James C Bartlett, N M Bartlett Inc v. Minister of National Revenue, [1983] CTC 2512, 83 DTC 461

M J Bonner:—The corporate appellant appeals from reassessments of income tax for the 1972 to 1976 taxation years. The individual appellant appeals from a reassessment for his 1976 taxation year. The appeals were heard together on common evidence.

N M Bartlett founded an agricultural chemical business in 1912. At some later time the business grew to include the manufacture of fruit grading equipment.

The business was carried on by N M Bartlett as sole proprietor until 1950 or so. The corporate appellant was then formed and the business was sold to it.

N M Bartlett was married to Lydia Bartlett. They had several children. The children included James C Bartlett, Mrs Evelynne Little and George Bartlett. The children of James C Bartlett included two sons, Scott and Craig.

N M Bartlett retired in 1963 and died in 1970. During the period from 1970 to 1977, out of 10,000 issued common shares of the company, James and George Bartlett held 3,650 each and Evelynne and her husband together held 2,500.

In each of the years 1972, 1973 and 1974 payments of $17,150 were made by the company to Lydia Bartlett. Those payments were entered by the appellant in its books of account and in its income tax returns as salary expense. The respondent, on assessment, disallowed the deduction. His position was that during 1972, 1973 and 1974 Lydia was not employed by the company; that she performed no services for the company, save as a director; and that the deduction was prohibited by paragraph 18(1 )(a) of the Income Tax Act. The appellant’s position was that . . the payments . . . were on account of wages and/or salaries for services performed by . . .” Lydia Bartlett, primarily past services.

On the evidence it was clear that Lydia Bartlett had, in the past, made substantial contributions to the business. James C Bartlett testified that his mother was ‘really a partner” of his father. He said she had never been paid, although she was always in the office in the early years. The office was in the family home. Mrs Bartlett worked at the collection of accounts, the delivery of orders and she also did the sewing necessary to make cloth tubes required as dust filters for purposes of the process of grinding sulphur. Mr Bartlett testified that his mother left the business in 1956 and was replaced by his brother, George. He said that in making the $17,150 payments the directors felt that they were paying Lydia Bartlett for past and present services, especially the former. The emphasis on past services is not surprising, having regard to the fact that in 1972 Lydia Bartlett was about seventy-seven years of age. James Bartlett added that his father did not leave his mother that much and that he had no pension.

The appellant and its witnesses clearly misused the word “salary” when they employed it to describe the payments made to Lydia Bartlett. They were simply ex gratia payments in the nature of a pension granted to a lady who was both widow of the appellant’s former chief executive officer and also a person who had, in her own right, made a material contribution to the success of the company’s business. It seems evident that paragraph 18(1 )(a) of the Act would not serve to prohibit the deduction of payments of the sort in question here in a case where payor and payee deal with each other at arm’s length. There is no basis for reaching a different conclusion as to the effect of paragraph 18(1 )(a) simply because the payor and payee here do not deal at arm’s length. The appeals of the corporation therefore succeed on this issue. It follows that it is unnecessary to consider the question whether the 1972 and 1973 reassessments were “statute-barred”.

The next issue is whether the appellant is entitled to deduct the full amount of payments of $1,000 made to Lydia Bartlett in each of the years 1975 and 1976. The appellant based its claim for deduction upon the assertion that the payments were director’s fees which it pleaded were . . similar in amounts to fees paid to the other directors . . The respondent allowed $400 only in each year and based his action on the finding that during the years in question director’s fees paid by the appellant were at an annual rate of $400 only.

James C Bartlett testified, on the basis of his unaided recollection, that during 1975 and 1976 the rate was $600 per director per year. That evidence ws contradicted by the evidence of Robert Winter, an assessor, who said that the rate was $400 based on his investigation of the company’s financial records. The records are more reliable. Although the company could have decided to pay one director more than the others, it was not suggested that such a decision had been made. Accordingly, the reason for payment to Lydia Bartlett of the extra $600 a year remains unclear and it cannot be said that the appellant has shown that the excess meets the paragraph 18(1 )(a) test. The appeals fail on this issue.

