Hotel Cartier Inc v. Minister of National Revenue, [1978] CTC 3029, [1978] DTC 1740

Guy Tremblay [TRANSLATION]:—This case was heard in Chicoutimi, Quebec on October 19, 1977.

1. Point at Issue

Counsel aareed at the start of the hearing that the points that remained at issue in consequence of the assessments issued and the appeal roceedings are the following expenses disallowed by the respondent.

2. Burden of Proof

The burden is on the appellant to show 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 judgments including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195: 3 DTC 1182.

3. Alleged Facts

In order to clearly. grasp the points at issue, we need to know the facts as alleged by the respondent in his Reply to the Notice of Appeal and his argument in this regard.

(A) STATEMENT OF FACTS

1. He denies, as written, the first paragraph of the Notice of Appeal.

2. He admits. having received the explanations mentioned in the second paragraph of the Appellant’s Notice of Appeal, although his conclusions were not the same.

3. In assessing the Appellant for the 1972 and 1973 taxation years, the Respondent relied on the following presumptions of fact.

(a) At the time in question, the Appellant’s books were not kept properly and it did not have its financial statements audited.

(b) The Appellant incorrectly deducted from its income for the 1972 taxation year a penalty of $131.09 it received for failing to send its return to the Minister of National Revenue on time.

(c) In respect of the 1972 taxation year, the Appellant incorrectly charged the following capital expenditures as operating expenses:

(i) cost of purchasing certain equipment	$3,407.47
(11) costs incurred for major improvements
to the hotel building	$5,685.57
(iii) cost of purchasing certain kitchen. table and linen items	$4,689.02
(iv) labour costs incurred for major improvements
to the hotel building	$1,489.50

(d) Mr Real Gauthier, a student and son of the majority shareholder, has for a number of years worked during the summer exclusively for the appellant's business.

(e) The appellant paid Mr Réal Gauthier an exorbitant bonus of $20.000 for the 1972 taxation year in addition to his salary of $1,900.

(f) An audit of the appellant’s books in respect of the 1973 taxation year revealed additional sales of $39.011.63.

(g) The appellant incorrectly deducted from its income for the 1973 taxation year a penalty of $888.17 it received from the provincial Minister of Revenue on a sales tax matter.

(h) The appellant incorrectly charged the following capital expenditures as operating expenses for the 1973 taxation year:

(i) cost of purchasing certain equipment	$ 752.26
(ii) costs incurred for major improvements
to the hotel building	$1,765.40
(iii) costs incurred for installing a heating system in the
building located at 247 Brochu in Sept-lles	$ 449.94

(iv) cost of purchasing certain kitchen, table and linen items $2,751.96

(v) labour costs incurred for major improvements
to the hotel building,	$2.263.00

(i) In respect of the 1973 taxation year the appellant entered expenses from November 1973 as accounts payable at October 31, 1973, thereby incorrectly reducing its net income by $7,647.98.

(B) STATUTORY PROVISIONS AND SUPPORTING REASONS

4. The respondent relies on, inter alia, section 3, paragraphs 18(1)(a), 18(1 )(b), 20(1)(a) and section 67 of the Income Tax Act (SC 1970-71-72, c 63, aS amended).

5. The Respondent duly refused to consider as an operating expense the bonus paid to a summer employee, a bonus which was ten times more than what he had earned in the year.

6. The respondent duly assessed the Appellant’s capital expenditures and allowed the correct depreciation.

7. The appeal is incorrect in fact and in law.

FOR THESE REASONS, may it please the Tax Review Board to dismiss the Appellant s appeal in respect of the 1972 and 1973 taxation years.

3.2 When the points at issue were established by the parties at the outset, the appellant explained that the breakdown of the $39,011.63 in additional sales for 1972, mentioned in paragraph 3(f) of the Reply to the Notice of Appeal, was as follows:

4. Facts Entered in Evidence

4.1 Witnesses for the appellant were Messrs Bernard and Réal Gauthier, its shareholders, and Mr Yvan Flibotte, its manager, and for the respondent, Mr Jean Langevin.

4.2 According to the evidence, the appellant’s business was a family affair that its head, Mr Lucien Gauthier, had run for 20 years.

4.3 Counsel for the appellant sought to introduce as evidence bearing on the main points at issue an affidavit signed by Mr Lucien Gauthier. who has died since signing it. This evidence was not allowed. The legal reasons are explained below. Further. the same counsel indicated that witnesses could give the same testimony as the affidavit.

