G W Dorman Pulp Chip Company LTD v. Minister of National Revenue, [1981] CTC 2005, 81 DTC 21

The Assistant Chairman:—G W Dorman Pulp Chip Company Ltd (the appellant) has appealed to this Board from assessments for income tax for the 1973 and 1974 taxation years. The appellant reported a taxable income for 1973 and 1974. By the time the final reassessments were made for those two years, the Minister had determined that the appellant had a non-capital loss in 1975. The Minister’s reassessments disallowed a boat expense for 1973 and 1974, and disallowed a management bonus of $100,000 for 1973. A portion of the 1975 non-capital loss was applied against the 1974 income, with the result that no tax was assessed for the year 1974.

The appellant filed a notice of appeal for each year, which appeals were later amended. The appellant contended that the boat expenses were properly deductible and that the management bonus was properly deductible in 1973 but in the alternative it took the position that, if it were not so deductible, then it was deductible in 1974. The appellant continued that if it were deductible in 1974, the appellant then had a non-capital loss in that year which should be applied against its profit for 1973, which year, after such application, would still show a profit. The appellant in effect took the position that if its facts and arguments with respect to the “bonus” for 1974 were not heard because of the “nil” assessment, it could be that that issue might never be heard because of the operation of time. It could be six, eight or ten years before the non-capital loss of 1975 was exhausted and the issue of this bonus in 1974 could be considered, which would then be too late to apply the 1974 non-capital loss to 1973 income.

The respondent, in his reply to the notice of appeal, with repect to the 1974 year took the position that there was no appeal from that assessment. A decision was made to proceed with both appeals and to rule on the respondent’s position after hearing the appeals. If the appeal with respect to the bonus were allowed in 1973 then, of course, the same bonus could not be claimed in 1974 and so the 1974 year would be a nil assessment, after the application of a portion of the 1975 non-capital loss. However, if the bonus were not deductible in 1973 and if it were deductible in 1974 then, without the application of any of the 1975 non-capital loss, the 1974 year would on its own have a non-capital loss which must be applied against the 1973 profit to determine the taxable income in 1973.

Counsel advised me that just before the commencement of the proceedings they had settled the issue relating to the boat. They had not had time however to prepare a written consent reflecting the same but would forward it to the Board shortly. Consequently, the 1973 appeal is at least allowed in this respect and that assessment will be referred back to the respondent for reassessment in accordance with the terms of the consent.

There is only one issue remaining—the deductibility or non-deductibility of the “bonus”. The appellant conducted a sawmill operation. Mr G W Dorman (hereinafter referred to as “Dorman”) started a sawmill business, and in 1956 he caused the appellant to be incorporated. He sold that business to the appellant. While he and his wife were the only shareholders and directors, he ran the business on behalf of the appellant. It was very hard getting started in business and it took time to build up a successful enterprise. There were in 1973 over 100 employees together with supervisors and foremen. Dorman himself was active through all phases of the operation of the appellant, putting in 11 or 12 hours each day as well as considerable time on weekends. That type of business had its good years as well as its lean years. An active campaign to sell its product produced the large profit in 1973 but, because of a rise in the cost of goods in 1974 and later because of the contracts Dorman had signed on behalf of the appellant, the profit disappeared and business reflected losses after 1974. Around September 1973, just before the appellant’s year-end of December 31, Dorman discussed a bonus for himself with the appellant’s auditor. Nothing further was done at that time, but on February 4,1974, the appellant passed the appellant passed the following resolution:

MINUTES OF A MEETING OF THE DIRECTORS OF G W DORMAN PULP CHIP COMPANY LTD, HELD AT THE COMPANY OFFICE AT 1840 STEWART AVENUE, IN THE CITY OF NANAIMO, IN THE PROVINCE OF BRITISH COLUMBIA, ON MONDAY, THE 4TH DAY OF FEBRUARY, AD 1974 AT 10:00 AM.

The President, George William Dorman, called the Meeting to order.

The Company Financial Statement for the year ending December 31, 1973 was presented to the Meeting.

IT WAS RESOLVED THAT:

The President, George William Dorman, received (sic) a bonus of $100,000 for his efforts and foresight that has enabled the Company to show a marked improvement in profits for the year 1973.

ADJOURNMENT

As there was no further business at hand, the Meeting adjourned.

(signed) George W Dorman

PRESIDENT

(It would clearly appear that the word “received in the above resolution is incorrect as the bonus was never paid.)

