R M Latta and Active Petroleum Products LTD v. Minister of National Revenue, [1978] CTC 3003, [1978] DTC 1719

Delmer E Taylor:—These are appeals heard on common evidence from income tax assessments in which the Minister of National Revenue disallowed as company expenses certain amounts claimed as promotional expenditures by Active Petroleum Products Ltd for each of the taxation years 1971 through 1975, and charged the said amounts against the shareholder’s account of the individual, Mr R M Latta. In addition, the Minister disallowed portions of monthly payments for an automobile leased by the Company (Active Petroleum Products Ltd) for Mrs Latta, the wife of the appellant Latta, and also charged these amounts against the shareholders account of Latta. The respondent, in the various Replies to Notices of Appeal, relied, inter alia, upon sections 3 and 4, subsection 8(2) and paragraph 12(1 )(a) of the Income Tax Act, RSC 1952, c 148 and amendments; and upon section 3, subsections 9(1) and 15(2) and paragraph 18(1 )(a) of the Income Tax Act, SC 1970-71-72, c 63 as amended.

Facts

The Company, incorporated under the laws of the Province of British Columbia, is engaged in the retail distribution of petroleum products in the City of Kamloops, and the surrounding district in British Columbia. Latta is its controlling shareholder and President. The promotional expenses involved were $3,600, $3,991, $5,130.65, $6,604.20 and $6,604.20 for the years 1971, 1972, 1973, 1974 and 1975 respectively. The funds were paid by the Company directly into the personal bank account of Latta, and approximated the amounts of monthly payments on the mortgage on his residence. The automobile lease payments were for $1,389.36 and $1,272.74 respectively for 1974 and 1975. It was noted that there were “nil” assessments for the years 1971, 1972, 1974 and 1975 for the company Active, and on motion of counsel for the respondent, these appeals were quashed. This did not, however, affect the issues involved in the appeals and the agent for the appellants requested that the matter proceed as scheduled.

Contentions

From the Notices of Appeal the following may be extracted as being the position of the appellants:

— The company operates on a low margin basis and depends on large sales volumes in order to cover overhead and generate a reasonable profit.

— The President of the company, Mr R M Latta, is frequently required to entertain current and prospective customers in order to maintain and hopefully increase sales volumes for the company. In this regard, Mrs Latta. is also requested by her husband to be active in the community and socialize with the company’s business associates. Mr and Mrs Latta do not submit expense accounts for purposes of reimbursement of these promotional expenditures.

— Both Mr and Mrs Latta are remunerated in the form of salaries for the above activities as well as for the management of the company.

— The promotional expenditures are properly deductible for income tax purposes as evidenced by the consistent annual increases in sales volume.

— Mrs Latta is a bona-fide employee and is engaged in gainful employment. In this regard, the automobile lease payments are properly deductible for income tax purposes.

The respondent contended that:

(for the Company)

— the appellant did not make the outlays of $3,600, $3,991, $5,130.65, $6,604.20 and $6,604.20 for the purpose of earning income from a business.

— Mrs Latta did not carry on any business purpose in her use of the leased car.

(for Latta)

— the advances from Active and the portions of the leased auto payments were properly included in the appellant’s income.

Evidence

R M Latta, speaking for both himself and Active, presented no physical evidence in support of the appeals, but described to the Board the general basis upon which the expenses claimed had been incurred by him on behalf of the Company. These ranged from room and meal costs to supplying presents such as liquor for his clients or prospective customers. He was completely direct and candid in his verbal evidence, and described the difficulty, if not virtual impossibility, of obtaining and retaining receipts and records for the expenditures. The simplest process then in his mind had been to obtain an “advance”, which happened to be the amount of his personal monthly mortgage payments, and to consider that advance as the Company keeping him in funds for the purposes described. Latta also gave the Board some indication of the general services provided to the Company by his wife

—picking up packages, making small deliveries, etc. Generally, his Wife was available to help out at the main plant in Kamloops when he himself was travelling, which occupied most of his time.

Argument

In summary, the agent for the appellant concluded:

The company, to reiterate, contends that the amount was paid to an employee whose duties were to perform certain services and the allowances were to reimburse him for his expenses, travel and entertainment, that he expended on behalf of the company. The company contends that the amount of the allowance is reasonable in the circumstances, given the marketing conditions that existed with the type of company that Active Petroleum is, and in the type of product that it sells. Mr Latta contends that the receipt of these allowances was not a loan to him, but rather a reasonable allowance received from the company for these expenses.

