Skeena Northern Boat LTD v. Minister of National Revenue, [1983] CTC 2750, 83 DTC 699

Goetz, TCJ:—This appeal was heard by me in Vancouver, British Columbia, on October 29, 1982 in my capacity as a member of the Tax Review Board but this judgment is being rendered in my present capacity as a judge of the Tax Court of Canada.

This is an appeal with respect to the appellant’s 1975 to 1977 taxation years inclusive. The appellant seeks to invoke the provisions of subsection 78(3) of the Income Tax Act, SC 1970-71-72, c 63, as amended, relating to the holdback of salaries or bonuses with respect to the taxation years in question.

The respondent, on the other hand, in his reply to notice of appeal alleges and assumes as follows:

2. In each of the fiscal years under appeal the appellant established an accrual for salary and bonuses payable to the Directors of the company in the following amounts:

1975	$56,000.00
1976	$45,505.00
1977	$86,000.00

which amounts were then deducted from the Appellant’s income in the respective years under appeal.

3. The 1975 accrual was reversed by the Appellant in 1976; the 1976 accrual was reversed by the Appellant in 1977; and the 1977 accrual was reversed by the Appellant in 1978.

4. By way of Notices of Reassessment dated December 12, 1980 the Respondent disallowed the amount of $56,000.00 in 1975, $45,505.00 in 1976 and $86,000.00 in 1977 claimed as expenses with respect to wages and bonuses on the basis that they were not expenses incurred for the purpose of gaining or producing income but rather were amounts credited to a reserve for which no deduction is permitted by virtue of para 18(1 )(e) of the Income Tax Act and further that the said wages and bonuses would unduly or artificially reduce the Appellant’s income.

5. In assessing the appellant in the manner set forth in para 4 herein by disallowing the accrued wages and bonuses payable in each of the years under appeal, the Respondent relied, inter alia, upon the following assumptions of fact:

(a) the salary and bonuses payable in the amounts of $56,000.00, $46,505.00 and $86,000.00 claimed as a deduction from the Appellant’s income in 1975, 1976 and 1977 respectively were not incurred by it for the purpose of gaining or producing income in those years;

(b) the Appellant did not create nor did he intend to create a legal obligation to

pay the amounts described in para 5(a) herein as salary or bonuses;

(c) the amounts described in para 5(a) herein and claimed as a deduction for wages and bonuses in the years under appeal were an undue and artificial reduction of the Appellant’s income in each of the years under appeal.

Paragraph 3 of the reply to notice of appeal was amended at the outset of the hearing and now reads:

3. The 1975 accrual was reversed by the Appellant in 1976; the 1976 accrual was not reversed by the Appellant in 1977 but was reversed in 1978; and the 1977 accrual was reversed by the Appellant in 1979.

In assessing the appellant, the respondent relied, inter alia, upon sections 3, 4, subsection 245(1), and paragraphs 18(1)(a) and 18(1 )(e) of the Act.

Facts

Howard Melo, President of Melo Management Ltd and of the appellant company, testified that Northern Marine Supply Ltd (“Northern Marine”) was incorporated in 1962 and its business was that of selling marine supplies. Northern Marine sold its shares in 1978 to Skeena Northern Boat Ltd (“Skeena”). As of 1972, 45 per cent of the shares were sold to key employees as follows:

The remaining 55 per cent of the shares was retained by Melo. Howard and Alice Melo as well as all other shareholders had agreements whereby their salaries were fixed and a percentage of the company’s profits was applied on account of the share purchase agreements in March of each year. Agreements for purchase of shares did not mention bonuses.

