Attorney General for Quebec v. Steinberg’s Wholesale Groceterias Ltd., [1945] CTC 223

THE COURT has heard the witnesses; examined the proceedings and documentary proof ; heard the Parties, by their Counsel, upon the merits of the present case; and has, upon the whole, deliberated.

This action is based upon that part of the Corporation Tax Act in force in 1938 (i.e. cap. 26 of the Revised Statutes of 1925 as amended up to that date) which relates to the taxation of profits.

Section 5a of the Statute provides for a tax of 214% of the profits of certain corporations (of which ‘Defendant is admittedly one), after deducting ‘‘only actual expenses.’’ Subsection "‘d‘‘ of section 5a reads as follows:

"‘d. That the Provincial Treasurer may disallow as a deduction from profits the whole or any part of any salary, bonus, commission or directors’ fees which he may consider in his Opinion in excess of what is reasonable for the services performed.”

In accordance with the Statute, Defendant submitted to the Provincial Treasurer, on the form designated as C.1, a Statement covering its operations for the fiscal period ending August 10th, 1938 (Exhibit P-1). This Statement was apparently accepted by the Provincial Treasurer, with the exception of the following item, which appears among the "‘Liabilities'' and was deducted as an expense ’ ‘ :—

"Bonus payable $100,000.”

The Provincial Treasurer disallowed this item in toto and demanded from Defendant (in addition to the amount which the later admitted as payable) 212% thereof, namely $2500. The position taken at that time by Defendant is set forth in a letter from its solicitors to the Revenue Department, dated September oth, 1939, (Exhibit P-5), which reads as follows :—

" " Provincial Revenue Offices,

Parliament Building,

Quebee, Que.

Dear Sirs,

Messrs. Steinberg’s Wholesale Groceterias Limited have consulted us with reference to your statement No. 51863, dated March 1st, 1939, in which you deduct from their profits for the fiscal year August 10th 1937 to August 10th 1938 an item referred to as Bonus in the sum of $100,000.00. This item has been erroneously called bonus, when in fact it represents salary adjustment in respect to the salaries payable to several officers and employees of the Company.

From a very small beginning, this Company has made a steady growth, those responsible for the progress contenting themselves with very nominal salaries, with the understanding that the necessary adjustment in salaries would be made as soon as business conditions warranted. As you will see from the balance sheet for the year in question, the Company’s income was quite substantial and because of that the adjustment in salaries was effected. The books of the Company show that these adjustments were made in the salaries of the officers and employees in question and that is why the company answered question No. 96 of form C-1 in respect to payment of bonuses in the negative, considering that the sum in question constituted, as it does in fact, salary increases rather than bonuses. The Revenue Office of the Province of Quebec has benefited materially over the past number of years due to the fact that the Company’s officers and employees were satisfied to accept small salaries in order to encourage the Company’s growth, and it seems to us that the Company should not be penalized by this laudable desire on the part of its officers and employees. The books and records of the company are available for your inspection and you will find therein confirmation of the facts herein set forth.

Under these circumstances, in view of the fact that the $100,000.00 has been erroneously termed bonus, when in fact it represents salary adjustments, we believe that your Department should not consider this item as taxable. We are satisfied liat verification of the Company’s books and records by tue Provincial Treasurer will satisfy him that the salaries paid to the officers and directors of the Company are not in excess of what is reasonable for the services performed as required by Section D of Article 5a of the Act. The profits reported by the value of the services on the part of those who have contributed to such earnings.

Yours truly,

ROBINSON & SHAPIRO.”

The Department replied by a letter dated September 30th, 1939, in the following terms (Exhibit.P-6) :

“Messrs, Robinson & Shapiro, Advocates,

Transportation Building,

132 St. James St. W.,

Montreal, P.Q.

Dear Sirs,

RE: STEINBERG’S WHOLESALE GROCETERIAS, LIMITED.

This will acknowledge receipt of your letter of September 5th pertaining to the Crown’s claim for tax on profits in the case of the above mentioned company.

You will find herewith enclosed copy of ruling No. 6 issued under the Corporation Tax Act which deals with the question of bonuses.

In view of the provisions of the ruling in question, I regret to advise that the assessment issued in this case cannot be revised.

Yours truly,

THE CORPORATION TAX SERVICE.

J. M. Gosselin,

Special Officer.”

The enclosure mentioned in this letter (Exhibit P-6) was a printed sheet of paper (Suitable for inserting in an office copy of the Statute) reading as follows:

" " Instructions and Regulations of the Provincial Treasurer concerning the application of the Corporation Tax Act, R.S.Q., 1925, Chapter 26.

PART 6

(Applying only to the tax on profits)

SALARIES, BONUS, COMMISSIONS AND DIRECTORS’ FEES

(Ch. 26, section 5a, par. d.) SALARY

Shall be disallowed as a deduction from profits:

1. The whole of any salary paid or payable to a person who is not an officer nor an employee of the company or corporation.