One of the things that came out of Mr Latta’s testimony or evidence was the fact that he retained no receipts or vouchers for these expenses, much to his detriment, I suppose. However, he has tried to give evidence to the fact that he was required to undertake these duties of salesmanship and he has attempted to demonstrate the type of situation that arose where he in fact expended these monies. Perhaps it could be considered that the amounts were rather arbitrary, particularly in that they were specifically geared to pay a mortgage payment on his personal residence. However, he has said that in his opinion, in his estimation the amounts that he did spend were approximate to or greater in some cases than the amount received beneficially from the company. Perhaps Mr Latta should have reported this as income and properly claimed expenses against ‘that personally. However, relying upon subparagraph 6(1)(b)(v), the Act specifically excludes from the income of an employee, any reasonable allowances for travel expense paid to an employee by the employer. I would like to quote from Information Circular 76-4R, issued by the Minister of National Revenue on June 27th, 1977. Albeit this Information Circular is dated subsequent to the events that we are discussing today, I do think that it puts into writing a policy by the Tax Department, by the Minister of National Revenue, that it had adhered to prior to that date. This part of the Information Circular does not conclusively say, yes, you do not need to retain vouchers. However, it does say in part, and perhaps this is a small point, but the Circular says:

Small amounts of unvouchered cash payments may be allowable provided it can be established that the total of such expenditures is reasonable in the circumstances and that they have been incurred for the purposes of gaining or producing income.

Mr Latta has tried to demonstrate today that the expenses or the payments by him are reasonable in the circumstances and that he has outlayed these funds for the purposes of gaining and producing income. Obviously, there is no definition in the Circular for small amounts, and whether or not the payments in question can be considered small amounts, it’s not up to us to determine that. Mr Latta has based his evidence on the fact of being reasonable.

The other matter of the automobile provided to Mrs Latta by the company in the taxation years ’74 and ’75, Mr Latta has stated that Mrs Latta was an employee of the company, received a salary from the company. This Salary presumably has been accepted by the Minister of National Revenue as reasonable, in that they have not contested it. Therefore, I would submit that she is an employee and according to Mr Latta, she did perform duties on behalf of the company which. would entail the use of an automobile. One point I would like to make with regard to this automobile, that would be my understanding of paragraph 6(1 )(e) of the Income Tax Act, is that any taxable benefit arising from the use of an automobile provided to an employee by an employer should be included in the income of the user. Consequently, in this case, Mrs Latta has included one third of the lease payment in her income on her T4 slip as a taxable benefit, which is the minimum standby charge as provided for in the Act, and I would submit that any taxable benefits that could be construed in this situation should be taxed in the hands of Mrs Latta, and that they not be considered loans to Mr Latta by the company. But further, and primarily, I would submit that they should be allowed as deductions from income of the company.

For the respondent:

With respect to the expenses, the appellant must show, and I would say this applies with respect to both the corporate and the individual appellants, the allowability of the company expenses. First of all, the appellant must show that the expenses were in fact incurred by the company or by the individual on behalf of the company, that the expenses were incurred for the purpose of gaining or producing income and that the expenses incurred, if they were incurred, were reasonable.

Now, basically, Mr Chairman, the Minister doesn’t quarrel in a theoretical sense at least with the assertion that the types of expenses described here were, a) for the purpose of gaining or producing income; and b) that they were considering the volume of business of the company reasonable.

Where the Minister disagrees with the appellants is in the manner in which the appellant has sought to prove that those expenses were in fact incurred, before the Board. Clearly, there is no rule of law that would require such expenses being proved by the submission of vouchers or other documentary evidence. However, we’re dealing with a business here and I think that the Board has a right to expect a certain standard of evidence with respect to such claimed expenses, and it is the Minister’s position that the appellants have not met the standard which the Board can reasonably require of them with respect to proving that the expenses were incurred. Now, Mr Latta gave oral testimony, quite general testimony, as to his work on behalf of the company and as to the claimed expenses. It would seem that what emerged from your questioning, Mr Chairman, is that the majority of the expenses would fall into the category of promotion or entertainment rather than travel.

