20(1 )(m) come into play. Any indication that there were either “goods” or “services” to be provided after the end of the 1979 fiscal year by the corporation Duramould are scant indeed and no quantum was even attached to that assertion. There is no basis known to me that would provide relief under paragraph 20(l)(m), to Duramould for that amount. With regard to the balance of $14,666.67, the same situation obtains under paragraph 12(l)(b). No reasonable or practical explanation was given to support the view that the rendering of the account for services (subparagraphs 12(l)(b)(i) and (ii) should not have followed directly upon the fulfilment of the contract by the provision of the goods required from Duramould to its clients. While the clients might well have chosen not to pay any balance of the account until “final approval”, for business reasons, I am persuaded the Minister’s position that title of the moulds had passed to the clients upon delivery to and acceptance of them by their clients is correct, and that the final approval date has no bearing on the issue before the Court. The comments regarding the inapplicability of paragraph 20(1 )(m) to paragraph 12( l)(a) above would also be relevant here.

In the final analysis, it is my view that the specific provisions of the Income Tax Act, noted above, govern the recording and reporting of the amounts at issue, and that the Minister’s assessment is correct. In addition the very character of the amounts themselves, leave it open to serious question, if even “Generally Accepted Accounting Principles” have been followed in the recording and reporting of the income before the assessments.

The appeal is dismissed.

Appeal dismissed.