2. That part of the salary which is inconsistent with the services rendered, when paid or payable to a person who is an officer or employee of the company or corporation and at the same time a shareholder thereof, and such inconsistency shall be measured by the differences in salary which would be considered reasonable if it was paid to another person not a shareholder but doing a similar work and having the ability and experience of the shareholder,

3. The above instructions numbered 1 and 2 shall apply, whether the salary has been established by the Board of Directors, or otherwise.

BONUS

Shall be disallowed as a deduction from profits:

4. Any bonus paid or payable to a person, whether such person is a Shareholder or is an employee or is both a shareholder and an employee of the company or corporation, provided that when the bonus consists in the contribution of the company or corporation towards a pension fund which is created for the general benefit of its employees, the amount of such contribution made during the year may be allowed.

COMMISSIONS

Shall be disallowed as a deduction from profits:

5. The whole or any part of a commission which is not earned, 6. The whole or any part of a commission which is at a rate in excess of the one set forth in the contract passed between the company or corporation, and its employee or agent.

DIRECTORS’ FEES

Shall be disallowed as a deduction from profits:

7. Any amount of Directors’ fees paid or payable during the year, which is excessive having regard to the extent of the operation of the company or corporation.

Before the Province instituted the present action, Defendant discussed the question of this $100,000 bonus” with the Federal Income Tax Department, which latter eventually allowed $55,422 thereof to be deducted as increased salaries to certain employees and disallowed the balance of $44,578. (See Exhibits D-2 and D-3.) After this decision of the Federal Income Tax Department had been made, Defendant, by its solicitor in the City of Quebee, wrote to the Provincial Controller of Revenue a letter dated February 22nd, 1948, and reading as follows (Exhibit D-l-a) :—

"‘With reference to our letter to you of the 16th inst., and our previous conversations, please find herein a cheque from the above named company payable to the Provincial Treasurer in the amount of $1335.80.

This cheque is in payment of the profits tax, at the rate of 21%, upon an amount of $44,578, or a tax payable of $1114.45, with interest at 5% computed up to the 18th inst. The interest amounts to $221.35, thus making a total sum of $1335.80.

The amount of $44,578 above mentioned represents that part of the additional salaries paid to the Officers of the Company which the Commissioner of Income Tax disallowed as a deduction from taxable income for fiscal period ending August 10th, 1938, the said Commission having allowed as an expense the balance of such additional salaries.

The present payment is made under protest and reserve, without prejudice to any of the Companys rights and without admission of liability. It must not be considered as an acknowledgement or admission that the decision of the Commissioner of Income Tax in the matter was well founded, for this payment is solely made for the purpose of effecting a compromise. The Company therefore expressly reserves to itself the right to claim the recovery of the said sum of $1335.80 in case proceedings should ever be instituted by the Crown, in an attempt to claim any further amount of tax in respect of such additional salaries. ‘

So far as the record before the Court shows, there was no further correspondence between the parties and the action was served on the 2nd July, 1943. The amount sued for ($1,673.37) represents the amount which the Provincial Treasurer considers to be due on the 2% profits tax above referred to, less what Defendant has already paid.

It is apparent, from the foregoing, that the sole question for this Court to decide is whether or not the Provincial Treasurer acted legally and justifiably in disallowing^ as a deductible expense, the aforseaid item of $100,000.

At the trial, which took place on the 7th May, 1945, Plaintiff offered no testimony. Exhibits P-1 and P-2 were already in the record. Plaintiff produced Exhibits P-3, 4, 5 and 6. The parties, in open Court, admitted that all the Exhibits produced made proof of their contents, including their respective dates.

Exhibits D-1 and D-2 had already been produced by Defendant. Exhibit D-l-a was produced as the original of Exhibit D-1.

The following additional proof was adduced by Defendant:

1. HARRY COWAN, controller of the Defendant Company : At no time did any representative of the Provincial Government examine any of the company’s books or make any enquiries, other than the written enquiries in the correspondence already produced.

The witness was then asked to explain the item of "bonus $100,000.00.’’ Plaintiff’s Counsel objected because the item was mentioned in the return as a ‘‘bonus’’ and this was confirmed in a subsequent letter. The objection was reserved; but the Court, after consideration, now dismisses it, because the name given to an item does not necessarily determine the character thereof.

The witness then explained that the item constituted increases in salaries to certain employees of the company, as indicated in the schedule or analysis forming part of Exhibit D-3. This schedule indicates for each employee concerned: the regular salary, the bonus, the total, the amount allowed by the Federal Income Tax Department, and, finally, the amount disallowed by that Department. The witness produced, as Exhibit D-4, a Statement showing the percentage of wages of certain employees to the total sales of the Company in the years 1931 to 1938 inclusive, as well as the percentage of profits and salaries to the sales. He also produced as Exhibits D-5 and D-6 printed leaflets of the Finacial Post Corporation Service referring respectively to Thrift Stores Limited and to Dominion Stores Limited, which were intended to show that the salaries thus increased by the bonuses were reasonable in the circumstances. He added that the amount of the bonus of $100,000.00 distributed as indicated in Exhibit D-3 was approved by the Directors on the 6th of August, 1938, and was confirmed by the shareholders on the 16th of that month.

