Lamarre Proulx, J.T.C.C.:-These appeals were heard on common evidence. With respect to the appellants 528061 Ontario Limited ("528061") and 528062 Ontario Limited ("528062"), there are two issues. The first one is whether expenses shown in the "shop expenses account" and the "suspense expenses account" were properly disallowed as not having been incurred for the purpose of producing income but incurred for personal purposes. The second issue is whether the penalties pursuant to subsection 163(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71- 72, c. 63) (the "Act") were properly imposed. The appellants’ taxation years under appeal are 1987, 1988, 1989 and 1990.
With respect to the appellant 608787 Ontario Incorporated ("608787"), the question at issue is whether the appellant was required to use the accrual method of accounting and whether it is entitled to a reserve pursuant to paragraph 20(1 )(1) of the Act. The taxation years at issue are 1987 to 1989 inclusive.
At the outset, counsel for the appellants stated that in the appeals of 528061 and 528062 there would be no evidence as to whether the bad debts and the reserves for doubtful debts were properly disallowed, and in the appeals of 608787, there would be no evidence as to whether the appellant had income from an active business and whether the non-capital loss claimed for 1985 was properly disallowed. Consequently, on these aspects, the assessments of the Minister of National Revenue (the "Minister") will stand.
With respect to the appellants Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) the question at issue is whether the expenses of 528061 and 528062 that were disallowed by the Minister as being personal expenses, were properly included as a benefit conferred on the appellants either as employees pursuant to section 5 of the Act or as shareholders pursuant to subsections 15(1) and 56(2) of the Act. An alternative question is whether section 245 and subsection 246(1) of the tax avoidance part of the Act could apply. Another question at issue in these appeals is whether the Minister properly imposed penalties pursuant to subsection 163(2) of the Act. Counsel for the respondent informed the Court at the end of the evidence that he conceded that wages in the amount of $5,000 should not have been included in the respective income of these appellants. The taxation years in question regarding the individual appellants are 1987, 1988 and 1989.
Appeals of 528061, 528062, Jerome M. Rondelez (Jr.) and John
M. Rondelez (Jr.)
Messrs. Jerome Rondelez (Sr.), Jerome M. Rondelez (Jr.), Sanford the accountant, and John Rondelez (Sr.) testified on behalf of the appellants.
The facts are the following: 528061 and 528062 are partners in a business known as Rondelez Brothers, a business engaged in the retail and wholesale supply of furniture and floor coverings and their installation. The shares of the two aforementioned corporations are held by 617855 Ontario Limited, the shareholders of which are Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.). Jerome M. Rondelez (Jr.) holds 50 per cent of the outstanding shares of 617855 in trust for his cousin John M. Rondelez (Jr.). Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) were born respectively on November 17, 1966 and July 25, 1968, thus being of the age of majority in the years in question. They were still living with their parents. The fathers of the shareholders are the directors and officers of the three aforementioned corporations.
The expenses that are in dispute in the calculation of the income of 528061 and 528062 for not having been incurred for business purposes, are described in Exhibits A-5 and A-6. Exhibit A-5 is entitled "Summary of shop expenses" and is for the years 1987, 1988 and 1989. Exhibit A-6 is entitled "Summary of suspense" and is given for the same three years.
These schedules show that expenses such as expenses for groceries, utilities pertaining to the residences, medical accounts and payments made to the spouses of the directors were paid by these corporations in very substantial amounts. The evidence showed that most of these expenses listed in those two schedules were not incurred for business purposes but for personal purposes.
The evidence also showed that Mr. Jerome Rondelez (Sr.), who was the president of the corporations, was the key and dominant person in the management of the business. The reason provided by Mr. Jerome Rondelez (Sr.) for having deducted a substantial amount of personal expenses in the calculation of the business income of 528061 and 528062 was that he did not prepare the corporate tax returns himself and that the bookkeeper, a person that had been in the business’ employment for many years, prepared these returns. However, the accountant testified that Mr. Jerome Rondelez (Sr.) was a man of above average business acumen and the evidence showed that the bookkeeper was an intelligent and diligent person.
