Citation: 2008TCC409
Date: 20080711
Docket: 2005-1804(IT)G
BETWEEN:
JOLLY FARMER PRODUCTS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bowman, C.J.
[1]
These appeals are from
assessments for the appellant’s 1998, 1999, 2000, 2001, 2002 and 2003 taxation
years. The central question is whether the appellant is entitled to claim
capital cost allowance (“CCA”) on houses and a large building called the
“Commons” which the appellant owned on the farm which it owned and operated. The
houses (collectively referred to as “the Village”) were occupied by the employees
of the appellant who were also shareholders. The Commons was a large building
of which approximately 25% was for the use of the shareholder/employees at
least on one sketch put in evidence and 75% was for storage of and processing
of meat and dairy products and other farming produce. This percentage is a
matter of dispute. The respondent says that 95% was for the
shareholder/employees. For the reasons that follow I have concluded that the
entire building, whatever portion may have been used by the
shareholder/employees, was acquired by the appellant for its business purposes.
[2]
The denial of the CCA
on the Village and the Commons including the equipment is based on the single
assumption that these properties were not acquired for the purpose of gaining
or producing income. If they were not acquired for the purpose of gaining or
producing income they are excluded from the classes of property in respect of
which capital cost allowance may be claimed. Paragraph 1102(1)(c) of the
Income Tax Regulations provides:
1102. (1) The classes of property described in
this Part and in Schedule II shall be deemed not to include property
. . . . .
(c) that was not acquired by the taxpayer for
the purpose of gaining or producing income;
[3]
There are some
preliminary points that should be disposed of before dealing with the main
issue:
a) It is alleged that
the 1999 assessment was made beyond the normal reassessment period and was
therefore statute-barred. The appellant now agrees that a waiver was signed and
that therefore the Minister was entitled to reassess the 1999 taxation year
beyond the normal reassessment period;
b) The respondent
however now concedes that the reassessment for 2000 was statute-barred and that
therefore it should be vacated. This removes one of the issues from the case,
the deductibility of the wages paid relating to the Commons in 2000 as well as
the claim for CCA;
c) The treatment of
the land clearing costs in respect of the Commons in 1998 is no longer in issue.
The parties agree that of the $85,392 claimed for this item, $70,392 should be
added to the capital cost of the Commons building and its treatment will depend
upon the disposition of the issue whether the Commons is depreciable property.
The parties agree that the remaining $15,000 land cleaning costs will form part
of the capital cost of the land; and
d) CCA on a house
called the “Farmhouse” has been allowed by the respondent and is no longer in
issue.
[4]
This leaves then the
question whether the Village and the Commons were acquired for the purpose of
gaining or producing income within the meaning of paragraph 1102(1)(c)
of the Income Tax Regulations.
[5]
The appellant was
incorporated on December 1, 1995 under the New Brunswick Business
Corporations Act. It was formed in contemplation of its carrying on
substantially the same business as was carried on in New Hampshire by a “non profit corporation” called Jolly Farmer
Products. I do not know what a non‑profit corporation means under United States law. Mr. English, a director of the appellant
testified that it had “members” instead of shareholders and paid United States income taxes. The members received payments on which
they paid tax.
[6]
The United States corporation carried on an extensive and profitable horticultural
operation in which plant cuttings and plants were grown in a large greenhouse.
It ran out of space for expansion and, after investigating a number of locations
in Maine, Quebec, Nova Scotia and New Brunswick, the directors chose a location near Woodstock, New Brunswick.
[7]
All but one or two of
the original members that ran the operation in New Hampshire moved to New Brunswick.
[8]
The appellant acquired
two farms, the south farm and the north farm. On the south farm are located the
greenhouse, the outside farming operations, the gardens used by the
shareholder/employees and the Commons. It now has a third farm.
[9]
Since 1996 the
greenhouse operation has grown from 3 acres to 10 acres. It ships cuttings and
plugs throughout North America and is the biggest operation of its type in New Brunswick. Its agricultural operations outside of the
greenhouse continue to grow and expand so that it is an integrated agricultural
operation consisting of beef cattle, pigs, sheep, chickens and dairy products.
[10]
The financial statements
for the corporation from December 1, 1995 to April 30, 2003 were put in
evidence (Exhibit A-1, Tabs 8-15) show sales that have grown from $5,884 in
1996 to $25,000,700 in 1999 and $21,677,294 in 2003. It is a large, profitable
and highly successful operation.
