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Citation: 2003TCC256
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Date: 20030417
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Docket: 2000-1129(IT)G
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BETWEEN:
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GLUECKLER METAL INC.,
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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
McArthur J.
[1] Glueckler Metal Inc. is a
Canadian-controlled private corporation and carries on the
business of manufacturing and processing metal products for the
building construction industry. The majority of the outstanding
shares of the Appellant was held by Bailey-Hunt Limited, a
corporation related to Bailey Metal Products Limited (both
referred to as "Bailey"). Mr. Glueckler held 27% of the
shares. In 1994, the Appellant deducted from its business income
the amount of $502,738, claiming that it was a business expense
paid for financial and administrative services provided to it by
Bailey. The Minister of National Revenue disallowed the
deduction.
[2] Of the $502,738, the amount of
$294,738 was for interest on loans owing by the Appellant to
Bailey for the period from November 30, 1989 to November 30,
1994. The balance of $208,000 was for fees for administrative
services rendered by Bailey to the Appellant over the same
period. Prior arrangements for payment were inconsistent and
inadequate. At the insistence of its banker, the Appellant and
Bailey sought a financial review in 1994. BDO Dunwoody, chartered
accountants, performed an audit, reviewed past procedures and
recommended changes which resulted in an agreement between the
Appellant and Bailey in November 1994 whereby the Appellant by
way of a one-time adjustment would pay for outstanding interest
and administrative services.
[3] At a meeting in
November 1994, Mr. Glueckler represented the Appellant and
Mr. Hunt represented Bailey. It would appear that both Bailey and
the Appellant were having financial problems and an agreement was
entered into as a result of their Bank's intervention. The
agreement entered into in November 1994 was at the
recommendation of Christopher Barltrop, a chartered account with
BDO Dunwoody.[1]
[4] The only witnesses for the
Appellant were Mr. Barltrop and Ms. Susan Schalburg, a
financial officer for the Appellant. In answer to the question as
to why the two principals of the agreement, Mr. Hunt and Mr.
Glueckler did not give evidence, counsel for the Appellant
explained that it was intentional. The two witnesses, who had
also attended the November 1994 meeting established that Mr.
Hunt, on behalf of Bailey, and Mr. Glueckler, on behalf of
the Appellant, agreed that the amounts be paid and recorded in
the respective corporate books. The November 1994 agreement is
evidenced by debit and credit entries in the records of the
Appellant and Bailey.
Appellant's Position
[5] The determination of the
deductibility is a question of law and "it is important for
the Courts to avoid delegating the legal test of profit to the
accounting profession".[2] The fact that it was a voluntary payment does
not preclude it from being deductible. The Appellant's
position is best stated by President Jackett of the Exchequer
Court in Olympia Floor & Wall Tile (Quebec) Ltd. v.
M.N.R.,[3] where he stated at page 6087:
... The fact that the business man makes a bona
fide decision to make disbursements for business reasons
raises a presumption in my mind that it was
"reasonable" to make such disbursements unless facts
are proved that establish that it was not
"reasonable".
The payment represented a compilation of expenses that were
incurred in respect of business operations in the 1989 to 1993
taxation years and, therefore, under normal circumstances, would
have been charged in those respective years. There was no
deductible expense until there was an obligation to pay which
arose with the agreement to pay in November 1994. The Appellant
was under no obligation to pay, nor was Bailey legally entitled
to receive the payment until the 1994 agreement.
[6] The Appellant makes three
submissions: (i) that the question in this appeal is largely a
question of law; (ii) that the nature of the payment, being a
voluntary one, does not preclude it from being deductible; and
(iii) as a matter of law, this transaction should only be taken,
at the earliest, when it occurred in November 1994. This is
when an obligation to pay arose, the amount was quantified and
paid.
Respondent's Position
[7] The Respondent also presented
three basic submissions: (i) that claiming the $502,738 deduction
in the 1994 taxation year does not reflect an accurate picture of
the Appellant's 1994 financial year; (ii) that if it is found
to be an expense in 1994, it is not a reasonable expense under
section 67 of the Income Tax Act since the parties are
non-arm's length and $502,738 changed hands for services
already rendered and previously paid for; and (iii) the payment
is an outlay on account of capital and is not deductible pursuant
to paragraph 18(1)(b) of the Act.
