Melva J Clarke, John Keegan v. Minister of National Revenue, [1984] CTC 2944, 84 DTC 1839

Sarchuk, TCJ:—These appeals were by consent tried together on common evidence. The issue is not complex. The appellants operated a turf farm as a partnership. In the 1978 and 1979 taxation years wages claimed as expenses in the amount of $10,800 and $18,000 respectively were disallowed as deductions from income of the business by the respondent.

Facts

The appellants John Keegan (Keegan) and Melva J Clarke (Clarke) live together at Surrey, British Columbia, with Clarke’s four children, Arlie, Robin, Diana and Shane. Keegan has been involved in the sod supply business for a number of years and since 1975 the two appellants carried on business in partnership under the firm name of B.C. Lawn Turf Farms.The farm, formerly an abandoned nursery, required substantial clearing and preparation before sod could be grown. Clearing was a gradual process and the first small crop of sod was not taken off until 1976. By 1977 approximately twenty acres were cleared and in production with further acreage becoming available in 1978 and 1979. The appellants maintained a small sales office on the site from which the crop was sold.

Although the clearing and preparing of the land required substantial manual labour, the cultivating of sod itself is a comparatively simple process. It is by its nature seasonal with two separate seeding and harvesting periods, creating a fluctuating volume and intensity of work. Once the land is ready the process consists of seeding, frequent fertilizing, mowing and eventually harvesting where the sod is taken up in strips, hand rolled and placed on skids. It was not disputed that although equipment was used a great deal of manual labour was nonetheless required. It was not until 1978 that the partnership acquired a mechanical harvester which enabled the appellants to cut and roll the sod in one continuous action.

Both appellants maintained that it was necessary for the children to do much of the farm work and that an arrangement existed whereby they were to be paid for their work. Mr Keegan’s evidence was vague and imprecise on this issue. Although a crude system of keeping track of employees’ hours was utilized, Keegan was not able to tell the Court what books were in fact kept or what times were recorded. In so far as the four children were concerned he simply assumed that they recorded their time in the same manner as outside help and that they would turn over their time slips to Clarke for recording in the partnership records and for payment.

His evidence was of no assistance to the Court. He could not recall the hourly rate paid to any of the children in the years in question, he was unable to recall whether the hourly rate was the same in 1979 as it was in 1978, he was unable to tell the Court whether or not Arlie, who was eleven in 1978, was paid on the same scale as her older sisters and, more particularly, on the same scale as her brother, Shane, who was eighteen. Keegan was not able to recall how many hours any child worked, nor was he able to tell the Court whether or not any of the children kept track of the number of hours they worked. Even when shown four handwritten time sheets he was unable to confirm the hourly rates apparently recorded therein by the children.

According to the 1978 financial statements of the partnership, Robin, Diana and Shane were each paid a lump sum of $3,600. Keegan did not know whether or not those amounts were actually paid, he did not recall why each child was allocated exactly the same amount and was unable to tell the Court whether the amounts were based on the actual number of hours worked. Although minutes of partnership meetings authorizing the payments were produced, Mr Keegan could not recall whether they were prepared prior to or following the reassessment nor when or where he signed the minutes.

At some stage, acting on the advice of their accountant, Keegan and Clarke signed promissory notes in favour of their children, purportedly in payment of 1979 wages. Keegan’s recollection of when these notes were prepared, when they were signed and why the transactions were handled in this manner was so marginal as to be without value.

An analysis prepared by Clarke of the hours allegedly worked by the children in 1978 and 1979 was produced and shown to Keegan. Diana and Robin were both shown as having worked 830 hours each in 1978. In the case of Arlie, no analysis appears to have been made at all. Keegan stated that he had never seen the document before and had no idea of its accuracy.

I cannot leave Mr Keegan’s evidence without saying that his recollection of events was so marginal that it is difficult if not impossible to attach much weight to it.