[11]
The trial lasted five
days. The principal witness for the appellant was Mr. Robert English, a
director and Vice‑President of the appellant. Also, three expert
witnesses were called, two for the appellant and one for the respondent. The respondent
also called Ms. Keeler, the bookkeeper of the appellant and Mr. Leblanc,
an appeals officer of the Canada Revenue Agency (“CRA”). The issue is, however,
far less complex than the length of the trial would indicate. I think the focal
point of the problem is evident from Schedule A to the articles of
incorporation of the appellant. It reads as follows:
The holders of all classes of shares shall be limited to those persons
who willingly submit to the disciplines of the commandments of the Lord Jesus
Christ and who also will make their permanent residence in one of the
communities established by the Corporation (the “Community”) in accordance with
above disciplines. A shareholder can be dismissed who does not keep the peace
of the community in accordance with the disciplines of the commandments of the
Lord Jesus Christ. A person can become a shareholder through the Directors’
approval and general shareholder acceptance after a probationary period, not to
exceed three (3) years, by a majority vote.
[12]
Many paragraphs of the Reply
to the Notice of Appeal are devoted to assumptions about the religious beliefs
and practices of the shareholders and their desire to live a simple Christian
life in their own community. The Minister seems to see the shareholder/employees
as some sort of a quasi-monastic religious organization whose purpose in living
on the farm is in furtherance of their religious beliefs and practices and not
for commercial reasons. I do not see religious beliefs and practices as being
inconsistent with commercial motivation.
[13] Mr. Leblanc,
the appeals officer called as a witness by the respondent, stated that he saw
the shareholder/employees as wanting to live “separate and apart”. This, I
think, goes beyond being an overstatement. It is simply not accurate. The
members are very active in the community. Mr. Leblanc struck me as a
conscientious and honest public servant but I think his views reflect a ministerial
mindset that is out of touch with commercial reality. While it is acknowledged
that the appeals officer’s evidence is hearsay (in some cases, second or third
degree) it is useful in determining the thinking that went into making or
confirming the assessment. Here, I think the CRA has become fixated (counsel
for the appellant used the word “mesmerized”) on two things — the fact the
employees are shareholders, and the fact that they profess and adhere to
certain basic Christian beliefs reminiscent of the early Church. These facts
are, in my view, of no significance. Once we get rid of these two red herrings
and focus on the fact that the appellant provides its employees with living and
other facilities, the provision of those facilities becomes a perfectly normal
and ordinary cost of carrying on the appellant’s business.
[14] I think the
Minister’s approach to this problem results from a confusion between (or
perhaps a melding of) two or more concepts. An individual cannot deduct in
computing his or her income “personal or living expenses”. The Minister seems
to think, I gather, that the cost to an employer of providing to its employees
living amenities (or the capital cost of property used for that purpose) falls
equally within that prohibition. Moving on from this fallacious inarticulate
premise the Minister then seeks to require the employer to show that its
business decision to provide accommodation to its employees is commercially
justifiable and is a better way of doing business than some other method. In
this way the fallacy of the original premise is compounded and is exacerbated by
the fact that the Minister, in some way that I cannot fathom, throws into the
mix the fact that the employees are also shareholders and also have strong
religious beliefs. Then, even after the employer, Jolly Farmer Products Inc.,
overwhelmingly demonstrates (unnecessarily in my view) that its business organization
results in a resounding commercial success, the Minister still hangs on with
the tenacity of grim death to his original error and argues that the appellant
should have adopted a way of doing business that the Minister finds more
palatable, even though it is less economic. Mit der Dummheit kämpfen Götter
selbst vergebens.
[15] It is true, the shareholders seek to lead a
simple Christian life somewhat removed from the hurly burly of materialistic pursuits.
This does not, however, prevent them from running a commercially oriented,
highly successful operation. One of the reasons for the success of the
operation is the very fact that the shareholders who are all employees and who
are paid salaries by the appellant, live on site where they can take care of
the horticultural operation. One example is of course the fact that they all
serve on the fire brigade where the response time in case of a fire is a
fraction of the time taken for the Woodstock fire department
to respond. This prevented a small fire in May 2008 from getting out of control
and destroying the greenhouse and the millions of dollars of equipment and
plants in a conflagration of the type that occurred in 1996.
