J a Leroux Inc v. Minister of National Revenue, [1979] CTC 3051, 79 DTC 833, [1979] CTC 3051

Guy Tremblay [TRANSLATION]:—This case was heard at Sherbrooke, Quebec on January 26, 1979.

1. Points at Issue

(a) It must be decided whether the appellant is correct in claiming that certain rents are income from an active business for the 1973 and 1974 taxation years and that it is, therefore, entitled to tax deduction provided for in subsection 125(1). The respondent maintains that the rents in question are investment income.

(b) Further, the respondent has added to the appellant’s income for 1974 the sum of $13,552.43, thus disallowing an adjusting entry to sales made by the appellant. The appellant maintains that there was quite simply an accounting error which was corrected by the adjustment.

2. Burden of Proof

The appellant has the burden of showing that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in Ft W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.01 The appellant company was incorporated in 1961. Its principal object is the wholesaling of potatoes and sugar. Its business office is in Granby, Quebec.

(A) Rent: Income from an active business?

3.02 The principal shareholder is Mr J A Leroux, who describes himself as an investor who works 15 hours a day.

3.03 In 1973 and 1974 the appellant company owned two buildings in Granby: one at 45, rue Guy, and the other at 50, rue Centre. These buildings brought in gross income of $22,562.72 for 1973 and $22,257.28 for 1974; the net income amounts were as follows: 1973: $9,364.14 and 1974: $8,538.87.

3.04 When it filed tax returns, the appellant treated these rents as income from an active business. The respondent, however, issued notices of reassessment treating these rents as investment income.

3.05 At the outset of the hearing, the respondent’s representative informed the Board that the respondent agreed that the rents from the building at 45, rue Guy were income from an active business. It appears that the basis of this agreement is that the apartments are part of the building in which the appellant’s main business—a store—is located.

3.06 During the years in question, the tenants of the building at 50, rue Centre were the health unit, the Jean Marquis law firm, Granby Finance and a Christian association.

3.07 The services provided by the appellant to its tenants were janitor service, heating, electricity and window cleaning. The appellant also did any necessary painting. There was also a person who cleaned the offices regularly. The tenants could always reach Mr Leroux by telephone.

(B) Adjustments to sales: $13,552.43 (1974)

3.08 The appellant’s accounting system, as described by Mr Gérald Allaire, CA, and by Mr Leroux, has the following characteristics:

(a) The accounting system is on the cash basis. At the end of the year, however, the accountant makes the adjustments needed to prepare the accounts on the accrual basis;

(b) Mr Leroux issues invoices, but only for credit sales; there are no invoices for cash sales. The accountant had not advised him to issue invoices for cash sales;

(c) Apart from the invoice system, however, all sales are entered in a Small blue book;

(d) The total daily and monthly sales figures are entered in the general ledger;

(e) All the appellant’s expenses are paid by cheque;

(f) Most of Mr Leroux’s totals are wrong. The accountant noted that there was always a discrepancy between the cash figure in the books and the bank deposits plus petty cash. After conducting an audit the accountant has to ask Mr Leroux to increase his sales figures nine times out of twelve. The rest of the time the figures have to be reduced;

(g) As the bank was next to the appellant’s shop, Mr Leroux made deposits every day.

3.09 It is not Mr Leroux’s habit to keep money on his person. He specifically denies that he has even taken money from the company. He does not pay himself a salary through his company. He has enough personal rental income (apart from the company’s rental income). He receives between $80,000 and $100,000 a year from 40 to 50 housing properties.

3.10 Sometime around the fall of 1974, the accountant’s office hired a new employee, who advised Mr Leroux to increase his sales when he should have told him to reduce them. This was probably done for two or three months. Mr Allaire stated that the incorrect overstatement of income by $13,552.43 was caused by this employee’s mistake. The auditor noticed the employee’s mistake in February 1975 and made the adjustment needed to correct it. The respondent disallowed the adjustment.

3.11 Mr Allaire conceded that he had not advised the appellant to change its accounting system and issue invoices for cash sales. He did not think it appropriate to do so. The system had been operating in that way for ten years; following audits by qualified accountants and adjustments the errors were eliminated and the financial statements filed represented the true State of affairs.