During argument, counsel for the respondent informed the Court that he was of the view that some of the amounts described in the shop account and suspense account could be deductible in the calculation of the business income as having been incurred for business purposes. From the evidence, I would not have found that more expenses should have been allowed. However, as there was some evidence, albeit unclear, that some of the expenses shown in the shop account and suspense account may have been incurred for business purposes, I am inclined to allow the same amounts that counsel for the respondent suggested to allow. The next two paragraphs consist of a description of the expenses the deductions of which are allowed as having been incurred for business purposes or refused for not having been incurred for business purposes.
From the amounts shown at Exhibit A-5, first page, for the year ending January 1987, the amounts of expenses relating to groceries, unknown, and haircut are not allowed. The expenses in respect of meals, LCBO and beer are allowed for half the amount as there had been some credible evidence that they may have been incurred for representation purposes or for employees having to work longer hours. The same treatment will apply to the expenses regarding meals, LCBO and beer for the taxation years ending January 1988 and January 1989. That is, these expenses are allowed to the extent of 50 per cent. For the year ending January 1988, the expenses relating to groceries are disallowed. For the year ending January 1989, the expenses with respect to unknown, groceries and dentist are denied.
Insofar as Exhibit A-6 (summary of suspense) 1s concerned, the first page describes the list of the suspense expenses for the year ending January 1987. On this page, the expenses identified as OHIP prescriptions, unknown and Dr. Grayson, Madeline and Pat are refused. The storage expense is allowed to the extent of the amount of $800 and the amount regarding utilities insurance is allowed to the extent of $3,600. On page two of the same exhibit for the year ending January 31, 1988, the expenses relating to prescriptions, OHIP, unknown, Pat and Madeline are disallowed. The storage expense is allowed to the extent of $4,200 and the utilities and insurance expenses are allowed to the extent of $3,600. On the third page of the same schedule, for the year ending January 31, 1989, the amount concerning OHIP, rent for homes, Dr. Grayson (dentist), are not allowed. With respect to the expense relating to home utilities insurance,
the amount of $7,000 may be included in the calculation of income.
As to the penalties imposed pursuant to subsection 163(2) of the Act against 528061 and 528062, counsel for the respondent referred to the decision of Mr. Justice Strayer in Venne, L. v. The Queen, [1984] C.T.C. 223, 84 D.T.C. 6247 (F.C.T.D.). He brought the attention of the Court to the following passage at C.T.C. 233, D.T.C. 6255:
As noted earlier, in order for the defendant to levy penalties under subsection 163(2) of the Income Tax Act it is necessary that the taxpayer have "knowingly, or under circumstances amounting to gross negligence...participated in, assented to or acquiesced in the making of a false statement in a return, etc...".
and at C.T.C. 234, D.T.C. 6256:
"Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not....
From the evidence adduced, I find that the president of the board of directors and chief executive officer of the two corporations 528061 and 528062, knew that personal expenses, his own and those of the other director, his brother, were deducted in the calculation of the business income. It is not possible for me to believe that the president did not know that this should not have been done. He knew that in so doing, he was not complying with the requirements of the Act. Furthermore, there was no evidence adduced to the effect that the shareholders objected to the actions of the directors. For this reason, the imposition of penalties shall be upheld against the two corporate appellants. However, the amount of the penalties should be varied in accordance with the preceding finding as to the amount of personal expenses paid by 528061 and 528062.
Analysis of the appeals of Jerome M. Rondelez (Jr.) and John
M. Rondelez (Jr.)
The personal expenses that were paid by 528061 and 528062 have been added to the income of Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) in their quality as employees or shareholders of these corporations.
It has already been mentioned that Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) hold all the outstanding shares of the holding corporation 617855 Ontario Limited and that Jerome M. Rondelez (Jr.) holds, as trustee, the shares of his cousin John M. Rondelez (Jr.). The evidence did not show any legal impediment preventing the shareholders from exercising their voting power and there was no evidence either that the shareholders denounced the acts of the directors of the corporations.