[16] The respondent argues that the cost of keeping
the shareholder/employees on‑site and providing them with houses in which
to live and facilities such as a dining room and gymnasium in the Commons is
not a cost of property acquired for the purpose of gaining or producing income.
That is, with respect, not a commercially viable proposition. The
shareholder/employees pay rent and nonetheless have been assessed for taxable
benefits in respect of their homes. The operation is clearly more successful
than it would have been if the appellant had followed the unsolicited commercial
views of the CRA and done the following:
a) Not provided
housing and other facilities for its shareholder/employees on‑site;
b) Hired employees from
the outside and paid wages to a much larger workforce at a higher rate than the
salaries paid to the shareholder/employees;
c) Got rid of the on‑site
fire brigade and relied on the Woodstock fire brigade to get to the fire after
it had spread to the adjacent buildings and greenhouse; and
d) Taken out crop
insurance in the hope that it might cover a part of the value of the property
and crops destroyed.
I should mention briefly the expert
testimony of Gary Daneff. He is a professional engineer and a co-owner of
Point of Origin Consultants Ltd. He is an expert in fire and explosion
investigations and fire protection.
[17] The following
statements in his report relating to the fire in the lab on
May 13, 2008 are self-explanatory:
Fire-resistance and fire-protection
ratings for building materials and assemblies are determined on the basis of
their performance under laboratory fire conditions. These fire tests follow a
standard time-temperature curve which models compartment temperatures achieved
during uncontrolled fires. The standard time‑temperature curve shows that
compartment temperatures of 538oC (1000oF)
will be achieved after 5 minutes, 704oC (1300oF) after 10
minutes and 843oC (1550oF) after 30 minutes. In contrast,
the fire which occurred within the soils lab on May 13, 2008, did not spread
beyond the work bench to adjacent furnishings and did not continue to grow. As
a result of early intervention by the Jolly Farmer fire brigade and possibly
other factors which limited the fire’s growth, such as air supply, fuel loading
and arrangement, fire damage was principally contained to the soils lab.
. . . . .
The entrance to the Jolly Farmer Products
operation is located south of Woodstock on the opposite side of the St. John River, requiring the Woodstock Fire Department (WFD) to
travel a minimum distance of about 14 km during a response to a fire event on
the grounds of Jolly Farmer Products. According to Chief Ricky Nicholson, the
WFD received a call directly from personnel at Jolly Farmer Products at 4:47 am
on May 13, 2008, and the first WFD apparatus arrived at the property of Jolly
Farmer Products at 5:04 am, about 17 minutes later. According to the incident
log maintained by Jolly Farmer personnel, the Jolly Farmer fire brigade and
subsequently the WFD were notified of the fire after its discovery at 4:41 am.
The Jolly Farmer fire brigade assembled at the scene between 4:44 and 4:54 am
and the first charged hose was advanced at 4:58 am, approximately 17
minutes after fire discovery. According to Jolly Farmer records, at
approximately 5:15 am the first WFD apparatus arrived with two men on board and
between 5:20 and 5:23 am the WFD service van arrived with 6 fire fighters. At
5:25 am the WFD personnel were equipped to enter the building, approximately 44
minutes after fire discovery.
. . . . .
The following statements can be made
regarding early intervention by fire fighting personnel.
1.
The response of
trained fire fighting personnel is an assumption on which provisions of the NBC
pertaining to life safety and property protection from fire are based. The NBC
acknowledges that a fully developed compartment fire and associated high fire
radiation levels can occur within 10 minutes from the outbreak of fire.
2.
Early intervention by
trained fire fighting personnel is essential in arresting fire growth and
spread.
3.
Based on the fire
event which occurred on May 13, 2008, on the premises of the Jolly
Farmer Products operation, times recorded by Jolly Farmer personnel indicate
that the Jolly Farmer fire brigade advanced a charged hose line within 17
minutes of the discovery of fire, prior to the arrival of personnel from the
WFD (Woodstock Fire Department).
4.
During the fire event
on May 13, 2008, the early intervention by the Jolly Farmer fire
brigade served to contain the fire to the soils lab and likely prevented it
from spreading from that room to the remainder of the east warehouse.
