James H. Odishaw Professional Corporation and James H. Odishaw v. Her Majesty the Queen, [1996] 3 CTC 2863, 97 DTC 23

Bowman J.T.C.C.: — These appeals were heard together on common evidence. They relate to assessments made under the Income Tax Act for the taxation years 1990, 1991 and 1992 of both the individual appellant and his corporation.

At the commencement of trial counsel for the respondent advised the court that the respondent was conceding the appellant James H. Odishaw’s appeal for 1990 in respect of the issue of the shareholder’s benefit of $29,840 on the basis that this amount, if taxable, should have been assessed in 1989, a statute-barred year.

The parties filed an agreed statement of facts which reads as follows:

1. James H. Odishaw Professional Corporation (“JHO”) was a professional corporation duly incorporated, in accordance with the laws for the time being in force in Alberta, having a year end of July 31.

2. The James H. Odishaw (“James”) was the only shareholder of JHO.

3. The James was a member of the Law Society of Alberta and was practicing his profession as a lawyer in Alberta as the employee of JHO. The Appellant plus one other were the only employees of JHO.

4. At all times material to this appeal, James H. Odishaw Holdings Ltd. (“JHOH”) was a corporation duly incorporated according to the laws for the time being in force in Alberta, and its shareholders were, Janine 20 per cent, Michelle 20 per cent, Carla 20 per cent (all daughters of James), James 20 per cent (in trust for his aforesaid daughters Janine, Michelle and Carla), and his wife, Esther E. Odishaw 20 per cent, and having a year end of September 30.

5. At all times material to this appeal, JHO Holdings & Management Ltd. (“JHO H&M”) was a corporation duly incorporated according to the laws for the time being in force in Alberta. JHO H&M was wholly owned by James and had a year end of September 30.

6. Under the terms of a leasing agreement dated October 28, 1983 amended on November 05, 1985, JHOH leased the premises bearing municipal address 2200, Sun Life Place, #10123 - 99 Street, Edmonton, Alberta from the SunLife Assurance Company of Canada (“Sun Life”).

7. JHOH then sub-leased the aforesaid premises to JHO and James carried on the practice of his profession as a lawyer from these premises. There were also other lawyers who were occupying the aforesaid premises as subtenants of JHO.

8. James carried on the practice of a lawyer under the name of Odishaw & Odishaw. Odishaw & Odishaw was neither a partnership nor a professional corporation. All the expenses incurred in relation to the office maintained at #2200 Sun Life Place, 10123 - 99 Street, Edmonton, Alberta, were paid through the account of Odishaw & Odishaw. James and the other lawyers who used the aforesaid premises paid advances from time to time to the account of Odishaw & Odishaw.

9. In 1990, 1991 and 1992, the sums of $80,342.00, $74,076.00 and $84,047.00 were paid by Odishaw & Odishaw to Sun Life as rent for the aforesaid premises.

10. Out of the aforesaid amounts, $54,793.00, $51,853.00 and $55,723.00 were allocated as the share of James in respect of rent of the aforesaid premises. The balance of the said amounts were allocated to the other lawyers using the aforesaid premises.

11. In addition to the above, JHO claimed as rent expenses the further amounts of $5,000.00 in respect of each of the years 1990 and 1991 and $2,500.00 in respect of 1992 as being owed by it to JHO H&M and $30,000.00 each year in respect of the years 1990, 1991 and 1992 as being owed by it to JHOH.

12. JHOH had non-capital losses against which the aforesaid amounts claimed by JHO as rent expenses could be deducted.

13. At the beginning of the taxation years ended September 30, 1988, September 30, 1989, September 30, 1990, September 30, 1991 and September 30, 1992, JHOH reported non-capital losses in its returns of income in respect of those taxation years as follows:

1988: ($272,534.00)

1989: ($251,563.00)

1990: ($232,067.00)

1991: ($199,431.00)

1992: ($165,050.00)

14. In the 1990, 1991 and 1992 taxation years of James, JHO paid life insurance premia in the amounts of $2,625.00, $5,570.00 and $5,743.00 respectively, in respect of two policies of life insurance taken by James on his life.