Mr Allaire maintained that this case involved only an error by his employee and that he held himself responsible to the appellant for this error. He regards this as a matter of principle.

4. Act, Case Law and Comments

4.1 Act

The principal sections of the new Income Tax Act applicable in this case are sections 3, 4, 9 and paragraph 125(1 )(a); where necessary, these will be cited in the Comments.

4.2 Case Law

Counsel cited the following cases:

(A) Cases cited by the appellant

1. Centennial Shopping Centre Ltd v MNR, [1974] CTC 2255; 74 DTC 1190;

2. Cosmopolitan Investments Co Ltd v MNR, [1974] CTC 2335; 74 DTC 1252;

3. Farlan Investments Ltd v MNR, [1975] CTC 2016; 75 DTC 12;

4. Lazare Investments Corp v MNR, [1975] CTC 2036; 75 DTC 26;

5. Smithers Plaza Ltd v MNR, [1975] CTC 2171; 75 DTC 137;

6. Granite Apartment Ltd v MNR, [1975] CTC 2175; 75 DTC 140;

7. Radke Bros Construction Co Ltd v MNR, [1975] CTC 2187; 75 DTC 149;

8. L & F Holdings Ltd v MNR, [1975] CTC 2192; 75 DTC 150;

9. Marlee Investments Ltd v MNR, [1975] CTC 2189; 75 DTC 153;

10. Millers Credit Jewelers Limited v MNR, [1975] CTC 2214; 75 DTC 154;

11. Parico Limitée v MNR, [1975] CTC 2234; 75 DTC 173;

12. Lawrence J Barron v MNR, [1975] CTC 2279; 75 DTC 221;

13. M R T Investments Ltd, E S G Holdings Ltd and Rockmore Investments Ltd v Her Majesty the Queen, [1975] CTC 354; 75 DTC 5224;

14. A C R Corporate Services v MNR, [1976] CTC 2432; 76 DTC 1322;

15. Her Majesty the Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156;

16. E S G Holdings Limited v Her Majesty the Queen, [1976] CTC 295; 76 DTC 6158;

17. Her Majesty the Queen v Cadboro Bay Holdings Ltd, [1977] CTC 186; 77 DTC 5115;

18. Spence Building Limited v MNR, [1977] CTC 2348; 77 DTC 71;

(B) Cases cited by the respondent

19. Horkent Holdings Limited v MNR, TRB judgment, April 26, 1977;

20. Henry Wertman v MNR, [1964] CTC 252; 64 DTC 5158;

21. Lois Hollinger v MNR, [1972] CTC 592; 73 DTC 5003;

22. Harry Walsh and Archie Robert Micay v MNR, [1965] CTC 478; 65 DTC 5293.

4.3 Comments

4.3.1 Income from an active business

The problem of deciding what is a business carried on actively within the meaning of section 125 has been dealt with by the courts on many occasions. The problem has often arisen in connection with loan companies. Many times too, as in this case, the appellant’s income came from apartment buildings.

In this latter area, the judgments delivered concerning the distinction between income from property and income from business are referred to. The main principle involved—the number and extent of the services performed by the landlord for the tenant—is generally relied on in deciding cases like the case now under consideration. Are the services performed by the appellant as described in paragraph 3.07 sufficient to give rise to business income?

A review of the case law on this matter, principally the decision delivered by the Federal Court in Harry Walsh and Archie Robert Micay v MNR (supra), leads the Board to conclude that the income in this case was income from property and not from business. The Board must, therefore, dismiss the appeal on this point.

4.3.2 Sales adjustment: $13,552.43

Despite certain weaknesses in the appellant’s accounting system, the Board, relying on the facts set out in paragraphs 3.08 to 3.11 and on the credibility of the witnesses heard, has come to the conclusion that the problem stems from the error made in the fall of 1974 by the employee in the accountant’s office and that the adjusting entry properly corrected this error.

The Board therefore allows the appeal on this point.

5. Conclusion

The appeal is allowed in part and the matter is referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed in part.