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Citation: 2005TCC359
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Date: 20050524
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Docket: 2002-425(IT)G
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BETWEEN:
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SANDRA WELTON,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Sarchuk J.
[1] During
the 1996 taxation year, the Appellant was a self-employed real estate agent
working for the brokerage firm, Countrywide Associates Ltd. In computing income
for that year, she claimed $32,000 in management fees and $1,027.50 in meals
and entertainment expenses. By Notice of Reassessment dated October 4, 1999,
the Minister of National Revenue disallowed the deduction of the management
fees and $704.58 of the meal and entertainment expenses.
Background
[2] The
Appellant earned a Bachelor of Arts degree at Western University and a teaching degree at Althouse College. In
1985, she married John Zebulon Welton ("Welton"). She continued
teaching until 1989 when the first of three children was born and she went on
maternity leave. Two more children followed, the last in July 1994 and
throughout this period, she remained on extended leave.
[3] Welton's
family had been involved in the land development business for a number of
years. In 1984, after completing his university education, he began to work for
United Lands Corporation, a company owned by his father and uncle. He described
its business as a combination of actual construction and land development. It
ran into financial difficulties in 1991 and his employment was ultimately
terminated in May 1996 when all of its assets had been sold. Prior to leaving
United Lands and in anticipation of its demise, Welton and his brother
"set up Welton Developments, a condominium townhouse project". As
well, John Welton Custom Homebuilding Limited (Sunvale Homes) was registered in
1996, a manager was hired and construction commenced that year.
[4] In
1991 and 1992, both the Appellant and her husband enrolled in a series of
courses to prepare them for registration as real estate salespersons. At some
point of time, Welton learned that he could not become registered because
pursuant to the relevant legislation, his involvement with United Lands
exempted him from registration. The Appellant, for her part, completed the
courses and was registered. She testified that given the flexible hours and her
demanding schedule as the mother of three children, a decision was taken not to
return to teaching but to become more actively involved in real estate sales.
She sold her first property in 1994, a residential home constructed by her
husband, and continued to build her practice.
[5] During
the taxation year in issue, the Appellant continued to carry on her real estate
business from the family residence in Mississauga. Although
Welton's employment in his father's business was terminated in that year, he
continued to be actively involved in condominium construction with his brother
and in Sunvale's construction activities. For the latter he used the family
residence "as sort of a model … to attract customers for our custom home
building business - - my custom home building business". He believed it
was an effective tool and attracted potential customers which provided "an
opportunity for me to obtain construction contracts". In this context, he
said the Appellant's registration as a real estate sales person was an
important adjunct since she could offer her services to help his potential
customers sell their current homes and thus provide them with funds to finance
construction of new homes or to buy new homes from Sunvale. In the course of
her testimony, the Appellant stated that Welton provided assistance to her in
showing houses, bringing potential customers to her and offering extra services
because of his knowledge of construction, zoning, renovation, and the value of
custom homes in the market. She also observed that prospective purchasers who
approached her as a real estate sales person provided him with a potential
customer base for Sunvale Homes from which the family benefited.
[6] With
respect to the fees in issue, Welton said he took "the responsibility of
discussing with the accountants the tax returns … Sandy would leave it to me. And when the tax returns needed to be submitted, I
would get her to sign them and I would send the cheque in and return the tax
returns". The management fees in the amount of $32,000 were determined
following the end of the 1996 taxation year in the course of a discussion with
the accountant. It was conceded by the Appellant that no contemporaneous record
was kept of the services that are alleged to have been performed by Welton nor
did he make any note of the time spent or the nature of the services provided
to any of her clients. Welton also conceded that the fee was decided as a
single global number, the basis for which was that "the accountant had
suggested that that was a reasonable figure" and was acceptable to him and
the Appellant. No evidence whatsoever was adduced to establish the rationale
underlying the accountant's conclusion.
Appellant's submission
[7] Counsel
argued that in the taxation year in issue the Appellant's husband had the time
to provide valuable services to her real estate business. Specifically, his
knowledge of matters such as renovations, business construction, environmental
considerations, planning and construction budgeting for purchasers and vendors
provided significant value-added service to her customers. As well, certain
clients were introduced to the Appellant and a referral fee was paid to her
husband because they came to her through his other contacts, mainly his
father's business and other relationships. Thus, notwithstanding that Welton
was at the same time soliciting construction business for his own company, it
should not take away from the fact that his ability to provide her clients with
information capable of maximizing the sale price of their own homes was a
significant value‑added service for her customers.
