John A. Fehrenbach v. Minister of National Revenue, [1986] 1 CTC 2605, 86 DTC 1472

Goetz, T.C.J. [ORALLY]:—This is an appeal relating to the appellant’s assessments for his 1979 and 1980 taxation years. The problem arose by virtue of the fact that the appellant who is a practising lawyer sought to deduct certain expenses relating to a condominium that he purchased at Cranberry Village in the Collingwood, Ontario, area. These expenses were deducted by the appellant on the basis that they constituted business development and entertainment expenses. The Minister of National Revenue (the Minister) has disallowed these deductions and the question is then for the Court to decide whether in fact these deductions by the appellant were permissible.

The Minister in presentation of his case invoked the provisions of paragraph 18(1)(l) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, asking the Court to determine that this condominium was in fact a lodge and came under the prohibition of deductions under paragraph 18(1)(l) of the Act 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

(1) an outlay or expense made or incurred by the taxpayer after 1971,

(i) for the use or maintenance of property that is a yacht, a camp, a lodge or a golf course or facility, unless the taxpayer made or incurred the outlay or expense in the ordinary course of his business of providing the property for hire or reward, or

(ii) as membership fees or dues (whether initiation fees or otherwise) in any club the main purpose of which is to provide dining, recreational or sporting facilities for its members;

The appellant certainly did not hire out his condominium for hire or reward. He stated that he used the condominium to entertain clients or potential clients or people that he had met through other friends whereby they would get to know him and he would get to know them and as a result of this he says he was able to derive a good relationship culminating in people that he met becoming top clients. He mentions a developer and showed the substantial fees that this man paid after the years in question here and also the German investor who was interested in acquiring agricultural or development land in Canada. He also had a number of other initials for clients that he entertained there. I cannot stretch the meaning of the word ""lodge" to include the physical set-up that the appellant had at the condominium.

The condominium is a two-bedroom apartment with two bathrooms, a kitchen and livingroom. The condominium was located in Cranberry Village and was centred in a recreational area with swimming, tennis and, in particular, skiing facilities.

The appellant says that he would discuss business but most of the time it was a social meeting. He felt that this had enhanced his drawing power and his billings. Document five of Exhibit A-1, which is attached to the appellant's 1979 income tax return, is a document entitled “Client Entertainment

— Business Development" listing the expenses. I will go through them without putting the figures on — Realty Taxes, Occupancy Charge, Interest on Niagara Realty Mortgage, Mortgage Interest Adjustment, Interest on Bank of Montreal Loan (which related to the down payment), Common Condominium Expenses, Utility Charges and five-eighths of a cord of wood, totalling $7,202.88. He says that he deducts from that 25 per cent as being personal use with a then net expenses claim of $5,402.16.

The same approach was taken for the year 1980 on document 7 of Exhibit A-1 also entitled ""Client Entertainment — Business Development" and in that year the appellant comes out with a ""Deductible Expense" of $5,669.86. He says that the condominium was used for 68 days in total — Client entertainment of 47 days or 69 per cent of the time and personal use 21 days or 31 per cent.

The appellant was practising law with another lawyer on a fifty-fifty partnership. The appellant filed a tax return to which was attached the Balance Sheet of the firm of ""Morscher & Fehrenbach” (Fehrenbach being the appellant). The Balance Sheet for the year 1979 shows gross fees of $176,330.93 and deduction of expenses of about $89,506.24 and each partner had an equal share of $43,412.34, so all of the expenses relating to their practice of law in partnership are set out.

It is at this point that the appellant departs as a partner from the partnership in his own personal capacity to acquire his condominium for entertainment and business development and the expenses thereof he deducted from his own income. But the problem facing me is that this departure from the partnership operation, more or less on a venture of his own, puts him in a position where he is acquiring a condominium, he is buying it. All the expenses of the purchase of the property and the maintenance of that property he seeks to deduct on the premise that it was used in the main to entertain clients not overnight but to sit them down with a bottle of wine and woo them as clients. It is the break-off from the partnership operation that to me puts the appellant in a difficult position. It would seem that when practising in partnership that if there was to be an item for entertainment and business development and it costs money, that that should have been shared by the partnership. In other words, if any benefit accrued, the expense of any such benefit was the responsibility of the partnership and would fall equally on both partners and that they would both have the same use of it.

The property in question, the condominium, was in the name of the appellant and not in the name of the partnership. He says this gave him greater drawing power than his partner and that in the years in question was not so. In 1985 he says that his fees were up dramatically but I find it difficult to relate that to the ownership and operation of the condominium as an entertainment centre and it is on the basis that his partner was totally excluded from the operation of the condominium, excluded from acquiring equity in it. The partnership paid no expenses relating to the condominium. It was entirely a personal thing as far as Mr. Fehrenbach, the appellant, is concerned. It would seem on the face of it a legitimate expense for a professional to expend moneys for the purpose of entertainment. This is a unique way of doing it.

The appellant did admit that he enjoyed personal use of the condominium in light of its location in a very popular recreational area. He has shown expenditures for liquor and so forth but the list of expenses in owning that property as set out by the appellant in his tax returns indicates to me clearly that it was an investment in property and it was not a revenue bearing property and the way that he seeks to pay the expenses of buying the condominium is to set it up as a recreation centre for himself and for his clients and friends.

The Court is not satisfied that the ownership and use of this condominium, for the purpose for which the appellant says he had it, enables him to deduct the large expenses as deductions from his income. He has indicated and has given us figures of a survey by the Canadian Bar Association and that relative to his gross net income for 1985 that the expenses do not seem untoward. I cannot just go by the figures but rather by the principle involved here.

Counsel for the Crown cited Brooks v. The Queen, [1978] C.T.C. 761; 78 D.T.C. 6505, a judgment of Grant, J. of the Federal Court — Trial Division. This decision relates to, and it is not on all fours with the case before me, merely of a man seeking to make deductions for the expense of using his home in addition to what he did at his office and I quote from pages 762-63 and 6506 respectively of that judgment, where Grant, J. states in referring to paragraph 18(1)(a):

The section of the Income Tax Act applicable to the 1971 assessment is section 12(1)(a) and for 1972 section 18(1)(a). Although numbered differently both sections read as follows:

In computing income, 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 property or a business of the taxpayer.

The Judge goes on to say:

All the items of mortgage payments, taxes and telephone bills were nothing more than personal or living expenses. They were not increased in any way by the fact he saw clients there in the evening. . . .

If these sums were incurred for the purpose of producing income then they were properly payable by the firm which received all revenue from the business. No such credit was allowed by the firm to the plaintiff in the division of their income.

The appellant was on a venture of his own, aside from his partnership, in acquiring a condominium residence. The cost of acquiring the condominium and the expenses relating thereto are not deductible as entertainment expenses.

For these reasons the appeal is allowed and the matter referred back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to deduct ten per cent of the “client entertainment and business development” expenses claimed for the taxation years 1979 and 1980. In all other respects, the appeal is dismissed.

Appeal allowed in part.