Les Placements Sogelan Inc. v. Minister of National Revenue, [1995] 2 CTC 2721, 95 DTC 697

Bowman J.T.C.C.:—These are appeals from assessments of the appellant for the 1981, 1982 and 1983 taxation years. The appeals relate to the deduction of expenses for salaries and fringe benefits in the amount of $62,955, $140,824 and $15,730 in computing the appellant’s income for the above-mentioned years. The Minister of National Revenue refused the deduction on the assumption that the expenses had not been made or incurred for the purpose of gaining or producing income from a business within the meaning of paragraph 18(l)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”) and that, in any event, if the deduction were permitted, it would reduce the appellant’s income unduly or artificially.

The facts are not complicated. The majority shareholders of the appellant were Jean-Pierre Landry and Mario Landry. As of October 1, 1980, the appellant held shares in the following companies:

Distribution Boisbec Ltée ("Boisbec")100%

Gestion Tilly Ltée (’’Tilly”) 50%

Matériaux Rénomat Inc. ("Rénomat”)100%

Armand Hébert Marchand de Bois Inc. ("Hébert”) 50%

As of January 1, 1983 the situation was the same except that Boisbec had been sold.

The president and principal shareholder of the appellant was Mr. Jean- Pierre Landry. Besides Tilly, which managed a business in the latex and rubber field, the other three companies, Boisbec, Rénomat and Hébert, managed businesses in the construction materials field.

The appellant’s duty and also its business were to hold the shares of the other companies and to provide them with management services during the years in question. It hired all the employees and provided these companies with the services of these employees.

The economic reasons for this arrangement were explained by Mr. Aubin, a chartered accountant who acted for the appellant. In short, the reasons were as follows:

A. from the management point of view, it was easier because there were employees who could work in several companies or in several branches. Thus, it was not necessary to make inter-branch charges;

B. the fact that all the salaries were in the same corporation allowed for economies of scale;

C. there were also important savings with respect to contributions to the Commission de la santé et de la sécurité au travail [Workers’ Compensation Board].

These commercial reasons were valid and I accept them. The purpose of the arrangements was not to minimize income tax. In fact, these reasons had nothing to do with tax.

Mr. Aubin filed the appellant’s financial statements for the years preceding and following the three years in dispute. The income and expen- ditures for these years and for the years in dispute were as follows:

In its income tax return the appellant reported the following amounts for the years in question:

The Minister of National Revenue added the amounts mentioned earlier, that is $62,955, $140,824 and $15,730 to the appellant’s income for these years. The addition of these amounts is essentially the result of a refusal to allow a deduction of part of the appellant’s expenditures.

In the figures I gave above there are insignificant sums for interest paid by the appellant and other income it received but the largest part of its income was management fees received from the companies whose shares were held by the appellant and to which it provided management services. Most of the expenditures were the salaries and other fringe benefits that it paid its employees. The services it provided to the other companies were provided by the appellant’s employees.

The reason why the management fees fell below the salary expenditures was quite simply that during the recession that held sway during these years the companies did not have the means to compensate the appellant for the fixed salary expenditures it was obliged to pay its employees.

In the circumstances Mr. Landry had three options:

A. to send larger invoices to the other companies which they would not have been able to pay;

B. to lower the salaries of the appellant’s employees or dismiss them;

C. to charge the other companies amounts that they could pay.

There was another consideration. Two of the companies-Hébert and Rénomat-had financial difficulties and their business was closely monitored by the bank, which, in any event, would not have allowed them to pay more by way of management fees.

Mr. Landry chose the only option open to him. He allowed the appellant to accept from the other companies amounts that they could pay. This was a decision made in good faith and in accordance with common sense and commercial requirements.

The Minister sees in this decision more sinister motivation. He notes that in these years expenses exceeded the level of income and he concluded from this fact alone that the excess could not have been incurred in order to produce a profit. If the reason was not to produce a profit, what was the reason? According to the Minister, the goal was to transfer the losses of the other companies to the appellant and, in this way, to reduce its income artificially. I find it hard to understand this reasoning. The sole reason for the appellant’s existence was to make a profit. Its sole source of income was the corporations in which it had an interest. Trying to force them to pay sums they were not able to pay would have been pointless and would also have been contrary to Mr. Landry’s objectives. Mr. Landry’s purpose was to maintain the business during a period of serious difficulties. These companies, which were simultaneously customers, investments and sources of income, were experiencing bad times. To attribute tax-related motives to a decision that was, from a commercial point of view, reasonable and even inevitable, is, in my view, lacking in common sense and understanding of the reality of the world of business. Even if the appellant had charged Rénomat larger management fees, the result would have been the same. Rénomat would not have been able to pay them and the excess would have become a bad debt that the appellant could have deducted in computing its income. This unpaid excess would have been added to Rénomat’s income under the provisions of section 78.