The evidence indicated however that the shareholders did not have a role in the management of the business and that their role was strictly as employees. In the years in question Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) worked full-time or part-time for the business. They were at that time living with their respective family and behaving in the same way as children living at home where the father and the mother take care of mostly everything.
The reason why the benefits were added to the appellant’s income rather than to the fathers’ income has not been clearly explained. Counsel for the respondent said that it may be because they were shareholders and had some employment income. The fathers had not filed any income tax returns and apparently did not withdraw any salary from the business. In the reply to the notice of appeal, it is one assumption of fact that the fathers of Jerome M. Rondelez (Jr.) and of John M. Rondelez (Jr.) did not receive wages or salary or other forms of income as a result of their involvement in the business. The sons stated that they were not aware of any payments made to persons for non-business purposes, did not direct any such payments and had no control over the monies appropriated. These testimonies were not in any way contradicted.
Counsel for the respondent then submitted that the appellant’s benefited from the room and board that their parents, through the use of the corporation’s money, were able to provide for them and that the moneys appropriated for personal expenses should be added to the sons’ employment income pursuant to section 5 of the Act.
What would be the basis for the inclusion of such benefits in the calculation of the sons’ employment income? There was no evidence whatsoever that the sons consented to the appropriation of the funds. Furthermore, there was no evidence that the appropriated funds were specifically used for their room and board. It is neither a matter of adding to the employment income the benefit of room and board offered to an employee. This requires that the provision of room and board be part of the contract of employment. There is no such evidence here.
I find that benefits of room and board that the appellant’s received were received in their quality as children of the directors of the company and not in their quality as employees and, therefore, I find that the amount of personal expenses cannot be added to their employment income pursuant to section 5 of the Act.
Counsel for the respondent submitted that subsection 15(1) or subsection 56(2) of the Act may apply against the appellants in their quality as shareholders.
Subsection 15(1) of the Act refers to a benefit conferred on a shareholder. From the evidence adduced, I cannot find that the moneys appropriated were a benefit conferred on the shareholders within the meaning of subsection 15(1) of the Act.
Is it a case for the application of subsection 56(2) of the Act? That provision refers to a transfer of property made with the concurrence of a taxpayer for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person.
Counsel for the appellants referred to the case of Fraser Co. v. The Queen, [1981] C.T.C. 61, 81 D.T.C. 5051 (F.C.T.D.) and more specifically at C.T.C. 71, D.T.C. 5058 where Cattanach J. enumerates the conditions that must be present for the application of subsection 56(2) of the Act:
For the transactions between the plaintiff and its subsidiary to be taxable in the hands of the plaintiff each essential ingredient set out in subsection 56(2) to taxability must be present.
These ingredients are fourfold:
(1) there must be a payment or transfer of property to a person other than the taxpayer;
(2) the payment or transfer is pursuant to or with the concurrence of the taxpayer;
(3) the payment or transfer must be for the taxpayer’s own benefit or for the benefit of some other person on whom the taxpayer desired to have the benefit conferred, and
(4) the payment or transfer would have been included in computing the taxpayer’s income if it had been received by him instead of the other person.
Counsel for the appellants submitted that there was no concurrence of the taxpayers. This proposition is right when the appellants are considered qua employees but, is this the case when they are considered qua shareholders? The shareholders had de jure control of the corporations. This control has been defined by the courts has having more than 50 per cent of the voting rights. In Buckerfield’s Ltd. et al. v. M.N.R., [1964] C.T.C. 504, 64 D.T.C. 5301, at page 507 (D.T.C. 5303), Jackett J. stated:
the word "controlled" contemplates the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors.
In M.N.R. v. Bronfman, [1965] C.T.C. 378, 65 D.T.C. 5235 (Ex. Ct.) it was held that the concurrence or participation of the taxpayer in conferring the benefit need not be active. Concurrence may be passive or implicit and can be inferred from all the circumstances, not the least of which is the degree of control which the taxpayer is entitled to exercise over the corporation conferring the benefit. In this decision, Dumoulin J. of the Exchequer Court of Canada said with respect to the shareholders who were not assessed (at C.T.C. 385, D.T.C. 5239):
Shareholders possessing voting rights could have, had they so wished, objected to and voted down at annual or specially convened meetings their directors’ generosities. And, of course, they also might have resorted to the radical remedy of voting out of office the entire board and elected a more thrifty slate of directors. Their abstention or indifference, unbrokenly maintained, becomes tantamount to an approval of their administrators’ gift distributing policies, and they should, with the latter, have shared proportionately to their individual holdings, the burden of taxation decreed by subsection 16(1).