[8] Counsel
also observed that Welton did substantially significant work for each of the
Appellant's clients such as providing them with construction budgeting and
dealing with other aspects of the various transactions which were beyond the
ability of the Appellant to deal with. This arose from the opportunity presented
by the failure of Welton's father's business enabling the Appellant to avail
herself of his expertise, a factor that other spouses and real estate agents do
not have. Thus, the expenses claimed by the Appellant on her tax return for
1996 are a reflection of the arrangement she had with her husband, i.e. that
the two of them would be partners in the situation. Counsel also made reference
to Costigane v. Canada
to support the position that there is "nothing illegal or inappropriate
for a taxpayer to arrange his affairs to provide for some income‑splitting.
That is not the issue. The issue is the reasonableness of the
expenditures" and in this instance, the evidence was clear Welton provided
certain relevant services and that the value placed by him on those services
was reasonable.
[9] Counsel
for the Appellant also submitted that the fact that Welton had a number of
different projects going during the relevant taxation year was an argument
against the Minister's position that he was providing services to the Appellant
for no compensation. He could have done something else in real estate
development but, according to counsel, instead made a considered decision to
assist the Appellant to increase her commissions and provide services to the
general public. That was, counsel argued, an economic and not just a
"matrimonial natural love and affection decision". Furthermore,
counsel observed that the $32,000 which was claimed as an expense by the
Appellant was "roughly an equal division of what is left over", i.e.
after other expenses, and that was consistent with their position that a
partnership existed during that year which increased her commissions.
Respondent's submission
[10] Counsel advanced two arguments in support of the Respondent's
position. First, with respect to the deductibility of the management fees,
there was no evidence of a legal obligation requiring the Appellant to pay her
husband the $32,000 in issue. This submission is premised on two decisions of
the Federal Court of Appeal, Fédération des caisses populaires Desjardins de
Montréal & et de l'Ouest du Québec v. Canada and Wawang Forest Products Limited
et al v. Canada,
each of which suggests that an expense is incurred only when there is a legal
obligation to pay. Counsel specifically noted that in the Caisse populaires
decision, Desjardins J.A. made reference to R. v. Burnco Industries Ltd. et
al
and stated "this Court has consistently held that an expense is only
'incurred' within the meaning of s. 18(1)(a) of the Act when
there is an obligation to pay a sum of money … ". Counsel also observed
that a similar conclusion was reached in Wawang that "generally, a
taxpayer incurs an expense when it has a legal obligation to pay a sum of
money." Based on the foregoing, counsel argued that whatever the
arrangement between the Appellant and her husband was, it did not create a
legal obligation between them. If anything existed, it was a domestic
arrangement and not a legally binding agreement.
[11] With respect to the salary claimed, counsel for the Respondent argued
that no reasonable businessman "would have contracted to pay such an
amount having only the business consideration of the Appellant in mind".
In addition, counsel made specific reference to the fact that payment for services
included a substantial number of items that would normally have been the
responsibility of the Appellant's clients or which related directly to Welton's
construction business. For these reasons, the expenses were not deductible by
reason of the provisions of section 67 of the Act.
Conclusion
[12] The issue before the Court is whether the management fees of $32,000
paid to Welton are deductible by the Appellant in calculating her 1996 taxable
income. There is no dispute that an expense is incurred
for tax purposes only when a taxpayer has a clear legal obligation to pay the
amount in question. Although there is no definition of expense in the Act,
in Burnco, Pratte J. defined the term as follows: "In our opinion, an expense, within
the meaning of paragraph 18(1)(a) of the Income Tax Act, is an
obligation to pay a sum of money. An expense cannot be said to be incurred by a
taxpayer who is under no obligation to pay money to anyone …". As
well, in The Law of Contract in Canada, G.H.L. Fridman wrote:
… A contract can only arise if
there is the animus contrahendi between the parties. Without the
expressed or implicit intention that a contract should emerge as a result of
the language or conduct of the alleged parties, no contractual obligations can
be said to exist and be capable of enforcement. Hence the offer that is made
must be an offer to contract involving the creation of legal relations. …
Paragraph 18(1)(a) imposes a purpose test for the deductibility of
amounts in computing income from a business or property. It also precludes a
deduction if the amount cannot properly be described as an "expense
incurred". Although these words are not defined in the Act, case
law indicates quite clearly that an expense is incurred for tax purposes when a
taxpayer has a legal obligation to pay the amount in question.