1972 — (1) Bonus to Réal Gauthier — $20,000

4.4 The appellant. in a resolution, declared the following bonuses in 1972: $20.000 to Dame Rachèle Gauthier and $20.000 to Mr Real Gauthier. the former sum having been allowed by the respondent as an expense and the latter having been disallowed. In 1973. the appellant declared another bonus of $20.000 for Bernard Gauthier, which the respondent allowed as an expense. All these bonuses were actually paid in 1978.

4.5 According to Mr Real Gauthier. these bonuses were declared because the company was in a more liquid position at the time. First. the witness was quite happy to receive this bonus, and second, he believed he had earned it.

4.6 According to the witness. he had worked in the hotel since he was 16 (he was 21 in 1972). replacing, among others, employees on vacation. and performing all sorts of jobs required under the circumstances: from barman to cook and including assistant to the administrator. manager and night watchman. According to the witness, this bonus policy was intended to recompose persons for past services and also to encourage them to continue in the future.

4.7 In the first years he worked—1967 and 1968—when he was 16 and 17. he was not paid. In 1971. ne earned $1.540: in 1972, $1,900: in 1973. $1.400: in 1974. $6.250: and in 1975. $8.595. He began law studies in 1972 and was admitted to the bar in 1976. Even though, in the latter year. when he had not yet been admitted to the bar, he worked at the hotel—he acted as cashier. attended meetings of the board of directors. and so on—he was not paid.

4.8 Mr Yvan Flibotte. the hotel manager in 1972. described Mr Réal Gauthier as a jack of all trades in 1972 and 1973.

1972 — (2) Cost of purchasing certain equipment — $3,407.47

4.9 In so far as the equipment purchased in 1972 is concerned, the Board notes that no evidence was presented. Construction materials were mentioned. as will be explained below. but not equipment. The respondent nevertheless admitted the quantum of this amount in paragraph 3(c)(i) of his Reply to the Notice of Appeal. His complaint was that the appellant had deducted it as an operating expense, rather than capitalizing it and then taking depreciation on it.

1972 — (3) Labour costs incurred for improvements to the hotel — $1.489.50

4.10 According to Bernard Gauthier, it was not easy to obtain woodworkers in 1972. In this period of economic growth on the North Shore, all the major contractors employed woodworkers and carpenters. Before these labourers would agree to perform work at the hotel, they wanted to be guaranteed that they would be paid in cash and not by cheque. This was standard practice for hiring woodworkers, otherwise they would not work. This explains why sums were paid to workers without any. cheques being issued or there being any supporting vouchers for these expenditures. No evidence was presented, however, to support the specific amount of $1,489.50. The quantum of this amount, like the item regarding the purchase of equipment, is admitted by the respondent in paragraph 3(c)(iv) of his Reply to the Notice of Appeal. The respondent alleged that the appellant had not capitalized it, but counted it as an operating expense.

1973 — (1) Cost of construction materials — $14,900

4.11 During the 1972-1973 fiscal year, in the fall of 1972 to be precise, construction work costing several tens of thousands of dollars was begun. Repairs were made to 30 rooms where the gyproc walls were recovered with prefinished panelling. Doors, curtains, bedspreads, doorknobs and windows were also replaced. As there were no supporting vouchers, the Minister of National Revenue did not allow construction materials worth $14,900 as expenses. According to Mr Yvan Flibotte, about 45% of the construction materials were paid for by cheque and the remainder in cash. In that case, it was Mr Lucien Gauthier who made the purchases and paid for them. When materials were paid for in cash prices were lower.

4.12 According to Mr Flibotte, the hotel used a cash-receipt, cashdisbursement bookkeeping system. The money was given to Mr Lucien Gauthier, who made deposits or paid cash for the necessary expenses. Bernard Gauthier had himself seen his father take $1,000 in cash and pay a supplier. Moreover, the accountant established the expenses solely on the basis of cheques.

All three of the appellant’s witnesses testified that the president of the appellant, Mr Lucien Gauthier, made decisions alone without consulting anyone. Furthermore, he began to suffer from an illness in 1972 which frequently forced him to be away from his work.

1973 —■■ (2) Bonus to Bernard Gauthier — $9,000

4.13 According to Mr Bernard Gauthier, he was authorized by his father to take money from cash whenever he needed. it. He stated that in addition he was earning $200 every two weeks. According to Mr Jean Langevin, the respondent’s witness, Bernard Gauthier earned $3,600 in 1973. Before Bernard left on a trip to Mexico, his father authorized him to take $3,000, which he did. leaving a note indicating how much he had taken. Mr Flibotte clearly remembered having seen these notes when he was doing the cash, and he gave them to Mr Gauthier senior. Mr Gauthier took into consideration the fact. that Bernard worked from 16 to 18 hours a day, and that he had begun to work at the hotel at the age of 14. From the end of 1972 and during 1973, he took and received $9,000. As the appellant’s fiscal year ended on October 31 of each year, $9,000 was claimed for 1973.