This view was accepted by Mahoney J. in Smith, D.N. v. The Queen, [1993] 2 C.T.C. 257, 93 D.T.C. 5351, a decision of the Federal Court of Appeal. I quote Mahoney J. at C.T.C. 261, D.T.C. 5355:
That said, in my opinion, the learned trial judge correctly concluded that:
The concurrence or participation of the taxpayer to the conferring of the benefit need not be active. It may well be passive or implicit and can be inferred from all the circumstances, not the least of which being the degree of control which the taxpayer is entitled to exercise over the firm or corporation conferring the benefit.
The taxpayer’s entitlement to exercise control is to be stressed.
I understand that the shareholders were the children of the directors. But they were of the age of majority, there was no evidence of any legal impediment preventing them from exercising their voting power and no evidence that they disagreed with the acts of the directors when these acts became known to them. I therefore find that there was concurrence though passive by Jerome M. Rondelez (Jr.) and John M. Rondelez (Jr.) as shareholders.
The question of whether there was a legal impediment preventing John M. Rondelez (Jr.) to exercise his voting rights because his shares were held by Jerome M. Rondelez (Jr.) as trustee will not have to be addressed by reason of my findings thereafter respecting the fourth condition enumerated by Cattanach J. in Fraser Co., supra.
I will refer again to the decision of the Federal Court of Appeal in Smith, supra, where Mahoney J. interprets the application of the fourth condition:
It [Outerbridge] has added another precondition to the application of subsection 56(2), which seems to me to be relevant in the circumstances.
It was held in Outerbridge, supra, at C.T.C. 117-18 (D.T.C. 6684),
that the validity of an assessment under subsection 56(2) of the Act when the taxpayer had himself no entitlement to the payment made or the property transferred is subject to an implied condition, namely that the payee not be subject to tax on the benefit received.
That conclusion, obiter in the result, was based on the analysis by Marceau J.A. that preceded it. (C.T.C. 117, D.T.C. 6684)
It is generally accepted that the provision of subsection 56(2) is rooted in the doctrine of "constructive receipt" and was meant to cover principally cases where a taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount paid to some other person either for his own benefit (for example the extinction of a liability) or for the benefit of that other person [citations omitted]. There is no doubt, however that the wording of the provision does not allow to its being confined to such clear cases of tax-avoidance. The [Allan] Bronfman judgment, which upheld the assessment, under the predecessor of subsection 56(2), of a shareholder of a closely held private company, for corporate gifts made over a number of years to family members, is usually cited as authority for the proposition that it is not a pre-condition to the application of the rule that the individual being taxed have some right or interest in the payment made or the property transferred. The precedent does not appear to me quite compelling, since gifts by a corporation come out of profits to which the shareholders have a prospective right. But the fact is that the language of the provision does not require, for its application, that the taxpayer be initially entitled to the payment or transfer of property made to the third party, only that he would be subject to tax had the payment or transfer been made to him. /t seems to me however, that when the doctrine of constructive receipt is not clearly involved, because the taxpayer had no entitlement to the payment being made or the property being transferred, it is fair to infer that subsection 56(2) may receive application only if the benefit conferred is not directly taxable in the hands of the transferee. Indeed, as I see it, a tax-avoidance provision is subsidiary in nature; it exists to prevent the avoidance of a tax payable on a particular transaction, not simply to double the tax normally due nor to give the taxing authorities an administrative discretion to choose between possible taxpayers.
[Emphasis added.]