15. The benefit in respect of the aforesaid policies of insurance had not been assigned to the Bank of Nova Scotia or Roy Nat or any other creditor of JHO.

16. The beneficiaries under the aforesaid policies of life insurance were the wife and the daughters of James.

I shall use the same abbreviations as those used in the agreed statement of facts.

The two remaining issues are:

(a) whether the insurance premium paid by JHO on the life of James are deductible by it as a borrowing expense under paragraph 20(1 )(e) of the Income Tax Act and are not includible in James’ income personally as a shareholder’s benefit;

(b) whether the additional amounts of $5,000, $2,500 and $30,000 referred to in paragraph 11 of the agreed statement of facts are deductible in computing JHO’s income.

James is a member of the bar of Alberta, having been called in 1972. He has been in private practice since 1975 and, since the late 70s, has practised through a professional corporation, JHO. In 1983, he left the firm with which he had been practising, Brosseau, Maccagno & Hutton and set up practice with his sister Margaret under the name of Odishaw & Odishaw. Both James and his sister had professional corporations, as did other lawyers who were associated with them under the name Odishaw & Odishaw. Odishaw & Odishaw had no legal existence as a separate partnership, even though it had a trust account and a general account. It seems to have been more in the nature of an account that acted as a central clearing house through which expenses were paid and, presumably, revenues were received and distributed to the personal corporations operating as associates under its name.

In or about 1984 Odishaw & Odishaw moved into new premises. The lessor was SunLife and the premises were leased to JHOH, which in turn, according to the agreed statement of facts, sublet then to JHO. There was no written sublease, and the evidence does not disclose whether there was any oral agreement between JHO and JHOH with respect to the rent. The practice seems to have been to add a mark up to the rental paid to Sun Life by JHOH, in some cases as much as $20,000. This practice was, at least until 1990, not challenged by the Department of National Revenue. Mr. Odishaw contended that this practice constituted a sort of precedent from which I could conclude that the additional $30,000 claimed as an expense in 1990, 1991 and 1992 was reasonable. I do not think it can be so regarded. The acquiesence of the department in prior years in a practice does not establish reasonableness, and the Minister is not bound by his earlier assessments. Moreover, I suspect that the Minister’s willingness to ignore the earlier mark ups may have been based on the pragmatic recognition that in the earlier years, or at least in some of them, both companies were taxable and so a deduction in one was offset by an inclusion in the other.

Approximately $16,000 was spent on tenant improvements by JHO H&M, another company owned by James. Commencing in 1985 and continuing until 1992 JHO H&M depreciated this amount on a 10 per cent straight line basis. It is not clear whether the provision of $1,602 taken in each year was merely accounting depreciation or was also claimed as capital cost allowance for income tax purposes. What is equally unclear is the legal or accounting basis upon which any claim for depreciation or capital cost allowance could be made. JHO H&M was not the owner of the leasehold improvements nor was it the tenant which might have permitted it to treat the expense as a cost of depreciable property under subsection 1102(4) of the Income Tax Regulations.

In 1990 and 1991 the appellant JHO treated as a rent expense $5,000 for each year and in 1992 it claimed a further $2,500. The purpose appears to have been to reimburse JHO H&M for the cost of the leasehold improvements for which it paid in 1984.

I can see no basis for this claim. JHO H&M was not the owner of the leasehold improvements nor was it JHO’s landlord. There was no agreement to pay rent to JHO H&M (nor could there be) and there was no legal obligation to do so. The best characterization that I can make of the $16,000 paid by JHO H&M to cover the cost of the leasehold improvements was that it was a loan to JHOH by JHO H&M and if JHO paid it by an offsetting reduction in a loan account (which was not established in the evidence) it was simply repaying part of JHOH’s debt. It is not a rental expense or any other type of deductible expense. These amounts, inexplicably, were recorded as income in the records of both JHOH & JHO H&M.

