Crescent Air Conditioning Limited v. Minister of National Revenue, [1985] 1 CTC 2041, 85 DTC 59

Taylor, TCJ:—These appeals were heard on September 18, 1984 in Toronto, Ontario against income tax assessments for the years 1976, 1977 and 1978 in which the Minister of National Revenue disallowed as a deduction certain amounts paid to shareholders of the company, generally categorized as travelling and promotion expenses. The notice of appeal for 1977 is typical of all three years and reads as follows:

— The Appellant company operated during its 1977 taxation year the business of sales, service and maintenance of air conditioning equipment.

— The shareholders of the company during its 1977 taxation year were as follows:

Meindert Blom	— 3333 */ common shares
Karl Blom	— 3333 /3 common shares
Gordon Patrick Diaz	— 3333 */ common shares

the officers of the company during the 1977 taxation year were;

President	— Karl Blom
Vice-President	— Meindert Blom
Secretary-Treasurer	— Gordon Patrick Diaz

— All of the officers were employed by and were active in the day to day operations of the company.

— In accordance with their terms of employment with the company, each of the executive officers, Karl Blom, Meindert Blom and Gordon Patrick Diaz were to be allowed an expense allowance of $350.00 per month to meet expenses incurred in carrying out the duties of their office. This provision was included in their Agreement of April 23, 1976.

— Also during the taxation year 1977, the company credited each of its officers with an allowance of $100.00 per month for promotion. This allowance, which amounted to $3,600.00 was included in the travel and promotion expense of the company for the year. To the extent of $2,983.00 these amounts have been disallowed. The Appellant is not objecting to this disallowance in this Appeal.

— The Company made payments on account of the expense allowances referred to in paragraph 5, as follows:

— The company paid vehicle operating costs for company vehicles used by the officers in carrying out their duties and charged these amounts against the allowance referred to in paragraph 5. The Appellant acknowledges that these amounts have been allowed as a deduction and are not being questioned in this Appeal.

— The company paid personal expenses on behalf of the particular officers and made payments directly to the particular officers from the remainder of the allowance outlined in paragraph 5, after allowing for payments outlined in subparagraph (a) above.

— The company deducted, as auto and truck expenses for 1977, the allowances, as follows:

		$
Meindert Blom	12 X 350.00	4,200.00
Karl Blom	12 X 350.00	4,200.00
Gordon Patrick Diaz 12 X 350.00		4,200.00

— The Appellant relies on section 18(a) of the Income Tax Act of Canada.

— The Appellant is of the opinion that the allowances represented a reasonable expense of the company for the purpose of producing income from its business.

With specific reference to the $350 amount noted above the respondent asserted:

In assessing tax as aforesaid, the Respondent relied, inter alia, upon the following findings or assumptions of fact:

— the Appellant in issuing T-4 slips to the Shareholders did not include on the T-4 slips the amount referred to in paragraph (e) herein;

— the Shareholders did not include the amount referred to in paragraph (e) herein in their income in filing their income tax returns for the period under appeal;

— the amount of the allowance referred to in the Agreement was not calculated with reference to the estimated expenses of carrying out the duties of an officer of the Appellant, and was paid to the Shareholders in their capacity as Shareholders and not as employees;

— employees of the Appellant who were not shareholders did not receive similar allowances during the period under appeal;

— the amounts claimed by the Appellant and disallowed by the Respondent were not incurred for the purpose of gaining or producing income from business or property;

— the Appellant knowingly or under circumstances amounting to gross negligence in the carrying out of a duty or obligation imposed by the Income Tax Act made false statements or omissions in its 1977 income tax return . . .

— The Respondent submits that the amounts disallowed from deduction were not incurred by the Appellant for the purpose of gaining or producing income from a business or property but were expended to provide a benefit to the Shareholders of the Appellant and therefore were not deductible from income pursuant to paragraph 18(1)(a) of the Act.

The actual amounts at issue, in these appeals are not simple multiples of $350, but for each year are odd dollar amounts because the two other factors noted above — the “reimbursement payments” and the “personal payments” were taken into account in the calculation of the disallowance. However, as I see it the point at issue is looked at most appropriately by surmising that there were no such “reimbursement payments” or other “personal payments”, but that each of the three shareholders simply received his $350 per month. The question then becomes simply, would these amounts be legitimately deductible by the corporation, since there was no dispute between the parties about the relevant facts or the agreement noted?

First, I would dispose of two points raised by the respondent. I am unable to appreciate any significance to the assertion that the payments at issue ($350 per month) were paid to “shareholders”, as opposed to “employees”, and the respondent did not support this assertion in my view. The fact that other employees, who were not shareholders, did not receive this payment is not relevant either.

As I follow it, each of the three shareholders used his own car in the performance of his duties for his employer, the corporation, and each paid for his own expenses. As I comprehend the circumstances, the amounts would be “allowances”. I am not aware of any basis for denying such a deduction to the corporation — providing the amounts are reasonable. Monthly amounts of $350 for each shareholder — as an employee — for such a purpose is not unreasonable. Further, the Minister did not raise the question of “reasonableness”, and there was no suggestion that the employees were not required to use their cars. The fact that the individual recipients of the funds did not report the amounts in their tax returns, may be a problem for the recipients. Part of the documentation presented to the Court indicated that a strong and proper caution had been given by the corporation’s auditors, regarding possible risks involved in these payments and certain other corporate practices. But that is not the issue before the Court.

In making his argument to the Court, counsel for the respondent relied heavily upon the case of Latta et al v MNR, [1978] CTC 3003; 78 DTC 1719. While there are similarities between Latta, supra, and the instant appeals, there is no indication in that decision, the Tax Review Board (as it then was) was convinced that the amounts at issue had the necessary characteristics which identified them as “allowances”. In this matter, as I see it, there is no such residual question — the regularly paid amounts of $350 per month for travel and promotion, did not require that the recipients account for the funds in any way to the corporation. As explained to the Court, the purpose of these payments was quite the reverse

— to ensure that such costs incurred individually (but presumably in the interest of the corporation) did not exceed that $350 per month maximum. That is a point, as I understand it, quite consistent with the general definition of an “allowance” for income tax purposes.

This brings up the question of the penalties imposed. Obviously, since there is found to be no additional income tax to pay, there is no base upon which to impose a penalty. I have reflected on the point which might have been raised by the Minister — (that the corporation did not report as income to the recipients the amounts involved) — but I fail to see how that prospect can enter into this particular decision.

In summary, the appeals by the corporation Crescent Air Conditioning Limited against the disallowance of all or any part of the travel and promotion allowance included in the monthly $350 payments, are allowed. All penalties are to be deleted and the entire matter is referred back to the respondent for reconsideration and reassessment.

Appeals allowed.