1973 — (3) Wages for two part-time employees — $10,000

4.14 It was necessary to hire two additional employees in 1973 to maintain good order in the tavern; because of the heavy influx of workers to Sept-Iles who were from all corners of the province and, belonging to two large labour unions, were not always on good terms. To avoid fights and damage of all kinds, the witnesses felt that if they hired a doorman and bouncer for the tavern from among the workers, it would have a psychological effect. The two employees knew their own kind and how to talk to them. There were always two employees, though they were not always the same ones. These employees, like the woodworkers, wanted to be paid in cash, as a condition of working as doorman and bouncer. These men, incidentally, earned big wages elsewhere. They worked evenings and weekends and asked for and received about $100 in cash per week.

1973 — (4) Labour costs incurred for improvement to the hotel — $2,263

4.15 The facts entered in evidence are similar to those described in paragraph 3.10.

The respondent admitted the quantum in paragraph 3(h)(v) of his Reply. What the respondent alleged was that the appellant counted it as operating expenses. whereas this amount was a capital expenditure subject to depreciation.

5. Comments

5.1 Refusal to accept as evidence the affidavit of the late Lucien Gauthier

The respondent objected to the evidence that the appellant sought to introduce by filing an. affidavit that Mr Gauthier, the appellant’s former president, had signed shortly before his death.

The objection was upheld. The statements of a deceased person are admissable in evidence only in so far as they are against his interest. Nadeau and Ducharme deal with such statements in Volume 9 of the Traité de droit civil du Québec (treatise on Quebec civil law), paragraph 202 et seq. In the case at bar, the affidavit was of necessity in favour of the appellant, in which the deceased was the principal shareholder, and so cannot be accepted. The argument that the company and the shareholder are two different things cannot apply to this case. As the latter had shares and left them to his heirs, these shares are personal property, the value of which is affected by whether or not the company is taxed. Being against the appellant’s interests, the Statement was also against the interests of the deceased and his heirs.

5.2 Cost of equipment and labour

According to the appellant’s evidence as given in paragraphs 4.9, 4.11 and 4.15, the cost cf certain equipment ($3,407.47) and labour incurred for improvements to the hotel ($1,489.50 in 1972 and $2,263 in 1973) ought not to be considered as operating expenses but as Capital expenditures subject to depreciation. There is nothing in the evidence to persuade the Board that the burden of proof on the appellant was discharged. No evidence was presented with respect to the equipment, and as for the labour costs, we can readily assume that the workers repaired 30 rooms; these are capital expenditures subject to depreciation.

5.3 Bonus to Réal Gauthier — $20,000

This bonus was paid to a person who, for 5 years, worked for the company, lending a hand with everything. For 2 years he was not even paid. Though this person was not a full-time employee because he was still attending school, he worked weekends and frequently in the evenings. The sum was voted to Réal Gauthier when he began his law Studies in 1972. The Board believes that Mr Lucien Gauthier, who was then the moving force in the company, paid this amount not only for past services, but for forthcoming ones as well. According to the evidence presented, Real Gauthier was, of all the family members connected with the hotel, the only one who would have pursued higher education. In the normal course of events, he would become a valued adviser to the company. even though he was not the majority shareholder. In the Board’s view, this is a reasonable approach for a father of a family, who had spent most of his life building up a business, to take. He profits from a surplus of liquid assets to compensate his child for services already rendered, and at the same time secures his participation in the family business for the future.

The Board does not feel it is necessary to be a shareholder in order to receive a bonus; one need only be an employee. Further, it is not necessary for all employees to receive bonuses for them to be qualified as such. The employer need only have a good reason for giving a bonus. The Board believes that in the case at bar the reason was justified.

The respondent maintained that this expenditure was made solely to reduce the company’s revenues so that it could profit from all the tax advantages in section 125 of the new Act, which pertains to small businesses. The Board still believes in the old principle that anyone can use his assets so that he pays as little tax as possible, provided that the way he uses them falls within the framework of the law.

While it is true that fraud is not allowed, a justified expenditure is, even if it had the effect of reducing the taxpayer’s income.