Melva J Clarke stated that it was her responsibility to look after disbursements, to maintain all purchase and sales records and the general ledger and to eventually provide their accountant with all the information needed to enable him to prepare their tax returns and annual financial statements. It was her evidence that the children worked after school with the exception of Shane, who had graduated from school and worked more or less fulltime after June 1977. Shane turned nineteen in 1978, the first taxation year under appeal while Diana, Robin and Arlie were sixteen, thirteen and eleven respectively. Clarke produced a reconciliation of the hours she claimed the children worked in both 1978 and 1979 (Exhibit A-7). This document was prepared by her in 1981 following a request by a Revenue Canada auditor. According to Clarke the children had not kept time sheets and the partnership had no record of any nature of the hours actually worked by them. She said these figures were arrived at by reviewing in her mind the work that had been done on the farm and estimating from that the probable time that the children would have worked.

The amounts allocated to Shane, Robin and Diana in 1978 as wages and claimed as expenses by the appellants were not in fact received by the children. Clarke stated that the amounts she felt were due to the children were noted as a journal entry in the partnership’s books as wages “to be paid”. In December of 1978 on the advice of their accountant a further journal entry was made which transferred the sum of $10,800 (the amounts purportedly due to the children) from “wages to be paid” to the partnership equity account. Clarke said this arrangement was made because the partnership wanted to pay the children for the work that they had done, but since funds were not then available she was concerned that payment of accumulated wages at some future time would cause the children to incur higher income taxes. The evidence is quite clear that the $3,600 allocated to each of Shane, Robin and Diana in 1978 has not been paid, nor was any documentation produced to establish the existence of any indebtedness by the appellants to the children.

In respect of the 1979 taxation year, on December 30, 1979, Clarke issued partnership cheques payable to Shane, Arlie, Robin and Diana for $2,775.12, $3,701.71, $3,758.10 and $3,170 respectively (Exhibit A-8). These cheques were handed to the children on that day, were endorsed by them and were immediately returned to Clarke who deposited them the next day to the credit of the partnership’s general account. Clarke stated that the children voluntarily loaned these moneys to the partnership since capital was needed to keep it operating. She maintained this had been discussed and explained to the children and they volunteered to give up their wages to finance the farm. She produced demand promissory notes dated September 14, 1981, (Exhibit A-5) executed by herself and Keegan with a face value of $18,000 (the exact amounts claimed by the partnership as wage expenses in 1979). The discrepancy between the amounts of the cheques issued to the children on December 30, 1979, and the face value of the promissory notes was corrected on December 10, 1980, by the issuing of further cheques payable to Shane, Diana, Arlie and Robin for $1,725, $1,330, $799 and $742 respectively (Exhibit A-10). Clarke alleged that this was the balance of wages due and owing to them for work performed in 1979. It is a fact that the two cheques issued to each child totalled $4,500 the exact amount claimed by the partnership in 1979 as a wage expense in respect of each child.

All of the children testified. Shane was born in September 1959, completed school in 1977 and thereafter continued to live at home and work in all facets of the farm operation. He kept no record of the time worked and his estimates for the years in question were imprecise and uncertain.

In 1978 and 1979, he filed income tax returns prepared for him by the partnership’s accountant. The income declared in both years was, according to him, payment for casual labour on the farm. He could not recall whether he was paid on a regular basis or sporadically, in cash or by cheque or whether in fact he was paid at all.

With respect to the $4,000 he declared as income in 1978, Shane testified that he received the sum of $3,600 by way of a cheque. This statement was patently wrong since no cheques had even been issued for wages in that year. He could not recall, even when his mother’s testimony was brought to his attention, that he had received approximately $400 from petty-cash in 1978 and that the balance was handled as a journal entry in the partnership accounts as “wages due and owing to him’’. He persisted in maintaining that he received $3,600 in 1978 and that he made a loan in an equal amount to the partnership of his own volition without being asked to do so either by his mother, father or by their accountant. His evidence flew in the face of his mother’s testimony and of the partnership’s books of account. In relation to the $4,500 declared by him as income in 1979 it was his recollection that this payment was the accountant’s idea.