Mahoney J. allowed the appeal in Smith v. The Queen on the issue involving subsection 56(2) of the Act on the basis of the analysis made by Marceau J. in Outerbridge. Subsection 56(2) of the Act is in the nature of a tax avoidance provision and therefore subsidiary. It will apply if the payee is not subject to tax in respect of the payment or the transfer of property in question.
In the case at bar the shareholders had no entitlement to the property transferred and the benefit conferred could clearly have been taxed in the hands of the directors of 528061 and 528062 as employees or officers of the corporations. It is not therefore a case for the application of subsection 56(2) of the Act.
The alternative proposition of the respondent is that the tax avoidance provisions of the Act may apply. These would be subsection 245(2) of the Act for the taxation year 1987 and subsection 246(1) for the subsequent taxation years in question. It was not explained to me in which way the legal situation described in the present instance is one to which the provisions of Part XVI of the Act could apply, nor was I referred to any case law. At any rate, a reading of these provisions leads me to believe that these provisions do not point towards the appellants but towards the directors as being those who should be taxed. Therefore they do not bring me to conclusions other than those I have reached with respect to subsection
56(2) of the Act.
These appeals are allowed.
The appeals of 608787 (facts and analysis)
The appellant 608787 is a corporation that owns the premises in which the business carried on by 528061 and 528062 is located. The wives of Mr. John Rondelez (Sr.) and Mr. Jerome Rondelez (Sr.) were the shareholders and directors of this corporation. A lease was entered into on January 31, 1988 between 608787 and, 528061 and 528062. The annual rent was set for $42,000 per year. This amount was never paid. In 1987 and in 1988, the amount of $17,880 was paid and in the year 1989, the amount of $17,930 was paid. The appellant 608787 reported its income on a cash basis, whereas the tenants, 528061 and 528062, showed the full amounts each year as expenses.
At the hearing, both parties seemed to agree that the rental income should have been reported on an accrual basis without giving any reason except to say that it was required by the Act. That is true if the income is a business income but what if it is property income. There is a presumption that income from a corporate taxpayer is income from a business but this presumption is rebuttable (Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, [1986] 2 C.T.C. 465, 86 D.T.C. 6526). If it were income from a property, it is interesting to read what is said in Ward's Tax Law and Planning, vol. 2 at chapter 43.1 [b] entitled "Timing of inclusion of property income":
Although there is not a great deal of jurisprudence on the question, it is suggested that in light of the fact that sections 12(l)(a) and (b) are not applicable to income from property and that it was considered necessary to enact specific statutory rules requiring the accrual method to be used for interest income, income from property need not generally be computed on an accrual basis. In each case, however, it would be necessary to establish that the cash method was appropriate for computing the profit from the property in accordance with the ordinary principles of commercial practice. In view of the fact that in most cases a taxpayer deriving only income from property would not have to be concerned with items such as inventory or significant accounts receivable, it would appear to be clearly arguable that the cash method is the most appropriate for the computation of such profit.
Since the point was not made by either counsel, there is no need to discuss this aspect any longer. Counsel for the appellants said that, had the income been reported on an accrual basis, as he thought it should, a reserve for doubtful debt pursuant to paragraph 20(1 )(1) of the Act would have been asked for by 608787 because 528061 and 528062 were not in a financial position to pay the full amount. Therefore in the end, he stated, the total taxable income would have been the same. Counsel for the appellants also submitted that section 78 of the Act deals with amounts in respect of a deductible outlay that is owing by a taxpayer to a person with whom the taxpayer is not dealing at arm’s length. This amount so unpaid shall be included in computing the taxpayer’s income for the third taxation year following the taxation year in which the outlay or expense was incurred.
In the reply to the notice of appeal, it is shown as a fact assumed by the Minister in assessing 608787 that no claim for a reserve for unpaid rental income had been made by the appellant. Should I infer from this that if 608787 had done so, it would not have been disputed by the Minister. Asked to comment on this aspect, counsel for the respondent informed the Court that he could not say whether a reserve would have been allowed.
Consequently, I find that I was given no reason to dismiss the appeal of 608787 and it is therefore allowed.
There will be no orders as to costs.
Appeals allowed
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