. . I With respect to the use of the car by Mrs Latta, there was evidence that she made some use of the car for company purposes. It is true that she was accepted—the salary paid to her was accepted by the Department as a proper company expense. Mr Latta testified that on the average she may have done company business, I think he said three days a week. Now, I would point out that as a practical matter, because of the way the assessment was done, the standby charge of one third of the total lease payment which was included in Mrs Latta’s income was effectively allowed to the company as an expense. In other words, the expense was only disallowed to the extent of the net amount, the cost of the lease minus the one third standby charge. So, as the assessment stands effectively as far as the com- pany is concerned, there has been a one-third allocation of business use, and I would suggest that the evidence does not support a finding that any more than that percentage was used for business purposes and would urge that the assessment stand as far as that issue is concerned.

A discussion ensued with respect to the use by the Minister of subsection 56(2), and it was the contention of the agent for the appellants that there was a serious risk of double taxation in the entire assessing process used here since the company was denied /6 of the. lease payments as a deduction, tax had been paid by Mrs Latta on one third, and should. the Board find there was no business use at all for the leased automobile, this same one third might be added to the income of Mr Latta.

Findings

Dealing’ with the promotional expenditures first, if the Board follows the original argument of Mr Almond, then since these were treated as “allowances” (claimed as deductible by the Company by virtue of subparagraph 6(1 )(b)(v) of the Act), it need only be shown that they were reasonable and that is the end of the matter. A subsequent discussion with the Presiding Member, however, takes the following route:

Q Ms Williamson said, Mr Almond, that the Minister didn’t quarrel, I believe that was the word she used, with the kind of expenses which were described here this morning, that is, motel rooms, meals. Mr Latta was perfectly straightforward and direct, liquor, entertainment and so on. I’m just using that as a descriptive phrase. The Minister didn’t quarrel with those kinds of things. May I take it that you regard all of those as falling into the general categorization of subparagraph. 6(1)(b)(v)? A No, Mr Chairman, I do not consider all those—I don’t think that subparagraph 6(1 )(b)(v) to which you refer would include entertainment expenses. I would say, my interpretation would be that it would only include travelling expenses.

Q But that’s the only section of the Act on which you’ve relied for this monthly allowance. Have you relied on some other section of the Act to provide the basis upon which the corporation can charge off this monthly allowance of some $500 as an expense if it includes items other than. what a layman might -understand to be travel? A Gnerally speaking; we have relied upon paragraph 18(1)(a) which is a general limitation, limiting deductions to those that are incurred by the taxpayer for the purpose of gaining or producing income from business or property.

THE CHAIRMAN: Now, my problem is that you are saying there was an allowance a standard monthly allowance which the president of this corporation gave to one: of his employees (himself) for purposes of travel, and at least to the extent that this is covered under subparagraph (v) of paragraph 6(1)(b), it is not taxable in Latta’s hands. In that allowance, there was some kind of consideration for items other than that which you would describe specifically as travel, is that correct? A Yes, Sir.

Q Now, are you saying therefore, and I’m asking you really for information and I’m asking for it as a professional practising accountant in your position because I’m Sure it’s as troublesome an issue to you as it is to many other parties, under that set of circumstances, are you saying that a portion of this (and I don’t care what numbers you would put on it, but some portion of it) was an allowance to cover his travel, and are you also saying that items which might not:be included in the technical or specific definition of travelling expenses were promotional and entertainment expenses for the purpose of gaining and producing income and therefore covered as a deduction for the corporation under section 18. Is that fairly well described? A Yes, yes. And I haven’t attempted to arbitrarily say, as you have suggested, that a certain proportion, a percentage or a third or a half is travel or, consequently, the other part entertainment.

Q Is there any particular part of section 18 of which you’re aware which provides for or would allow for what you and I would describe as an allowance for promotion and entertainment? An allowance in the same terminology as appears to be given some consideration in subparagraph (v) paragraph 6(1)(b)? A No, sir.

Q Now, I discussed with Mr Latta the fact that had I been one of his employees and brought back travel expenses or entertainment expenses, I would have been required to explain these. Now, would you agree with me that Mr Latta was occupying a dual role, obviously a dual role because we have two sets of interlocking appeals that relate to a desired deduction from the corporate income, and a very much undesired, by the appellant, addition to his own income. So, he was occupying a role as an employee of the corporation and he was also occupying the role as the president of the corporation. That's quite realistic and quite understandable, and done every day of the week. A Yes.