There is another reason why I reject the respondent’s position. The amount for which the other companies were invoiced by the appellant was determined at the end of each month and not after the end of the year. It corresponded exactly to the money available to the companies. This was not a fictitious amount determined for purposes of the tax return.

I am not ignoring the accounting evidence of Mr. Yvon Giroux, an auditor with the Department of National Revenue. He came to his conclusion by a rather complicated process. He assumed that the appellant was not dealing at arm’s length with all the corporations except Tilly. On the basis of this principle, he concluded that the amounts charged to Tilly were reasonable but that those charged to the others, especially Rénomat, were insufficient. It follows, according to Mr. Giroux, that the difference between the amounts charged to the other corporations and the amounts received from them in management fees or shares of net profit were not paid in order to produce a profit. His logic and his calculation may be comprehensible but I reject his premises, which are not based on the commercial requirements that led Mr. Landry to make the decisions he made. It happens from time to time that the Minister, with his judgment after the event, confirms that an expense that did not in fact produce a profit in a particular year was not designed to produce one. Mr. Landry’s goals were to maintain the business in the long term in a difficult period and to avoid bankruptcy. The reply to the argument advanced by the Crown lies in the words of the Lord President in Vallambrosa Rubber Co. Ltd. v. Farmer,

[1910] S.C. 519, 5 T.C. 529 (Scotland.), at page 534, where he said:

The junior counsel for the Crown, encouraged by certain expressions which he found used by various learned judges who had given judgments in tax cases, wished your Lordships to accept this proposition, that nothing ever could be deducted as an expense unless that expense was purely and solely referable to a profit which was reaped within the year. I think that proposition has only to be stated to be defeated by its own absurdity. It is quite true that in some of the cases there are expressions to a certain effect, and I will take as an illustration, for instance, one that was founded on an expression of Lord Esher in the case of the City of London Contract Corp. v. Styles. He was dealing there with the question of whether a certain expenditure was capital expenditure or an ordinary expenditure, and he said this (page 244): "How can you carry on a business after you have embarked your capital in the purchase of it? You must find new money in order to pay the expenses year by year, but then you do find money to pay the expenses year by year, and you get the receipts year by year, and the difference between the expenses necessary to earn the receipts of the year and receipts of the year are the profits of the business for the purpose of the income tax." Well that is for the case quite correct, but it must be taken, as you must always take a judge’s dicta, secundum materiam subjectam of the case that is decided. But to say that the expression of Lord Esher’s lays down that you must take each year absolutely by itself and allow no expense except the expense which can be put against the profit which is reaped for the year is in my judgment to press it much further than it will go.

[Emphasis added. I

In the reply to the notice of appeal, the respondent stated the reasons why the Minister refused the deduction of the amounts in question. Paragraph 14 of the reply alleges that the Minister assumed the following facts, among others:

(p) The losses in question of $62,955 (1981), $140,824 (1982) and $15,730 (1983) represent the difference between the amount of salaries paid to the employees and the amount of the management fees invoiced to the three corporations concerned;

(q) The agreements concluded in this respect between the appellant and the three corporations carrying on a hardware business were not designed to produce a profit;

(r) The amounts in question of $62,955 (1981), $140,824 (1982) and $15,730 (1983) were not spent or expended for the purpose of gaining income;

(s) The appellant deliberately invoiced management fees lower than the salaries it paid in order to attain the following goals:

(i) to enable one or more of the corporations operating a hardware business to carry forward against income losses other than capital losses sustained by it during earlier taxation years, which could otherwise probably not have been used;

(ii) artificially to create losses in computing the appellant’s income in such a way as to absorb the profits made by the company from its other activities;

(t) The deduction of the amounts in question of $62,955 (1981), $140,824 (1982) and $15,730 (1983), if it had been allowed, would unduly or artificially reduce the appellant’s income for each of the taxation years in question.

According to the evidence and despite Mr. Plourde’s powerful and persuasive arguments, I find that the appellant discharged the onus of proof. It succeeded in demolishing the foundations of the assessments. The appeals are allowed with costs. The assessments are referred back to the Minister of National Revenue for reconsideration and reassessments in order to allow the deduction of the amounts of $62,955, $140,824 and $15,730 in computing the appellant’s income for the years 1981, 1982 and 1983 respectively.

Appeals allowed with costs.