Overtime was discussed but the new shareholders agreed not to take overtime pay. Melo, who was President, and Boehm, who was Vice- President, were the only ones, according to Howard Melo, who left money in the company. Howard Melo said he calculated overtime each year. In the journal entries for the general ledger as of November 30, 1975, $5,119 was shown as interest “to record bonus accrual”. The sum of $56,000 was also shown as payable to the shareholders as is shown in paragraph 2 of the reply to notice of appeal, but was not discussed with the shareholders. Howard Melo could not say whether this figure related to overtime or bonuses. Such bonuses reduced Northern Marine’s taxable income to $77,078. The journal entries for general ledger of Northern Marine, as of November 30, 1977, among other things state:

To record accrued wages — $86,000.00

This reduced the net income to $99,682.

Howard Melo was unable to answer many questions in cross-examination. He acknowledged that there were no minutes or written agreements with respect to important matters dealt with by him in his testimony.

Joseph Garzell, an auditor with Revenue Canada, examined all papers and documents provided him by the appellant’s accountant. The Minutes of the company had no mention of bonuses. His examination of the company’s books of account showed as follows:

Mr Garzell stated that the sum of $45,375 (see Appendix “A”) applied to 1978 and did not apply to any prior years. As can be seen, Garzell’s calculations do not conform to the records of accrued bonuses and wages payable in the appellant’s balance sheets for 1976, 1977 and 1978. He could not be budged in cross-examination and stated that his calculations indicated a “clear pattern of keeping corporate income to a beneficial tax level”.

Findings

From the plethora of documents filed by the appellant it is abundantly clear that the company’s cash, accounts receivable and inventory position increased substantially between November 30, 1977 and April 30, 1978. The balance sheet as of November 30, 1977, showed retained earnings of $249,385 and as of November 30, 1978, the retained earnings had risen to $404,686.

There were no meetings of the shareholders confirming bonuses or even the discussion of same. If there was to be remuneration for overtime, a document filed by the appellant entitled “Dollar Value of Estimated Overtime Hours Worked by Directors — 1974 to 1977” gives me the impression it was prepared at one and the same time, although I could be wrong in that assumption.

The sums referred to in paragraph 2 of the reply to notice of appeal do not appear to have been incurred by the appellant for the purpose of gaining or producing income pursuant to the provisions of paragraph 18(1 )(a) of the Act which reads:

18. (1) In computing the income of a taxpayer from a business or property 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 the business or property.

I draw my conclusion from a perusal of the balance sheets of the appellant for the various years involved. It appears to be a tax planning effort to reduce taxes by maintaining the company’s annual income within the small business deduction provisions. See Totem Disposal Co Ltd v MNR, [1981] CTC 2547; 81 DTC 493. I have come to this conclusion from all of the evidence before me and especially that of the auditor of Revenue Canada. It was a device to minimize taxes which, of course, a taxpayer is entitled to do; but in face of the appellant’s excellent financial position, the sums held back or in reserve, ie $56,000 in 1975; $45,505 in 1976 and $86,000 in 1977, are non-deductible under paragraph 18(1 )(e) 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

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part;

See Don Fell Limited, Gordon Fell Limited and Lawrence Fell Limited v The Queen, [1981] CTC 363; 81 DTC 5282.

I was not impressed with Howard Melo’s evidence. He filed a photocopy of a document entitled:

Skeena Northern Boat Sales Journal Entries Nov 30/78

which document had the bottom one quarter of the page blocked out. I have included in this judgment a photocopy of that document together with another photocopy which was attempted to be filed by the respondent over the objection of Mr Eidsvik, the appellant’s accountant. Nevertheless, our rules of evidence are not as stringent as in other Courts and I am accepting it as filed because it discloses relevant evidence, thereby affecting Howard Melo’s credibility. Note item 56 of the respondent’s document: “D R Management Bonuses $167,000”. Photocopies are used because it was impossible to decipher all of the writing of the accountant.

I am satisfied that the conduct of the appellant’s accountant was to unduly or artificially reduce the appellant’s income. See subsection 245(1) of the Act which reads:

245. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In short, the appellant has failed to negate the allegations and assumptions of fact in the respondent’s reply to notice of appeal and I dismiss the appeal.

Appeal dismissed.