In the years 1974, 1975 and 1976 the appellant paid $29,000, $40,620 and $10,483 respectively to Evelynne Little. The payments were said to have been made for services rendered. On assessment the respondent disallowed deductions of $23,578 for 1974, $35,000 for 1975 and $5,000 for 1976. He acted on the basis of a finding or assumption that, to the extent disallowed, the payments were unreasonable.

Mrs Little had considerable experience working in the family business. She started in 1940 after completion of studies at business college. She acted, initially at least, as receptionist, stenographer and bookkeeper and she also occasionally sold goods. Save for periods of absence totalling four years when she was having her children, Mrs Little worked from 1940 to 1965. She then retired for reasons of health. During the period from 1965 to 1971 Mrs Little did not work and she drew no salary.

In 1972 Mrs Little came back into the business. She was called back, apparently, because her brother, George, who was then serving as office manager, was causing problems. He was, it was said, threatening to leave, not producing much work and turning over many of his duties to an employee who was not a member of the family. He was also said to be uncommunicative. Mrs Little testified that she returned to work with the expectation that she would be paid.

It would seem that Mrs Little’s duties consisted of reviewing the financial statements and books of account and expressing her opinions thereon. There was no evidence as to how often she was called upon to do this or how long it took her. Without more precise evidence as to the nature and extent of the services provided by Mrs Little I am unable to reach any con- clusion as to the extent to which the amounts paid were reasonable in the circumstances. I therefore find that the appellant has failed to establish that the respondent was wrong in relying on section 67 of the Act to disallow the portions in question of the payments made to Mrs Little.

In computing income for 1974 the appellant claimed a deduction of $62,800 as a reserve for doubtful debts under paragraph 20(1 )(l) of the Income Tax Act. The respondent’s assessor, Mr Winter, made a number of upward and downward adjustments, the net result of which was the allowance of a reserve of $40,000. The appellant conceded at the hearing that one $500 claim had been wrongly made.

According to Mr Bartlett, the reserve claimed by the appellant was fixed after consideration, in each case, of the age of the receivable, the reason for non-payment, the means of payment available to the debtor and the debtor’s record. The information available was quite detailed.

Mr Winter reached his conclusions on the same issue, namely, whether the debt would probably be paid, following a review of the appellant’s records. However, Mr Winter appears to have used hindsight. He deleted some reserves on the basis of payments made after year-end. A doubtful debt reserve must be founded on predictions. It does not seem to me that a reserve Claimed can properly be criticized by a person who was, through the exercise some time later, using the benefit of hindsight. Furthermore, it does not appear that Mr Winter could possibly have possessed the full knowledge of the circumstances of each debtor which was demonstrated by Mr Bartlett when he gave his evidence. The appellant’s estimates are to be preferred. I therefore find the proper reserve was the $62,800 claimed, less the $500 conceded.

The final issue arises in the appeal of James C Bartlett from the reassessment for his 1976 taxation year. During that year the company paid a $4,500 bonus to each of Scott Bartlett, age seventeen, and Craig Bartlett, age nineteen. The respondent, on assessment, assumed that the bonuses were paid at the appellant’s direction and “.. . solely because the appellant desired to benefit himself or his sons and not for any business purpose of the company”. The respondent relied on subsections 56(2) and 15(1) of the Act. The appellant’s counsel argued that the bonuses were not paid pursuant to Mr Bartlett’s direction. He relied on the evidence of Hector Little.

Mr Little did not say that the bonuses were not paid to the boys at Mr Bartlett’s direction. On cross-examination he stated that he did not recall who brought up the idea. The evidence does not persuade me that the bonuses were not paid to the boys simply because they were the appellant’s sons. This appeal therefore fails.

Judgments will issue accordingly.

Appeals allowed in part.