Q Now, in his dual role, when Mr Latta as an employee of the corporation received his 500 odd dollar cheque each month, he received it from Mr Latta, the President of the corporation, is that understandable? A No, he received it from Active Petroleum Products Ltd.

Q And who approved the payment for Active Petroleum? A Mr Latta.

Q So, Mr Latta, as the President of Active Petroleum, approved Mr Latta as an employee of the company receiving roughly $500 of the company’s funds?

A Yes.

Q Now, once. Mr Latta as the President of the company had done so, then would it not be realistic to assume that he had taken the responsibility for the appropriateness of those expenditures by the corporation as the President, no longer as the employee? A Yes.

Q And Mr Latta, now as the President of the company, has the responsibility for justifying those expenses as an expenditure, aS an appropriate expenditure of the corporation, correct? A Right.

On the other hand, according to Ms Williamson, the. types of expenses described were for the purpose of producing income and they were reasonable; the disagreement rested with the manner of proving them before the Board. Some further delineation of the matter may be found in the following exchange:

MS WILLIAMSON: We are dealing with the payments made by one appellant, which is the company, and those payments were actually made to Mr Latta (the other appellant) by way of set-off. Now, clearly, if Mr Latta has not succeeded in proving that the expenses for which these payments were allegedly a set-off were in fact incurred, then the payments by the company to Mr Latta ought to be taken just at their face value, which is in the nature of personal mortgage payments.

THE CHAIRMAN: And this is precisely why earlier I discussed with Mr Almond the fact that Mr Latta, in his role as an employee, was then receiving funds approved by Mr Latta as President of the company in a dual role, and it is this relationship which causes the problem.

For the appellant, the position is essentially that where an employer (in this case Active) provides a reasonable allowance for travelling expenses to an employee (Latta), it is deductible to the Company under paragraph 18(1 )(a), and non-taxable to the recipient under sub- paragraph 6(1)(b)(v). Where the allowance covers expenditures other than travel (eg entertainment or promotion), it is still deductible under paragraph 18(1)(a) to the employer, but there is no specific section providing it tax-free to the employee. With this analysis I am in accord, and it would appear so is the Minister.

Counsel for the Minister goes further to the extent that the reasonableness of the expenditures is accepted, as is their purpose in gaining or producing income. It is at this point that the risk of confusing the dual role and responsibilities of the appellant Latta, as employee and as President, with that of Active as the other appellant becomes a matter of concern. When counsel for the respondent states “Clearly there is no rule of law that would require such expenses being proved by the submission of vouchers or other documentary evidence’’ and concurrently accepts their reasonableness and purpose in gaining or producing income, the gravest kind of possibilities and ramifications are raised, unless the specific situation is one to which that can be applied, based on other facts. Except in the most unusual circumstances (which in my mind might not include simply neglecting to obtain or retain receipts, records, journals, note books, or daily expense sheets), how else would anyone determine with any certainty the characteristics in the expenditures which should be a prerequisite for deductibility? I doubt that the Board has “a right to expect a certain standard with respect to such claimed expenses” (quotation from counsel) which is greater or different than that which is expected by the Minister from all taxpayers. It may be, however, that the requirement to demonstrate proof is simply more apparent before the Board. It should be noted in this connection that in the voluntary system of income declaration administered by the Department of National Revenue, only the taxpayer can decide for himself the extent to which his record keeping for business or personal purposes will also be adequate, if needed, in the determination of income tax liability for departmental purposes.

I am not as ready as counsel for the respondent to concede the universal applicability of the siren song in Information Circular 76-4R quoted by the agent for the appellants:

Small amounts of unvouchered cash payments may be allowable provided it can be established that the total of such expenditures is reasonable in the circumstances and that they have been incurred for the purposes of gaining or producing income.