Dorman stated that the appellant had paid one previous bonus, and that was to him in 1970. Dorman, like all other employees of the appellant, was paid a regular salary. Insofar as the bonus was concerned, he was the one who decided the quantum of it and, in February 1974, he did not need the money so he did not take it out of the appellant. He considered the quantum he was to get was fair compensation and he knew the appellant could pay it in mid-1974. The appellant had a good year and he felt he should have some of it. However, as the profit of the appellant declined, the appellant’s banker was happy to see the “bonus” returned to the appellant although Dorman believed the bank would have let the appellant pay it for the first few months of 1974.

The current financial adviser gave evidence on behalf of the appellant. He was a chartered accountant who had practised his profession for many years on Vancouver Island. Prior to 1977 he was not the auditor or accountant for the appellant nor did he have anything to do with the appellant. He had retired from his former position in 1977 and since then had acted on his own as a financial adviser. The witness was queried as to the propriety of an “accrued” bonus in the 1973 year. He stated that, providing the bonus was not excessive, it was not against good accounting principles to so accrue a bonus. The profit picture is usually considered before making a bonus. He would have preferred if the resolution had been passed before the year-end with the quantum to be decided after the year-end. What one was doing by accruing the bonus was matching the revenue for 1973 with the expenditures of 1973. In determining the bonus, the profits of the appellant are important as if the availability of working capital. Before giving his opinion as to the quantum of the bonus, which he stated he did not find to be unreasonable, he stated that the sales of the appellant and its profits before taxes, its working capital position, and the income reported by Dorman, would have to be considered. These were:

The appellant’s profit for 1973 is after the bonus was charged. No bonus was charged against the 1974 profit. No bonus was included in Dorman’s income as the bonus was never paid. As to the working capital position, there was a deficit position in 1973, 1974 and 1975. It was pointed out that the bonus in 1973 had no effect on the rate of tax as, even after the bonus, the appellant still had a taxable income in excess of $200,000. He did state that as far as he knew there was no annual custom with respect to bonuses. He also commented that Mr Dorman’s salary was within the normal range although he had seen cases where the remuneration was higher. In 1975 the accrued bonus was returned to income, yet the appellant for that year still had a loss. On re-examination he advised that he had never heard of a manager suing his corporate employer for a bonus in similar circumstances. He considered it a liability of the appellant.

Counsel for the appellant submitted that the deduction by the appellant of the accrued bonus in 1973 was a proper deduction as the appellant reported its income on an accrual basis. He continued that, while no quantum was settled upon in 1973, the fact of a bonus was mentioned to the accountant. He also submitted that it was not a gift but was earned. When asked, he stated he could not give any authority to show that Dorman could sue on the resolution.

In support of his submission, appellant’s counsel referred to several cases. He submitted that a portion of the case of McClain Industries of Canada, Inc v Her Majesty The Queen, [1978] CTC 511; 78 DIC 6356, was somewhat similar in principle to this appeal. In that case the individuals involved who were shareholders, managers and employees were remunerated by “accrued management commissions”. On selling their shares in the company, they assigned the management commission still due and unpaid. One issue in that appeal was whether or not, by the assignment, the assignor became taxable on the amount assigned. Of course since it was not paid to the assignor, the amount would not be income to him unless he could get it from the company; that is, it was a liability of the company to him. Mr Justice Cattanach, in the course of his reasons which concluded by holding that the amount assigned was income, stated at 514 and 6358 respectively:

Their remuneration came by way of a system of accrued management commissions established by a general resolution of the directors passed in 1950.

The system by which those persons were paid was established in 1950. The year in question in the appeal was 1972. In the instant case I have no hesitation in holding that there was no system.

Counsel for the appellant also likened this appeal to the case of Her Majesty The Queen v V & R Enterprises Limited, [1979] CTC 465; 79 DTC 5399, another case which supposedly involved the question of an accrued bonus. Mr Justice Grant, in giving his reasons, makes two comments in dismissing the Crown’s appeal at 465 and 5400 respectively:

The management performed their services throughout the year knowing that this further allotment would be made at the end of the year and depending upon it.

No part of such salary so fixed was in any sense a gift as the services were rendered each year on the understanding that such procedure would be followed.

Such comments do not and could not apply in this case. There was nothing in writing in 1973 concerning a bonus—at best there was only a conversation with the accountant.