5.4 Bonus to Bernard Gauthier — $9,000

The evidence presented leaves no doubt in the Board’s mind that the $9,000 taken by Bernard Gauthier, and authorized by his father, was in connection with his work. At that time, Bernard worked from 16 to 18 hours a day, according to the uncontradicted evidence, thereby earning $3,640 per year, according to the respondent. The $9,000 was a benefit received in connection with his job. a benefit that constituted a disbursement by the company and is hence allowable as a deduction by the company.

5.5 Cost of construction materials — $14,900 (1973)

The evidence in this case is that, at the end of the 1972 fiscal year, but especially during the 1973 fiscal year, major repairs, among other things, were made to 30 rooms in the hotel. We know that part of the materials were purchased with cash for which there are no supporting vouchers. Moreover, the accountant who prepared the financial statements only used cheques and supporting vouchers and did not take into account cash purchases unsubstantiated by supporting vouchers.

Thus, additional amounts of $4,383.44 and $10,121 shown on the appellant’s financial statements (deducted from the capital cost) for the years ending October 31, 1972 and October 31, 1973 respectively, no doubt referred to the repairs (walls, doors and so on) made to the 30 rooms, and in particular. to the cost of the materials, for which there are supporting vouchers to confirm the purchase. The amount of $14,900 for materials claimed here by the appellant. for which no supporting vouchers can be furnished, is thus added to this declared amount of $14,504.44 ($10,121 + $4.383.44), which would make the total cost of the materials $29.404.44.

A further $7,340.97 (admitted by the appellant elsewhere) should be added to this amount if we consider the amounts already included by the respondent, as appears in the Reply to the Notice of Appeal.

If the figure of $14,900 is correct. the grand total of the cost of materials would thus amount to $36.745.41. although no one can say for certain. We must know the total amount of the cost of materials. The only evidence of the total approximate cost of the materials is that, according to the manager, l\/lr Flibotte. about 45% of the materials were paid for by cheque; the remainder were paid for in cash for which there are no supporting vouchers. If the Board takes this as a base, the total cost of the materials would be $27,250 ($14,900 — 55 x 100), that is, a difference of $9,500 ($36.750 —. $27,250) with respect to the. total. The sum of $14,900 would therefore be overestimated by as much, leaving only $5,400.

The manager’s assessment does not. however, constitute the best evidence. Further, as the total approximate cost is. of necessity, calculated from the $14,900 and this amount was overestimated by $9,500, how can we validly use this base? What other base can the Board use to allow all or part of these expenses of $14,900? There is none, regardless of the fact that there are no supporting vouchers.

The burden of proof was on the appellant’s shoulders, and was not discharged; for this reason, the Board cannot accept this amount as expenses. In any case, this would be a capital expenditure subject to depreciation.

5.6 Wages for two part-time employees — $10,000 (1973)

In accordance with the evidence described in paragraph 4.14, the Board believes that the appellant had to pay out a substantial sum, perhaps even as much as $10,000, to hire doormen and bouncers to work in the tavern. The Board further believes that it was not possible to pay them by cheque and that the only way to obtain their services was to pay them in cash. Finally, the Board believes that their services were necessary.

Should the lack of supporting vouchers prevent the Board from allowing the full amount as expenses? There is, in fact, no section of the Act that compels the taxpayer to file supporting vouchers.

According to general accounting principles and methods, however (which apply to taxation matters unless there is a special section of the law to the contrary: Royal Trust Co v MNR, [1957] CTC 32; 57 DTC 1055), supporting vouchers are required.

If the Board in the ordinary course of administering the law allows a taxpayer expenses without supporting vouchers, it places this taxpayer on the same footing as the one who keeps all his supporting vouchers.

Such an approach may, however, be justified in special cases, as for example one in which the supporting vouchers were destroyed by’ a fire or some other means, and there is moreover a strong presumption that the expense was incurred.

Since the supporting vouchers cannot be obtained, does the case at bar not constitute a special case?

The Board is of the opinion that if the bookkeeping system had been maintained more efficiently, payment of expenses in cash would also have been recorded even though it was not possible to obtain a supporting voucher at the time.

It would then be conceivable to allow the expense in full if it could be substantiated elsewhere, and if the witnesses’ credibility was not placed in doubt.

There are a number of judgments dismissing the total expense claimed without supporting vouchers; in most cases, only one-third of the amount is allowed, and even rarer still, a half is allowed, depending on certain circumstances. In all these cases, however, supporting vouchers could have been obtained. In the case at bar, given on the one hand the impossibility of obtaining supporting vouchers from those concerned, that is, the employees hired, and on the other, the inadequate bookkeeping system, the Board feels that it is fair to allow 60% of the expenditure claimed.

6. Conclusion

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

Appeal allowed in part.