[8] The Respondent added that the
claimed interest expense was capital in nature and not deductible
pursuant to paragraph 18(1)(b) of the Act and not
deductible under paragraph 20(1)(c) of the Act
because it was not interest paid or payable in 1994. The
Respondent adds that the payments claimed on account of
administrative services are not deductible pursuant to section 9
and paragraphs 18(1)(a) and (b) of the
Act. The payment was for goodwill and not a non-capital
expense.
Analysis
[9] As stated by the Respondent's
counsel, to be deductible the payment has to meet the
requirements of the Act. These requirements include
paragraph 18(1)(a) which reads as follows:
18(1) In computing the income of a taxpayer
from a business or property no deduction shall be made in respect
of
(a) an outlay
or expense except to the extent that it was made or incurred by
the taxpayer for the purpose of gaining or producing income from
the business or property;
The Appellant must establish that the payment was made
"for the purpose of gaining or producing income". The
payment represents a compilation of the expenses that should have
been charged in the 1989 to 1993 taxation years. The Appellant
has the onus of establishing that there was an income purpose for
the payment.
[10] The two Appellant witnesses were the
individuals who made the recommendation to pay and implement the
entries. As stated, Mr. Glueckler and Mr. Hunt did not testify.
What we do have is uncontradicted evidence from two credible
witnesses who were most familiar with the books, records and
financial status of the Appellant and Bailey. I find as a fact
that there was an arrangement between the Appellant and Bailey
from 1989 to 1994 wherein Bailey provided services and loaned
funds to the Appellant for which Bailey was inadequately
compensated. On some occasions, the Appellant paid for the
services and paid interest on the loans, but more often, it did
not. I find there was an oral agreement between the Appellant and
Bailey wherein they accepted the amount of $502,738 as owing by
the Appellant to Bailey for past services and interest and that
the Appellant agreed to pay, and did in fact pay Bailey that
amount in 1994. The income earning purpose was to establish a
consistent charging system for the taxation years after 1993.
Further, Bailey in fact rendered services and loaned money to the
Appellant which were necessary for the successful operation of
the Appellant's business. The parties accepted the methodology
proposed by the independent accounting firm of BDO Dunwoody. The
parties further accepted the recommendation to make an adjustment
payment in order that the years 1989 to and including 1993 be
subject to the same method as future years. The agreement was
reached in November 1994.
[11] There is no question that there were
expenses incurred by the Appellant and owing to Bailey for
services and interest during the years 1989 to 1993, inclusive.
For lack of a more accurate amount, I accept that $502,738 is
appropriate. It was calculated by BDO Dunwoody and agreed to by
the corporate principals. No other figure was presented by the
Minister. An agreement to pay for these services using the
accounting methodology was not arrived at until 1994. This is
when the amount for past services and interest became payable and
was in fact paid. The actual deal makers, Mr. Hunt and Mr.
Glueckler, did not testify. Although their evidence would have
been preferable, the Appellant has met its onus and I find there
was an income earning purpose for the expenditure.
[12] I accept that the question of whether
the Appellant is entitled to deduct the payment is one of law.[4] Specifically, the
question is "which accounting treatment provides the most
accurate picture of the Appellant's 1994 financial position"?
The Appellant attempted to deduct the full amount in the 1994
taxation year and it was taken into income by Bailey in 1994.
Both counsel relied on Canderel and presented that it
provides the applicable test with respect to the accounting
treatment of the payment.
[13] In computing its income for 1996,
Canderel, a real estate developer, deducted all of the tenant
inducement payments made by it during that year. The Supreme
Court of Canada stated that the determination of profit is a
question of law. The Court must determine the most accurate
picture of the taxpayer's profit in the year. The taxpayer
has the onus of establishing that his method presents an accurate
picture of yearly income which is not in contravention of the
Act, the law and of well-accepted business principles.
Then the onus shifts to the Minister to show that the
taxpayer's position does not present an accurate picture.
Writing for the majority, Iacobucci J. stated at
page 6108:
The interpretive goal: an accurate picture of
income
Having established an appropriate framework for analysis, I
should now like to discuss what exactly is the question that must
be answered when attempting to assess a taxpayer's profit for
tax purposes. A good place to begin is with the decision of the
Federal Court of Appeal in West Kootenay, supra, where
MacGuigan, J.A. stated at p. 6028:
The approved principle is that whichever method presents the
"truer picture" of a taxpayer's revenue, which more
fairly and accurately portrays income, and which
"matches" revenue and expenditure, if one method does,
is the one which must be followed.
