Ken & Ray’s Collins Bay Supermarket Limited v. Minister of National Revenue, [1974] CTC 2267

Judge K A Flanigan (orally: March 6, 1974):—This is an appeal by Ken & Ray’s Collins Bay Supermarket Limited against the reassessment of the Minister of National Revenue for the 1969 and 1970 taxation years.

The appeal involves the question of whether or not bonuses, accrued in the financial statements of the appellant company and subsequently brought back into income because they were in fact not paid within the proper statutory time limit, were proper deductions for the taxation year to which they were said to pertain or whether, as the Minister had said in his presentation, they were either a sham or did not create an obligation created [sic]—and whether, therefore, the appellant company had no right to set up what, in effect, was not an accrued liability but perhaps a reserve not permitted by the Act.

More and more of these matching problems have been submitted to the Board lately as evidenced only last month, when the Assistant Chairman issued a judgment in VR Enterprises Limited v MNR, [1974] CTC 2099; 74 DTC 1089 (now under appeal to the Federal Court) dealing with this type of problem.

In many cases, employees count on such benefits even though the amount may not be certain. Management appreciates in most of these instances the incentive that the prospect of a bonus provides to its employees.

Ideally, I suppose one should declare a bonus at or as soon as possible after the year-end, but in practice I think one must recognize that final financial statements are not available from company auditors until sometime after the fiscal year end, and it is not until that time, really, that a decision can be made.

As a form of remuneration, a bonus is a business expense which should be charged to revenue in the year just closed off and to which it logically pertains.

To assume it is an expense agreed upon and therefore incurred in the new business year is a kind of formalism that is unrealistic in my view, just as unrealistic as not restating the recorded cost of inventories on the basis of facts which may have become known after the year- end but before the closing off of the accounts. If a bonus can easily be related to the revenue earned in a certain business period, it should be matched with that revenue.

This I think is what really happens in situations where businesses which maintain their accounts on the accrual basis set up reserves as at the year-end but in fact after the end of the fiscal year and take the reserve allowances into account in determining the final profit or loss of the company in the fiscal period just past.

The evidence in this case has been given by Mr Partridge, an auditor with the firm of Thorne Gunn & Co, the auditors for the appellant company, and in his view sound accounting business practices were followed in setting up a new form of bookkeeping system when they accepted this company as one of their accounts. In 1969 they set up an accrued bonus of $58,590, and in 1970 of $17,000; neither of these bonuses were paid and both were brought back into income; and it was agreed by counsel for the Minister that the amounts in question were reasonable.

I have also had the advantage of hearing the evidence of Mr McEwen, who is the major shareholder of the appellant company and, along with a man by the name of Robinson, shared equally in any salary and any bonuses that would be paid, although the shareholdings were two-thirds to one-third in favour of Mr Mc-Ewen.

This was obviously a two-man operation or two-man proprietorship that was incorporated, and they ran it as they would run a small unincorporated business. Obviously they relied heavily on their auditors and were not concerned with the formalities of minute books or income tax specifics.

The evidence of Mr McEwen was that they worked some 12 to 14 hours a day, five, six and sometimes seven days a week and that they anticipated being able to generate enough business to pay themselves the bonuses that had been accrued.

Like so many small grocery or fruit businesses in this day and age, when they appeared to be well on their way to substantial profits annually, they were faced with the intrusion into their market by several of the large grocery chains. This immediately had an effect on their business, and the evidence indicates that they finally went out of business early in 1974. In any event, they had to increase their advertising considerably in an effort to cope with this intrusion by the large chains, and they had to cut prices and go through what has been described as a “price war”.

I think that there is no question whatsoever that the intent was always there to pay or to achieve payment of those bonuses through their own personal work in building the business.

There is no question, and I am considering now what have been referred to me as some of the criteria set out by the Assistant Chairman in VR Enterprises (supra), that the bonuses are agreed upon as being reasonable. There is no doubt whatsoever, on the evidence of both Mr Partridge and Mr McEwen, that the services for which the bonuses were meant to be a remuneration were real and were rendered by these people in an effort to improve the net profits of the business through increased sales. Considering the evidence of Mr McEwen, which I accept, I think that there is certainly, in the manner in which he and his co-shareholder operated the business, justification for the granting of these bonuses in consideration of the work they were doing. From his evidence and from his answer to a question put by it, it was obvious to me that the prospect of receiving these bonuses certainly acted as an incentive in his mind to make the business go so he could retire as soon as possible. I think that the criteria set out in VR Enterprises, although they are not all the criteria that might be considered, are fair and reasonable in looking at these problems, and I think they have been met in this case.

I do not think we can expect the formalities to exist in this type of operation that would exist in the types of organization that gave rise to the “bonus cases” cited to me by learned counsel for the Minister.

I am certain that the two gentlemen discussed with their auditors the possibility of these bonuses, and I am certain that they expected to be paid. To say that there was no obligation to pay them is to say in effect that they were deceiving themselves and no one else, and this to me would be a very unrealistic and impractical approach to take to the subject. Of course, there was never going to be a legal action instituted to recover these bonuses because it would be a case of suing

themselves. As Mr McEwen said: “There was no thought of artificially reducing the income, because what would have been the difference.” He would merely have been paying the income tax himself instead of through the company.

I cannot find on the evidence before me that the transaction constituted a sham within the meaning of the cases cited and of the well- accepted principles that apply to such transactions.

I think on all the evidence there was a good sound business basis for accruing these bonuses and a reasonable expectation for assuming they would be paid within the year. However, as I said, external forces made that impossible and, in future years, the business did not allow the bonuses any more. As I have said, the business did not survive very long after the 1969 and 1970 taxation years.

Therefore, on all the evidence, I come to the conclusion that these were legitimate bonuses, that the appellant has discharged the onus cast upon it, and that the appeal should be allowed and the matter referred back to the Minister for reassessment accordingly.

Appeal allowed.