Steven Adam v. Minister of National Revenue, [1985] 2 CTC 2383, 85 DTC 667

Rip, TCJ:—The facts in Mr Steven Adam's appeal from an income tax assessment for 1982 are not in question. The issue is whether a salary, once paid as salary, can be made retroactively into a dividend.

During 1982 Mr. Adam owned 60 per cent of the issued and outstanding shares of Adamin Industries Ltd (“Adamin”), a Canadian controlled private corporation. Mr Adam’s son owned the other 40 per cent of the shares of the corporation. At the time Mr Adam and his son were employees of Adamin. According to Adamin’s payroll sheet for Mr Adam, each week during 1982 Mr Adam was paid a salary of $702.77; Adamin issued weekly to him for a net amount, cheques after deductions at source for Quebec Pension Plan, federal income tax and provincial income tax. The amounts withheld were remitted to the federal and Quebec governments.

Mr Adam’s son also received salary.

Adamin’s 1982 fiscal year ended on December 31.

On December 28, 1982 the following resolution was passed by all the directors of Adamin:

RESOLVED THAT: The Corporation declare a dividend of FOUR HUNDRED DOLLARS on each common share of the Corporation presently issued and outstanding payable as of today’s date to Shareholders as of record of today’s date.* [1]

The accountant for Adamin, Mr Gerald Rabinovitch, CA, testified that his firm advised Adamin to "reverse” the payroll records of Mr Adam and his son for 1982 so that the amounts paid to them in the year would be dividends and not salaries. Mr Adam, who also testified, stated that on the advice of his accountant he instructed his bookkeeper to "reverse” the payroll records accordingly. It should be noted that there was no corporate resolution authorizing Adamin to "reverse” the salaries paid during the year. I do not propose, however, to consider the significance of this omission.

No dividend was paid by Adamin prior to 1982; the sole source of income of Mr Adamin and his son was from the company by way of salary. At the end of 1982 Adamin had modest retained earnings available for distribution as dividends to its shareholders.

Mr Rabinovitch recalled that the budget of November 12, 1981 proposed a 12 /2 per cent tax on dividend distributions by small business and by a release dated June 28, 1982 from the office of the Deputy Prime Minister and the Minister of Finance it was announced that the 12 /2 per cent tax would be postponed to January 1, 1983. Then, in his budget address of October 27, 1982, the new Minister of Finance proposed that the 12 /2 per cent tax should apply only to dividends paid out of corporate income earned in taxation years starting after the end of 1982 and that dividends paid out of business income would be considered to come first out of income earned after 1982.

Thus, Mr Rabinovitch testified, his firm recommended to clients that in order to avoid paying the 12 /2 per cent on dividends after 1982 they reverse their payroll and take dividends in 1982.

In questions from the Court, Mr Rabinovitch replied that the costs would not have warranted the shareholders of Adamin to incorporate a new corporation to which they would transfer their Shares of Adamin and subsequently, but prior to 1983, cause Adamin to pay dividends to the new entity. He also said he did not recommend loans, instead of salary, be taken by Mr Adam and his son during 1982 since he feared they may be assessed tax in accordance with section 80.4 of the Income Tax Act ("the Act”).

Mr Adam, who is president of Adamin, was quite candid in admitting that in each week during the year when salary was paid it was the intention of Adamin to pay, and Mr Adam and his son to receive, salary. This was confirmed by Mr Rabinovitch.

However Mr Rabinovitch argued that since there is no provision in the Act prohibiting the reversal of book entries, it is permissible to do so. He also submitted that a closely held corporation, such as Adamin, ought to be treated differently from other corporations to permit the shareholderemployee to decide at any time the form of income he is to draw from the corporation.

It was admitted that during the year Mr Adam received salary. Adamin treated the payments as compensation for regular work performed by Mr Adam. When a taxpayer receives salary from his employer he is taxable in the year of receipt on the amount of salary since this constitutes income from employment (section 5 of the Act). The salary, once received, cannot for tax purposes become anything else. Mr Adam cannot by any “ex post facto” act alter the destination of the moneys, or the purpose for which they were paid to him and received by him. See Malkin v MNR, [1942] CTC 135 at 144; 2 DTC 587 at 591; Alepin v The Queen, [1979] CTC 360 at 364; 79 DTC 5259 at 5262. An adjustment to the books of account of a taxpayer cannot render null that which has transpired. Past events cannot be ignored. That is not to say a taxpayer cannot make entries in his books of account to reflect adjustments to his accounts as and when they take place. For example, in corporations the size of Adamin, it is not unusual for a shareholder-employee to draw money as loans from the corporation throughout the year and at the end of the year the shareholder-employee and the corporation decide as to the mix of dividends and salary the shareholder- employee is to receive; the loan account would then be adjusted accordingly.

However no taxpayer has the right to retroactively alter events when it best suits his purposes although there is no question he may prospectively plan events to suit these purposes: this is sometimes called tax planning. While I may sympathize with Mr Rabinovitch’s desire to minimize his client's taxes and the uncertainty in tax law during 1982, I am of the view that the retroactive adjustments to accounts is not a valid tax planning scheme, and I must therefore dismiss this appeal.

I wish to raise the question whether Mr Rabinovitch should have represented Mr Adam. In situations where an accountant, agent or solicitor was an actor, in whole or in part, in events leading to the income tax assessment it should be recognized that a potential conflict of interest exists and in most cases that person ought not to undertake to act as counsel or representative for the appellant. While in this case the agent did nothing improper, it is the view of this Court that acting for the appellant in such circumstances is not advisable and is to be discouraged. (See Tanaka v MNR, [1985]1 CTC 2333; 85 DTC 305).

Appeal dismissed.