The word “unvouchered" does not necessarily mean “unsubstantiated” or “unsupported”. I can visualize several ways in which some reasonable evidence of such payments could be maintained and provided which would not be “receipts” (vouchers) in the familiar sense of the word. Without anything it appears to me that a taxpayer has set himself a difficult chore indeed to prove the expenses claimed were “reasonable” and “for the purpose of gaining or producing income”. To claim a deduction, a taxpayer must first meet the criteria in paragraph 18(1 )(a) “incurred by the taxpayer for the purpose of gaining or producing income” before relying on the “reasonable” qualification to be found in section 67. That latter section only comes into play when the “amount is otherwise deductible”, and the only clause allowing for such possible deductibility is the aforementioned paragraph 18(1)(a). The Board is asked to simply accept the statement of the President Latta that he is satisfied the employee Latta spent the allowance on behalf of the Company, and the purpose was to gain or produce income. The Board respects the President’s confidence in his employee and regards this alleged disposition as quite possible but that does not fulfill in any way the onus placed upon the appellant to displace the Minister’s assumptions when called upon to do so. The basic decision of the Company not to require regular confirmation from the employee regarding the nature and the extent of the expenditures was a conscious, deliberate one, even if taken to simplify business procedures and record keeping. That decision, however, is now the genesis of the difficulty which the appellant Active brings before the Board, and it cannot be overlooked in the circumstances. That appeal on behalf of the Company will be dismissed.

Turning to the effect on the appellant Latta, he can only escape liability for tax on the amounts in question: under subparagraph 6(1)(b)(v) whether they are deductible to the Company or not, and then only to the extent of “reasonable allowances for travelling expenses”. Travelling expense, as agreed by the agent for the appellants, would not include “entertainment and promotion”. While the verbal evidence would indicate that some part of the total allowance might have been used by Latta for meals and lodging (travelling expenses), there is no way of knowing how much that could have been. The Board does not feel constrained to make some sort of arbitrary provision for such a possible amount for travelling expenses in the light of the neglect of the appellants to maintain any records showing a basis for it.

On the question of the leased automobile (the deductibility to the Company of the payments and/or the liability for tax on any portion of these in the hands of the appellant Latta), the Board notes the following:

(a) it has been established that the Minister considered Mrs Latta an employee;

(b) the Company was therefore entitled to provide her with a leased car for business, personal or combined business/personal use;

(c) she used it to some degree for Company purposes;

(d) the application of the stand-by charge in subsection 6(2) is appropriate, and there is no indication that the Minister felt the: /3 minimum to Mrs Latta was insufficient.

The question now facing the Board is whether the Minister’s action in charging the /3 balance of the lease payments to the shareholder’s account of Mr Latta was in order. It was explained at the hearing that this was based upon the application of subsection 56(2) of the Act which reads as follows:

(2) Indirect payments. A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

The agent for the appellant took the position that if the two-third portion of the lease payments was to be disallowed (with which he did not agree), it should not be charged against Latta but if necessary against Mrs Latta. The Board is not seized with any of Mrs Latta’s income tax matters, so can only consider the appropriateness of the action taken against Latta. In effect, by this portion of the assessment, as I follow it, the Minister has said he will allow the Company 1 /3 of the lease payments as a deductible expense, but he will consider that portion was used personally by Mrs Latta, and tax her accordingly; and he will not allow the Company the other two-thirds as a deduction, but he will tax Mr Latta on that portion anyway, as a benefit conferred by Latta on his wife. That could only be interpreted to mean that the leased automobile was not used at all for Company purposes—the Company "conferred” 1/3 of it on her and the other 2 /s on Mr Latta. This was a position which the respondent not only did not sustain but rejected. Certainly Mrs Latta would not be expected to use any of her 1 /3 personal portion of the car for business—so some part or all of the remaining 2/3 must have been used for business—and how then that could be regarded as any benefit conferred by Latta on his wife I do not see. The charge of this 23 portion of the lease payments to the shareholders account of Latta is not supportable. It should be a deductible expense to the Company on the basis of the evidence available.

Decision

With respect to the appeals of Active Petroleum Products Ltd, the appeals for the taxation years 1971, 1972, 1974 and 1975 are quashed; the appeal for 1973 is dismissed. In the matter of the appeals of Robert M Latta, the appeals for 1971, 1972 and 1973 are dismissed; the appeals for 1974 and 1975 are allowed in part and the matter referred back to the respondent for reassessment so that the amounts of $1,389.36 and $1,272.74 respectively shall not be charged against the shareholder’s account of this appellant in the Company records. In all other respects, the appeals of Robert M Latta are dismissed.

Appeal allowed in part.