In cross-examination he conceded that during the relevant taxation years he received a monthly allowance varying from $200-$300 and that this was in part for work done on the farm over and above the free room and board which he was receiving. He confirmed that these payments were not included in his declared income for either year and could offer no explanation for that omission.

In so far as the promissory note payable to him, Shane stated that it had never been in his possession and that his sole knowledge of the note was that at some period of time he recalled being told about it.

The three girls Diana, Robin and Arlie attended school in 1978 and 1979. It is not disputed that all were required to do substantial farm chores on a regular basis. They received allowances, generally paid out of petty-cash as and when needed, and all had their daily needs provided for. Each one testified that there was an arrangement whereby she would be paid for work done over and above her allowance.

Each filed the requisite income tax returns in 1978 and 1979, which were prepared by the accountant. Their recollection of the returns, their preparation and contents is exemplified by Robin’s evidence. She stated that she may have signed something but did not know what it was; could not recall having seen the returns at all; and had no idea how much she would have earned in either of the taxation years.

In relation to the cheques issued on December 20, 1979, Robin stated that she was given a cheque for $3,758.10 by her mother and that she immediately endorsed it for deposit to the parents’ farm account because “they needed money’’. It was her recollection that she was asked to do so, but said that “I would not have loaned them the money if it was not to be repaid’’.

Arlie remembered receiving a cheque for $3,701.71 and endorsing it back to the farm but recalled that the reason was that her mother needed the money for her income tax.

Diana, on the other hand was of the view that the cheque was immediately redeposited to the farm account to ensure that she would get wages in the following year.

The common thread in the evidence given by the three girls was that records of time worked were kept only sporadically and that during the years in question they were “paid” only when they needed money. For example, money for a vacation trip taken by Diana was provided from farm funds. All three testified that there was an understanding that they would be paid for their work when their parents had sufficient money, but none had any idea how much they were to be paid in 1978 or 1979. With respect to the promissory notes there is no dispute that they never received them. In fact Robin testified that she had never seen the note until the week prior to the trial and had no idea before that that the note existed.

In the course of the audit officers of the respondent located four documents which appeared to be casual time-sheets kept by the girls. Exhibits R-l and R-3 were written by Diana. Exhibit R-l related to the period March 9 to March 31, 1979 and indicated 35 hours of work at $3 per hour. Exhibit R-3 was a similar record for May (year unknown) showing a further 35 hours of work at $3 per hour. Her recollection was that she had been paid for this work in cash at the time.

Exhibit R-4 was Arlie’s record for August 1980. It set a rate of $2 per hour which she asserted was the rate that she had negotiated for herself in 1980. I note that in her testimony in chief she had stated that in 1978 and 1979 she expected to be paid $3 per hour (the rate utilized by her mother in her analysis).

Exhibit R-5 related to August 1-14, 1980, and had been prepared by Robin. The hourly rate of $2 set out in the note was a figure she said she had negotiated with her parents in 1980. It was her recollection that there had been no agreement as to a rate for the two prior years but that there was no substantial difference in the volume or quality of the work done in those years.

None of the girls were able to account for the discrepancies between these notes and the “wage analysis” prepared by their mother (Exhibit A-7). In relation to the analysis Diana stated that although it seemed fairly accurate it showed that she had worked a total of 160 hours in July 1978, whereas in fact she had been away on vacation. She stated that she had told her mother that this error existed approximately a week prior to the hearing of the appeals. This was not mentioned by Mrs Clarke in her testimony.