[18] The conclusions
expressed by Mr. Daneff are unassailable. Clearly the on-site fire brigade
was a commercial necessity. While I do not think the appellant has to justify
its business decisions, the existence of the Jolly Farmer fire brigade does so.
[19] The same is true of
the expert reports of the two accounting firms. The appellant put in an expert
report by Paul Bradley of PriceWaterhouseCoopers, LLP. The respondent put
in a report by Daniel Jennings of Deloitte & Touche, LLP.
[20] Although I shall
quote from parts of the two reports for reasons set out below, I do not
consider them particularly helpful in answering the question before me.
However, since both counsel saw fit to retain the services of highly qualified
business valuators, I shall deal with their evidence.
[21] Mr. Bradley’s
report reads in part as follows:
1. You have requested us, as professional
advisors experienced in business investigations and loss quantifications, to assist
you in quantifying the estimated economic benefits to Jolly Farmer Products
Inc. (“JFPI” or “the Company”) related to certain assets known as “the Village”
and a portion of “the Commons”.
2.
We understand that:
• JFPI was incorporated in 1995 and its
principal business activities include horticultural and agricultural
operations.
• JFPI constructed housing (“the Village”) and
certain other structures on its lands, including a barn and a building known as
“the Commons”.
• On April 12, 2002, the Canada Revenue Agency
(“CRA”) advised JFPI that an audit would be undertaken for the tax years ended
June 30, 2000 and 2001. The period under review was expanded to include
the tax years ended June 30, 1998 to 2003.
- As a result of the audits, CRA took the position
that JFPI’s expenditures to construct the Village and the Commons were not
related to gaining or producing income and therefore, CRA disallowed the
deduction of certain expenses reported in the Company’s income tax returns for
years during the 1998-2003 period, including capital cost allowance (“CCA”)
related to the Village and the Commons.
3.
JFPI’s position is that the Village and Commons
make economic contributions to the Company’s business. We understand that you
require assistance with regard to quantifying certain of the economic benefits.
4.
We understand that Counsel will argue that
JFPI’s economic benefits from the Village and the Commons include limiting the
potential loss of profits related to customer attrition, which may occur if the
Company were to experience an interruption of business operations. We have
considered this from the perspective of calculating the potential impact on
JFPI of the loss of a major customer. However, our calculation of potential
loss of profits is not included in the overall quantum of economic benefits
that have been calculated herein, and we express no opinion regarding this
potential loss.
5.
We also understand that Counsel will argue that
the expenditures to construct the Commons and the purchase of its equipment were
made for the purpose of gaining or producing income from the JFPI Agricultural
Division (with the exception that 25% of the Commons is considered to be used
personally by the shareholders, for which rental income is charged). We
understand that the decision to construct the Commons was independent of the
decision to construct the Village, the latter of which primarily supports the
Horticultural Division.
. . . . .
76.
Due to the Company’s remote location relative to
major centres, Management believes that the following employee costs are
positively impacted by the existence of the on-site residents:
-
Lower than average absenteeism
-
Reduced payroll costs for overtime or shift work
-
Lower than average employee turnover and
resulting training costs
-
Improved operating efficiencies, relative to the
industry
77. We understand that the proximity of the
Village residents to the operating facilities provides the Company with a pool
of labour, which is available to perform essential services beyond the standard
operating hours of the business. Employees may work overtime, split shifts, or
unusual schedules (including statutory holidays and filling in for vacation
leave) to accommodate such essential services as crop care, farming obligations
and shipping outside of normal business hours.
78.
We understand that all non-shareholder employees
are compensated as entitled in accordance with the New Brunswick Labour
Standards Act and Regulations, while employees that are also shareholders
(“shareholder employees”) are not subject to the same statutory entitlements.
Thus, certain shareholder employees earn a salary based upon a standard working
week, but participate in work activities beyond their job description and these
services are available at no incremental cost to JFPI.
79.
The premise of this calculation is that, without
the participation of the shareholder employees, Company employees would be
required to be on call, work split shifts and / or receive paid overtime to
compensate for commuting costs and inconvenience of being on call, working
split shifts, time away from families, including weekends and statutory
holidays. Further, employee shifts would have to be scheduled for services that
are currently on an ‘on-call’ basis, provided by employees who reside on-site,
such as the farming foreman and maintenance positions.