In the court below, Stone, J.A. took this passage as grounding
his conclusion that the matching principle of accounting has been
elevated to a rule of law. Obviously, in light of my previous
comments, I do not, with respect, subscribe to that point of
view. To my mind, the significance of this statement is to
confirm a much sounder proposition: that the goal of the legal
test of "profit" should be to determine which method of
accounting best depicts the reality of the financial situation of
the particular taxpayer. If this is accomplished by applying the
matching principle, then so be it. On the other hand, if some
other method is appropriate, is permissible under well-accepted
business principles, and is not prohibited either by the Act or
by some specific rule of law, then there is no principled basis
by which the Minister should be entitled to insist that the
matching principle - or any other method, for that matter - be
employed. MacGuigan, J.A. in West Kootenay seemed to
advert to this notion at p. 6028, in the passage immediately
following the above-quoted portion:
The result often will not be different from what it would be
using a consistency principle, but the "truer picture"
or "matching approach" is not absolute in its effect,
and requires a close look at the facts of a taxpayer's
situation.
As an aside, I would also observe that the
compartmentalization of income calculation has led to a process
that is far more complicated than necessary. To attempt to
achieve a useful picture of profit by reference only to rigid
categories of expenses - running expenses, matchable expenses,
etc. - can become a frustrating exercise in futility: see Richard
B. Thomas, "The Matching Principle: Legal Principle or a
Concept?" (1996), 44 C.T.J. 1693. Rather than trying to
discern into which pigeonhole a particular income expenditure
falls, the taxpayer's focus should be on attempting to
portray his or her income in the manner which best reflects his
or her true financial position for the year, that is, which gives
an "accurate picture" of profit. To do otherwise is to
lose sight of the taxation forest for the practice or principle
trees. In other words, the competing concepts of running expenses
and matching which appear to be at play in this appeal fall into
the category of well-accepted business principles, no more, no
less. They are simply important interpretive aids which may
assist, but are not determinative, in the illumination of an
accurate picture of the taxpayer's income.
[14] Iacobucci J. summarized the principles
he set out earlier and more particularly, at page 6110 he
states:
On reassessment, once the taxpayer has shown that he has
provided an accurate picture of income for the year, which is
consistent with the Act, the case law, and well-accepted
business principles, the onus shifts to the Minister to show
either that the figure provided does not represent an
accurate picture, or that another method of computation would
provide a more accurate picture.
I have attempted to apply this approach to the present
facts.
[15] The Appellant chose to deduct the
entire expenditures in the year they occurred. This not is
inconsistent with paragraph 18(1)(a) of the Act
which provides that a deduction may be made for an expense
incurred to earn income from the business. The Appellant's
procedure was consistent with the rule of the law that running
expenses which relate to an operating business as a whole, may be
taken as a full deduction in the year paid. This rule of law is
affirmed in Canderel. The present income picture is
complicated and unusual. The Supreme Court of Canada in
Canderel added at page 6109:
However, where the income picture is more complicated, as is
frequently the case, the taxpayer is free to employ whichever
well-accepted business principles will be most useful in
depicting profit, provided again that the method adopted is not
inconsistent with the law. As a general rule, and as I have
already stated, the Minister is in no position to insist on the
application of one principle or another, in the absence of some
legal rule so requiring, unless, as I shall discuss next, the
application of an alternative rule would yield a more accurate
picture of income than that which was obtained by the
taxpayer.
[16] The Minister has assumed at paragraph
5(h) of the Reply to the Notice of Appeal that the expenditure
was not incurred for the purpose of earning income. The
Appellant's witnesses were credible and they were advisers to
both Bailey and to the Appellant. It was through their
recommendation and in particular, that of Mr. Barltrop, that a
deal was struck. I accept their uncontradicted evidence that the
income earning purpose behind the payment was to formalize a
consistent charging methodology with respect to loans and
administrative services.
[17] Having found that a valid business
purpose exists, the full deduction of the expense in 1994 is the
most accurate picture of the Appellant's economic situation
presented to this Court. The appeal is allowed, with costs.
Signed at Ottawa, Canada, this 17th day of April, 2003.
J.T.C.C.
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