In Cross-examination, the witness testified that the amount of the regular salaries had been determined by the company and had been paid weekly; but 1938 was not the first year in which bonuses were paid.

2. NATHAN STEINBERG, Secretary-Treasurer of the Defendant Company and produce buyer thereof: This witness testified that the Mrs. Steinberg mentioned in Exhibit D-3 was the mother of the family and had founded the company. He explained the duties of the executive officers, all of whom devoted their entire time to the affairs of the company.

3. GERALD HAWTHORNE, chartered accountant: This witness is a member of the well known accounting firm of P. S. Ross & Sons and has been in practice for twenty-five years, with considerable experience in auditing the books of companies doing business similar to that of the Defendant Company. Under an objection by Plaintiff’s Counsel, which was first reserved and is now dismissed, the witness expressed the opinion that the salaries, including the part of the bonus allowed by the Federal Income Tax Department, were reasonable, in view of the nature and the amount of the business done by the Defendant Company.

The above constitutes the substance of the proof offered by Defendant.

Plaintinf made no proof in rebuttal.

The position taken by the Plaintiff is substantially as follows :

Sub-paragraph "‘d‘‘ of Section 5a of the Statute gives the Provincial Treasurer the authority to disallow, inter alia, "‘the whole or any part of any salary, bonus . . . .” The Provincial Treasurer has disallowed the bonus in question and that is the end of the story. Referring to the so-called ruling No. 6 mentioned in the Department’s letter of September 30th, 1939 (Exhibit P-6) and cited in extenso on pages 226 and 227 hereof, Plaintiff’s Counsel relied on Section 18 of the Statute, which reads as follows:

" 4 The Provincial Treasurer may :

a. Authorize a revenue officer to establish the forms of statements required under this act, which forms shall be used in its application ;

b. Establish and adopt regulations to determine the part of the profits which is taxable, in the Province, of any company or corporation doing business both within and outside of the Province, which regulations shall be followed in the application of this act;

e. Determine what constitutes investments within the meaning of section da, 25-26 Geo. V, c. 15, s. 6.”

The proof, however, indicates that the Defendant Company does not do any business outside of the Province; consequently, subsection b of Section 18 obviously does not apply.

It is apparent, therefore, that the only authority under which the item in question could have been disallowed is sub-paragraph "‘d‘‘ of Section 5a of the Statute. This sub-paragraph clearly grants considerable discretion to the Provincial Treasurer; and had the Provincial Treasurer really exercised his discretion, this Court would have hesitated (and would, perhaps, have been incompetent) to interfere therewith. It is, however, obvious from the proof that the decision of the Treasurer or the Department in this case was made automatically, by applying the so-called Regulation 6. This Court cannot consider that the provision of this regulation referring to bonuses constitutes a proper exercise of discretion. It is a sweeping regulation, which takes no account whatsoever of any special circumstances which might exist in any special case ; and there is not the slightest indication that the Treasurer or any member of his deparament gave any consideration, en connaissance de cause, to the question as to whether or not the whole or any part of the salaries or bonus in question was ‘‘in excess of what is reasonable for the services performed”? (sub-paragraph "‘d‘‘ of Section 5a).

The Court, therefore, finds that the Provincial Treasurer did not, in fact, exercise the discretion granted to him by the said subparagraph ‘‘d’’; and that his action (or that of his departmental employees) in rejecting in toto the item of $100,000.00, without any real enquiry, was ultra vires and illegal. Consequently, the Plaintiff’s action fails.

FOR THE FOREGOING REASONS:

THE COURT:

CONSDERING that the sole question at issue is whether or not the item designated as "‘bonus $100,000.00’’ is Exhibit P-1, or any part thereof, should be admitted as part of the expenses deductible from the gross profits of the Defendant for the fiscal period ending August 10th, 1938, under the provisions of the Corporation Tax Act then in force;

SEEING Section 5a of the said Act;

CONSIDERING that sub-paragraph "‘d‘‘ of the said section grants to the Provincial Treasurer discretion to ‘‘disallow as a deduction from profits the whole or any part of any salary, bonus . .. which he may consider in his opinion in excess of what is reasonable for the services performed’’;

CONSIDERING that, in the present case, the said item was disallowed in toto without any real enquiry on the part of the Provincial Treasurer or any of the employees of his department and that there was not before the Provincial Treasurer or any of the employees of his department adequate information upon which to base an opinion as to whether or not the amount was reasonable for the services in question ;

CONSIDERING that, in consequence, no real discretion was exercised either by the Provincial Treasurer or by any of the employees of his department;

CONSIDERING that the Provincial Treasurer of the employees of his department, in thus rejecting in toto the said item, acted ultra vires of the powers conferred by the said Act ;

CONSIDERING that, in view of the foregoing, Plaintiff’s action is unfounded and should be dismissed ;

DOTH DISMISS Plaintiff’s action sauf recours, s f il y a lieu, and DOTH RECOMMEND that the costs of the action be paid by the Crown to the Attorneys for the Defendant.