The respondent called Brigitte Danks, a field auditor during the relevant years. She reviewed the appellants’ files in relation to their 1978 and 1979 returns including all previous audit material. In August of 1981 she attempted to obtain precise information relating to the expenses claimed and in particular she asked the appellants and/or their accountant to produce any time reports for the years in question together with any proof of payment such as cancelled cheques, wage slips, promissory notes, etc. The appellants’ accountant, Mr Hayden, advised her that no such documents existed. She testified that at no time were any promissory notes ever shown to her, nor were the minutes of meetings with the attached promissory notes (Exhibits A-3, A-4 and A-5) ever produced to her, although she had a number of discussions with Mr Hayden relative to such documentation.

Submissions

The appellants submitted that the wages were paid and accordingly were expenses incurred for the purpose of earning income. Furthermore the amounts paid were reasonable in the circumstances. It was argued that in relation to taxation year 1978 proof that the expenses were incurred existed in the business records which showed a liability for the wages.Counsel submitted that an expense is incurred where a general liability exists with a reasonable expectation that the debt will be paid. In so far as taxation year 1979 was concerned it was submitted that reasonable wages were in fact paid to the children and the subsequent voluntary lending of the money by the children to the partnership did not alter the fact that the amounts paid were reasonable wages for the work that the children did in 1979 and were therefore properly deductible as an expense under paragraph 18(l)(a) of the Income Tax Act.

The respondent submitted that the amounts of $10,800 in 1978 and $18,000 in 1979 which were claimed as expenses were not in fact paid to the children and were not expenses incurred by the appellants in the sod business for the purpose of earning income from a business or property. The respondent further argued that amounts were not outlays or expenses in the operation of the business which were reasonable in the circumstances and therefore could not be allowed as deductions by virtue of section 67 of the Act.

Conclusion

On the evidence before me I find with respect to the 1978 taxation year that the wages claimed as expenses were not in fact paid to the children. The business records produced fail to support the appellants’ position that a legal obligation to pay the wages existed, while the so-called understanding as to future payment is too nebulous and ill-defined to be considered in any sense a legally binding arrangement.

In relation to the 1979 taxation year I am not satisfied that there was a bona fide payment of wages to the children. The evidence tendered on this issue was simply not persuasive. The appellants’ testimony generally was not credible. In particular the evidence relating to the issuing of the cheques to the children on December 30, 1979, the immediate endorsement and redeposit of the said cheques to the credit of the appellants’ business, the subsequent creation of promissory notes (which incidentally were not given to the children and whose existence was not known to them until prior to the trial), the issuing of further cheques in December 1980 to correct any inconsistencies between the 1979 payments and the promissory notes leads me to the conclusion that these were not steps taken to compensate the children for the work they had performed but rather were part of a process designed to increase the deductions available to the appellants and to enable them to retrospectively allocate some of their farm income to the children in an effort to minimize their own personal tax liability.

Although it may not be necessary to do so I feel constrained to note that in any event there was no acceptable evidence before me to support the appellants’ position that the payments (had they been properly made) were, in the circumstances, reasonable.

The onus is on the appellants to establish reasonableness. I accept that the children performed various duties and provided substantial assistance to their parents in the operation of the turf farm.Beyond that the Court is left to speculate as to the precise quantity of work done, the value of such work and the value of all other benefits received by the children such as board and lodging. The hours claimed were totally unsupported. An estimate subsequently prepared by Mrs Clarke was demonstrably inaccurate and unacceptable. No adequate records were kept which would permit the Court to do anything more than speculate as to the basis upon which the wages were purportedly paid. There was no adequate explanation as to the discrepancies between Exhibit A-7, the analysis prepared by the appellant Clarke and Exhibits R-l, R-3, R-4 and R-5, the only existing wage records. There was no satisfactory explanation for the fact that notwithstanding substantial differences in the physical capabilities of the children, the time available and their respective experience the children were paid identical amounts. The absence of such evidence precludes the Court from finding that the payments were reasonable.

The appeals are accordingly dismissed.

Appeals dismissed.