Counsel for the appellant also made reference to the case of Toronto Heel Limited v MNR, [1980] CTC 2277; 80 DTC 1250, as being authority for the allowance of the accrued bonus in 1973. I note from the reasons of my confrère, Mr Tremblay, the following statement:

Since 1969 they have been paid on a weekly salary basis and on bonuses.

He concludes his reasons with the following paragraph:

In the Board’s opinion, the present case is not substantially different from the McClain case, and consequently subsection 78(3) applies in the present case. The declared amount is deductible in 1973 and taxable in 1975.

Counsel for the Minister submitted several facts which, in his view, were very relevant to the determination of the deductibility of the accrued bonus: a resolution was passed after the year-end; Dorman’s salary was adequate within the normal range; any consideration for the bonus was past consideration and, since it was not paid, it was no consideration at all; and the accrued bonus was an isolated act. The words of Dorman himself were that the appellant had had a good year and he should have some of it.

Counsel also referred to the V & R Enterprises Limited case, but the reasons of Mr Cardin, Chairman of this Board, purely to indicate what, at least in Mr Cardin’s view, was the criteria to be met in the case of accrued bonuses.

Counsel also referred to the case of Her Majesty the Queen v Ken and Ray's Collins Bay Supermarket Limited, [1975] CTC 504; 75 DTC 5346. An appeal was taken to the Federal Court of Appeal, which appeal was dismissed. Application for leave to appeal to the Supreme Court of Canada was made but refused. In considering this case, Mr Justice Kerr, at pages 509 and 5350 respectively, stated:

In the present case, if the bonuses had been paid in the company’s fiscal year ending February 28,1969, the amount paid would have been an “outlay” made, within the meaning of the exception expressed in paragraph 12(1)(a) of the Income Tax Act, even if the payments were gratuitous. But I think that, to have the benefit of the exception where in fact there was not such an outlay, there would at least have to be an “expense incurred” by the company in that fiscal year, which leads to the question whether the company did incur such an expense in that year for payment of bonuses.

I think that the evidence establishes that in the fall of 1968 the company made a decision to pay bonuses to McEwen and Robinson, and I am satisfied that it was made for legitimate business reasons, but in my appreciation of the evidence I think that the decision to grant bonuses was gratuitous and that the company, although it really intended to pay them, provided that funds would be available, did not contract and legally obligate itself to pay them. In my opinion, if the bonuses had been paid when the decision to grant them was made in late 1968, 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, and the fact that the decision to pay bonuses and the expectation that they would be paid provided an incentive to McEwen and Robinson to continue their efforts in the business of the company did not make the grant of the benefit other than gratuitous. There was no variation in the terms of McEwen’s and Robinson’s contracts of employment in respect of salaries or services. There was, in my opinion, no new contractual obligation or undertaking by the company to pay the bonuses in consideration of McEwen and Robinson continuing their efforts and services.

As I view the evidence in these appeals and the decisions in the various cases referred to, if there is a finding that the so-called “bonus” is not a “bonus” but is in fact “salary”, then the corporate employer has incurred a liability and so the so-called “bonus” (but actual salary or wages) is a deductible expense within the meaning of paragraph 18(1 )(a) of the Income Tax Act after tax reform. However, if it is held that the bonus is a “bonus” and not “salary”, then no liability has been incurred by the corporate employer and so there is no deductible liability within the meaning of paragraph 18(1)(a).

As I have indicated previously, the “bonus” in this appeal with respect to the 1973 year was not part of salary and therefore not a liability. Consequently, it is not deductible for 1973 and in that respect that appeal will have to be dismissed.

With respect to 1974, as I see it, I cannot adjudicate for that year as the only evidence of liability in that year regarding the bonus is a resolution relating to 1973.1 cannot see, without deciding, how that resolution relating to 1973 can create a liability for 1974—1973 is the year supposedly when “revenue is matched with expenses”. I do not decide the issue for that year and consequently the purported appeal is quashed. In passing I should say I see no reason why the quantum of income for 1974, before the application of the 1975 loss, cannot be adjusted by the agreement reached by counsel.

The final result is, judgment will go allowing the appeal for the 1973 year and remitting the assessment back to the respondent for reassessment in accordance with the consent filed insofar as the boat expense is concerned, and in all other respects that appeal is dismissed. With respect to the 1974 taxation year, the purported appeal is quashed as there is no appeal from a notice which does not assess any tax.

Appeal dismissed.