80. We received payroll and scheduling
information from the Management of JFPI and obtained industry wage information
from private and public sources to calculate the cost of filling positions that
require attendance beyond normal operating hours that, we understand, is
currently fulfilled by on-site, salaried employees.
. . . . .
86. Based upon the information that we
have reviewed and relied upon, and subject to the assumptions, restrictions and
qualifications set out herein, we concluded that the estimated economic benefit
of the expenses as calculated was in the ranges set out below, and as set out
at Schedule 1:
Estimated economic benefit due to:
Insurance and security $807,072
to $964,225
Benefit of overtime/shift payroll costs
foregone $1,596,972 $1,596,972
Total $2,404,044 to $2,561,197
87. Based upon our calculations in the specific
areas considered for purposes of this analysis, the economic benefits
quantified herein represent approximately 81% of the net capital cost
deductions denied as set out at Line 9 of Schedule 1.
[22] Mr. Jennings
disagrees with Mr. Bradley, as follows:
In our view, PWC neglected to include
$322,061 of Village renovation costs in 2001 in their analysis of disallowed
capital additions. The impact of this change would be to decrease PWC’s
conclusion that the economic benefits quantified represent 81% of the capital
cost deduction denied.
In our opinion, discount/capitalization
rates of 18/15% (as opposed to PWC’s 14/11%) better reflect the risk in the
stream of avoided costs in the Company. The impact of this change would be to
decrease PWC’s conclusion as to the quantum of economic benefit.
In our view, because of the shareholders’
decision not to take economic salaries, PWC should not have assumed that
management’s assertion as to incremental payroll costs avoided by the existence
of the Village and Commons was correct. The impact of this change would be to
decrease PWC’s conclusion as to the quantum of economic benefit.
In our view, the fact that PWC’s
conclusion of economic benefit is less than 100% of the capital costs denied
implies that the Company may have incurred the least economical alternative by
building the Village and Commons (as opposed to incurring the alleged
incremental costs).
Even though the PWC calculation of lost
profits from customer attrition is not part of their conclusion, we offer
commentary that supports our view that this quantification is not appropriate
in this matter.
[23] Mr. Jennings
did not state how much lower his quantification of the economic benefit was
than Mr. Bradley’s. It is however clear that he believed there was an
economic benefit to the way the appellant conducted its business affairs.
Whether I accept one report or another or whether I come up with some figure
that differs from both of them is not the point. Even if there were no economic
benefit — and clearly there is — I would still have held that the business
decision of the appellant on the manner in which it conducts its business must
be respected. For what it is worth, I find Mr. Bradley’s report more persuasive.
I repeat, however, that this is not a contest between two experts on the best
way to carry on business. Obviously the appellant has chosen a method that succeeds.
Once I conclude that it is a business decision to house the employees in
company-owned houses and to provide other facilities in the Commons it is not
up to me or the Minister to question that decision, even if I were to disagree
with it, which I do not. It is
clear that providing facilities to the shareholder/employees such as housing
and a portion of the Commons was a business decision that in the present case
was a commercially advantageous one.
[24] This case is an excellent example of the
CRA seeking to substitute its business judgment for that of the taxpayer. The
alternatives suggested by the respondent would have made the operation far less
profitable. The way in which the appellant chooses to carry on its highly
successful commercial operation is a business decision and the Minister of
National Revenue has no right to substitute his business judgment and advance
other alternatives that are more palatable to him. (See for example Gabco Limited
v. M.N.R., 68 DTC 5210.) Clearly the provision of housing for the
shareholder/employees and of facilities in the Commons is an integral part of
the way the Appellant carries on business and of its income earning process.
The Village and the entire Commons were acquired for the purpose of gaining or
producing income. Accordingly, despite Mr. Woon’s very thorough and
careful argument, I have concluded that they are not excluded by reason of
paragraph 1102(1)(c) of the Income Tax Regulations from the
classes of depreciable property in respect of which CCA may be claimed.
[25] The appeals are allowed with costs and the
assessments referred back to the Minister of National Revenue for
reconsideration and reassessment in accordance with these reasons. The
statute-barred reassessment for 2000 is vacated.
Signed at Ottawa, Canada,
this 11th day of July 2008.
“D.G.H. Bowman”
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