So far as the $30,000 recorded as an additional rental expense deducted in computing the income of JHO are concerned, these amounts were not paid in cash although Mr. Odishaw stated that they reflected as well a reduction in the loan account of amounts owing by JHOH to JHO. I shall assume this to be so -1 certainly have no reason to question Mr. Odishaw’s word on this point although I was not referred to any evidence in the books of either company. At all events the method of accounting for the rentals was somewhat unusual. It will be recalled that the arrangement between JHO and the other associates in Odishaw & Odishaw was that JHO bore all of the expenses and was paid a negotiated amount by the other associates to cover their share of the overhead. Yet in the books of account of JHOH there was recorded as income, not the full amount of the rental expense paid to SunLife plus the additional $30,000 paid in each year, but rather only the portion of the full amount payable to SunLife that was allocated to JHO plus the $30,000 additional charge as well, inexplicably, as the $5,000 and $2,500 amounts that were also shown as a rental expense payable to JHO H&M. As rental expense JHOH showed only the portion of the amount payable to SunLife that was allocated to JHO plus, even more inexplicably, the $5,000 and $2,500 amounts mentioned above.

One example will suffice. JHOH’s income statement for 1990 shows rental income of $89,793 and rental expenses of $59,793. If we remove from those figures the $5,000 charge in respect of the leasehold improvements that everyone agrees should not be there, we are left with $84,793 and $54,793. The $54,793 is the exact portion of the $80,342 paid by Odishaw & Odishaw to SunLife that was allocated to JHO. The $84,793 is simply that amount plus $30,000. Mr. Odishaw suggests that in determining reasonableness I should compare $84,793 with the $80,342 paid to SunLife. This is not a valid comparison. $84,793 is only 64.61 per cent of the amount paid to SunLife. The true comparison is $84,793 with $110,342 ($80,342 + $30,000), a mark up of about 37 per cent.

There is certainly no evidence that a mark up of 37 per cent is justified or required between persons as closely connected as JHO and JHOH. Indeed, I can see no justification for any mark up. JHOH did nothing to earn it and no additional risk was involved [1] .

That consideration apart, there was no obligation on the part of JHO to pay the additional $30,000. It was a determination by the chartered accountant as a means of reducing the income of JHO, which was taxable, by transferring income to JHOH, which had large losses. Accounting records should reflect, not create reality. Reality is not created by the stroke of an accountant’s pen. Where a particular tax result is sought to be achieved by moving income around in a related corporate group the legal structure should at least be in place. It was not in this case.

With reference to the insurance premiums that were paid by JHO on the policies on James’ life, it should be observed that neither JHO nor the lending institutions were beneficiaries under the two policies. The beneficiaries were the wife and daughters of James.

Mr. Odishaw argued that the insurance premiums were a cost of borrowing money by JHO and that the fact that the lending institutions, RoyNat and Scotiabank did not insist on the assignment to them of the benefit under the policies does not mean that they were not taken into account in determining the creditworthiness of JHO.

For the cost of insurance to be a cost of borrowing by a taxpayer there must be some reasonable factual connection between the borrowing and the payment of the insurance premiums. No doubt a bank, in considering whether to extend to a borrower a line of credit, takes into account all of that person’s net worth, including his or her house and, no doubt, the insurance on his or her life. That does not make the cost of maintaining that person’s net worth a cost of the borrowing. The insurance on James’ life was in place irrespective of what amounts were borrowed by JHO. In my view the cost of the insurance was a personal cost of James. It was paid by his company and is a benefit to James. It was not laid out by JHO for the purpose of gaining or producing income by it and it is not a cost of JHO’s line of credit. The connection between JHO’s line of credit and the insurance costs is altogether too tenuous.

The appeals are therefore dismissed with costs except for the appeal for the 1990 taxation year which is allowed on consent and the assessment for 1990 is referred back to the Minister of National Revenue for reconsideration and reassessment to delete from Mr. James Odishaw’s income the sum of $29,840 mentioned at the beginning of these reasons.

Appeal dismissed.