[13] There is substantial merit to the Respondent's position that what
existed between the Appellant and her husband was nothing more than a domestic
arrangement which was not and could not be considered to have created a legally
binding agreement between them. I have reviewed the evidence and found nothing
to support the conclusion that the Appellant and her husband had entered into
an arrangement which was intended to result in or create legal consequences. This
conclusion is supported by the testimony of both the Appellant and her husband
and in particular, their characterization of the arrangement. By way of
example, Welton testified that:
… we had discussed it and we had
agreed that it was a good way for us to continue to earn an income because I
was not being paid by United Lands anymore, and because I was not eligible to
register as a sales person and have access to MLS, but Sandra was, that I would
generate as much business as I could for Sandra, and then of course when she
was paid, it would be money that our family would use.
Such an arrangement, in my view, falls far short of giving rise to a legal
obligation. Furthermore, in response to counsel's questions, both Welton and
the Appellant agreed that this was the basis upon which Welton and the
accountant concluded that $32,000 was a reasonable figure. In my view, the
testimony of the Appellant and her husband raised a substantial question as to what they actually had in mind and whether any
discussions they may have had crystallized into a definite offer capable of
being accepted. Absent such evidence, I have concluded that no contractual
obligations existed. Accordingly, the Appellant did not incur the management
fees in issue and is not entitled to deduct the expenses claimed pursuant to
paragraph 18(1)(a) of the Act.
[14] In
the alternative, the Respondent relying on section 67 of the Act, submitted
that the amount of $32,000 for management fees was not reasonable in the
circumstances and would not have been paid in an arm's length transaction. Although
it is not essential to the foregoing conclusion, I am of the view that some
comment with respect to the evidence adduced in this context is warranted.
[15] To justify that the amount paid to Welton was reasonable, a number of
invoices were produced and both the Appellant and her husband testified with
respect to the transactions referred to therein.
All of the invoices were generated for the purposes of the Revenue Canada
audit, were totally retrospective, were not supported by any documentation and
were provided to Revenue Canada for the first time by way of letter
dated June 7, 2000. As
well, each one purports to have been issued in the month in which the alleged
services were completed in 1996, a statement which was patently false. It is
also a fact that in a letter to his accountant, Roger Chaplin, dated October
16, 2000, Welton wrote: "invoices were not rendered on a periodic basis
but were done on a year end basis in order to maximize convenience". This
statement is also false in that no invoices were ever issued on a year end
basis and, as Welton conceded, had in fact been created in the year 2000
specifically for the Agency for its review.
[16] I turn next to a few of the invoices
which both the Appellant and her husband testified reflected the services he
provided.
The Barrie
transaction – invoice ten
This invoice was for a "referral fee introduction to Scott and Rita
Barrie from contract for renovations and inspection". Rita Barrie was a
personal friend of the Appellant and retained her for both the sale of the Barrie residence and the purchase of a new home. The
Appellant contends that Welton added value to the sale of the Barrie residence by arranging to have his tradesmen fix up
their house. She further noted that "they needed several repairs of broken
windows and tiles, some of the patchy carpet areas, some painting" and
said that Welton "got his trades" to do the work and the Barries paid them directly. As well, they wanted his input with
respect to their new property regarding some work to the basement and the
possible location of a hot tub. Welton conceded that although in the ordinary
course, he would have charged a client for making those arrangements, he did
not do so in this instance because they were close personal friends and when
asked whether he considered the $2,500 to be a referral fee for introduction to
the Barries, he responded "that's what the invoice says, yes, that's
correct". On the other hand, when asked what the invoice related to, the
Appellant contradicted her husband stating "yes, and that is, I have
already indicated, it wasn't the introduction. I mean that's just a misuse of
words. It was fixing up their house. … ". It is reasonable to conclude
there was no basis for the payment of a "referral" fee. Furthermore
arranging for the tradesmen was a service rendered by Welton to his friends and
not to the Appellant. He may well have assisted them in achieving a higher sale
price for their property (and there is no evidence that was the case) but it is
unlikely that any arm's length agent (or in fact the Barries or any other purchaser) would have been prepared to pay him $2,500 for that
limited service.
The Wolfs transaction – invoices 6 and 9
The first invoice was for "consulting, selection and inspection
services for Rudi and Veronica Wolfs - $2,500". The second is a
"referral fee for introduction to Rudi and Veronica Wolfs" also in
the amount of $2,500. In the course of their testimony, both the Appellant and
Welton maintained that the latter advised the Wolfs regarding the value of
their existing home and suggested that rather than renovating, they should
purchase and upgrade to a newly constructed house. The Appellant contends that
Welton assisted the Wolfs in finding one which had not been completed and gave
them some advice regarding the work still required and its likely cost. For
providing this service to her customers, Welton charged the Appellant $2,500,
but provided no reasonable information regarding the basis upon which the
services were valued. Invoice 9 for its part, purports to be a referral fee of
$2,500 paid to Welton for introducing the Wolfs to the Appellant. The referral
fee appears to be somewhat unwarranted given the fact that the Appellant obtained
the listing for the sale of the Wolfs' home as a result of their touring the
Appellant's residence which was both her office and at that time "was on
the market as an open house". They were, she said, looking at different
options and ended up purchasing the property in issue.
Welton's "services" – invoice 11 (and
missing invoice 7)
Invoice 11 in the amount of $5,000 was referred to by Welton as having
been paid for "services" which he described as
… assistance with house listings,
maintenance and installation of real estate signage, labour to move furniture
and assist with Customers, copy writing for listings, measurement of houses for
listings, meeting and driving customers to various listings for inspections,
home inspection services for various customers, administrative assistance from
January 1, 1996 through December 1, 1996.
I should note that the total of the amounts in the
invoices produced was $27,000, however, the income actually reported by Welton
to Revenue Canada was in the
amount of $32,000. The discrepancy was explained as reflecting a missing
invoice 7, which he said "must have been for $5,000". When asked
what services that invoice related to, he responded "probably similar to
invoice no. 11. Just general catchall services and sharing of duties".
What Welton is asserting is that the amount of $10,000 was a "reasonable
fee" for such services notwithstanding the fact that no records,
timesheets or any other information have been provided from which it would be
possible to determine what and when the alleged services were indeed provided,
how much time was expended, etc. to demonstrate a rational way how a $10,000
fee for "general
catchall services and sharing of duties" was warranted.
[17] It should be made clear that there is no dispute that Welton's
expertise was of assistance to the Appellant and that he did in fact perform
certain services. There is no question as well that, as Welton said, “we would
discuss, when we had the opportunity, or during negotiations on how things
might be done. And so that was something that gave some of the customers
comfort. But Sandy herself was quite good at it as well”. However, based on the
evidence before me, the only conclusion possible is that no reasonable
businessperson would have contracted to pay such an amount for the work done or
services rendered having only the business considerations in mind.
[18] In this context, counsel for the Respondent made reference to Mépalex
Inc. v. Canada
in which the Court observed:
17
Counsel referred to this Court's decision in Safety Boss Ltd. v. The Queen,
2000 T.C.J. No. 18 (Q.L.), more particularly to the following passages:
27 "Reasonable"
in section 67 is a somewhat open-ended concept requiring the judgement and
common sense of an objective and knowledgeable observer....
...
52 There have been numerous cases on the question
of the reasonableness of expenses. Essentially the determination is one of
fact. I shall refer to only one that sets out the principle and that has been
frequently cited: Gabco Ltd. v. M.N.R., 68 DTC 5210. At page 5216
Cattanach J. said:
It is not a question of the
Minister or this Court substituting its judgment for what is a reasonable
amount to pay, but rather a case of the Minister or the Court coming to the
conclusion that no reasonable business man would have contracted to pay such an
amount having only the business consideration of the appellant in mind. I do
not think that in making the arrangement he did with his brother Robert that
Jules would be restricted to the consideration of the service of Robert to the
appellant in his first three months of employment being strictly commensurate
with the pay he would receive. I do think that Jules was entitled to have other
considerations present in his mind at the time of Robert's engagement such as
future benefits to the appellant which he obviously did.
[19] One further item remains to be dealt with that being the Respondent’s
disallowance of the amount of $704.58 of the meals and entertainment expenses
claimed. At the conclusion of the cross-examination by counsel for the
Respondent, it became apparent that she had not been provided with any
information as to which of the expenses in issue had been denied. Counsel for
the Respondent indicated that the auditor would not be called as a witness and
that no testimony would be forthcoming from the Minister in this context. The
consensus appeared to be that in these circumstances, the full amount of $1,027.50
in meals and entertainment expenses should be allowed. To that extent, the appeal
is allowed and the Respondent is entitled to its costs.
Signed at Ottawa, Canada, this 24th
day of May, 2005.
Sarchuk
J.
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