Foley v. R., [1997] 2 CTC 3109

Dubienski DJ.T.C.:

In computing the income for the 1991 taxation year, the Appellant deducted $19, 260 as carrying charges and interest.

The Minister assessed the Appellant for the said taxation year, notice of assessment dated July 21, 1992 and was reassessed for the 1991 taxation year by notice of reassessment dated May 16, 1996 wherein the Minister disallowed the deduction of the carrying charges and the Appellant appeals this decision.

The Appellant is sole owner of a corporation known as Fridel Limited (Fridel) owning all the shares and being the sole director and officer of the company.

The company had been in existence for some time concerned with land development, building and construction. For years previous and with regard to the relevant year 1991, the company had several employees. In 1991, the company employed five people full time in the office and a field representative.

Concerning the company for the year 1991, the Appellant was the manager and looked after the day-to-day running of the business and was the project manager of all operations of the company.

Employed by the company was the Appellant’s father, John Foley, who had been with the company for some fourteen years on salary. He was in charge of land development and land acquisition for the company. His salary was $26,000 for a year. The Appellant, in his capacity as president and managing director, received a salary of $42,000 per year and particularly in the year under consideration.

Evidence further indicated that the year 1991 was a particularly profitable year for the corporation inasmuch as it had two large special projects that impacted upon that year.

The Appellant, as of December 31, invoiced the company for “administration, consultation and management services rendered for the period ending December 31, 1991”. The evidence was that these were extra services rendered to the company with particularly reference to the two extensive projects and had to do with “meetings with marketing and real estate agents, advertisers, promoters and consultants, negotiating construction financing and meetings with lawyers or counselling real estate brokers, meetings with building department of the municipalities, meetings with planners and engineers, surveyors, architects, coordinating construction design and other matters pertaining to the construction of new homes”. The amount of this invoice was for $41,500.

The Appellant and his father apparently discussed during the year the extra work that the father was doing and accordingly it was agreed that he would invoice, which he did, as of March 31, 1992, for “administration, consultation and management services rendered for the period ending December 31, 1991” personally to the Appellant.

This invoice was for “general services performed in respect to consultation regarding real estate transactions, mortgage financing, meetings with builders, bankers, mortgage lenders developers, negotiating funds and meetings with the accountants, lawyers, brokers, other investment agencies, attending meetings with potential purchasers and vendors of various parts of land, to review real estate income properties to appraise and evaluate residential subdivisions, to locate investment properties pertaining to the industry”. For this, the father submitted an invoice for $19,260 based on instructions from his son to render an invoice for that amount based on $1,500 per month for twelve months being $18,000 plus G.S.T. of $1,260 resulting in the total of $19, 260.

When the Appellant filed his income tax return for 1991, under the heading of investment expenses - “interest expenses carrying charges” he claimed the payment of the $19,260 to the father, John Foley.

From the evidence, it is clear that the Appellant had absolute control of Fridel Limited and indicated that he made all business decisions in the final analysis; that the father was not a director but an employee and that he retired as of 1996.

The Appellant stated that with regard to his income tax return for 1991 referring to the payment of $41,500 shown on the return as “employment income, Fridel Limited management bonus” that, that was incorrect, and that in fact it was invoiced for additional work done for Fridel and “was not payment for a bonus, it was work that enabled Fridel to do better and show more profit - it was an incentive”. He stated that these were particularly large projects referring to the two main properties in that year and it was additional employment income. He stated “that he no agreement with the company, it was purely his calculation and it had relation to base it on a good year.” He arbitrarily decided what it would be, because he felt he was entitled to it on his behalf as working for the company. He stated that he had not submitted invoices in prior years but had done so in subsequent years.

In explaining the invoice submitted by his father, he had discussed it with him in 1991 near the end of December about the same time as his own invoice and “I asked him to invoice me $1,500 per month”, “We might have discussed it earlier in the summer, however, I arrived at the amount in December 1991”.

He based the requirements of the invoice on the fact that he did not control his father with what he did on the two properties but that they worked together on some and he reported to the Appellant. The work by the father entailed purchasing it as raw land, developing it and then sold it to Fridel through a company owned by both the father and the son called Kingsbury Properties, the properties consisting of the two large projects had been acquired in 1990 from the father and 1991 houses were being completed and the father was still involved.

The Appellant advised that there was no written agreement with Fridel with the company for the two special projects either with himself or with his father.

The Appellant was questioned with regard to his submission at the time of Notice of Objection, referring to the payment of $18,000 to John Foley,

the Notice of Objection stated as follows: “Consultation and administration fees plus G.S.T. were charged and paid by the taxpayer as rendered”.

He stated the father’s invoice included fees that were costs of advice for various legal, accounting, financing and investment matters and permitted the taxpayer to earn investment income and future provincial income. He said the fees should be allowed as deductible by Revenue Canada. The Appellant’s explanation of the words “investment income” referred to Fridel’s investment in the two properties that is business income, not to help the Appellant get additional income, was really to help Fridel to earn added income from the two projects and as a net result he stated: “If Fridel does better so does myself’ (as sole owner).

The intent was to gain additional income for both, that is the Appellant as owner and the company. The words “future potential income” would mean income to Fridel and as result he would profit because Fridel would profit.

The Appellant stated that in his consideration with regard to the basis of such invoicing, he looks at the profits and if there are any “I would invoice Fridel”. It would be a consideration of the profits increase, the invoice would increase. He further stated that the incentive for an invoice would be based on the fact that the situation was due to additional sales efforts plus additional profits that would be due to him.

The father, John Foley, confirmed his employment and work that he did was, land development and construction, zoning, planning, customer relations, some supervision; and particularly in 1991 guaranteeing substantial loans to lenders on behalf of Fridel Limited.

When questioned about the invoice, he stated that it was rendered to the Appellant because he asked him to invoice him directly because he was trying to isolate the projects from other work at Fridel. He substantiated the arrangement for $1,500 per month for one year plus G.S.T.

The evidence was clear that services rendered by the Appellant to Fridel Limited and those rendered by John Foley to the company were the same as they always had been in the past but that they had increased and were more substantial during the year in question.

The Appellant argues that the work was done and the income earned by the Appellant and it should be subject to the expense submitted by John Foley.

The Appellant denies that the payment to John Foley or to himself was a carrying charge and says that the return was an error and is not binding upon the Appellant because the evidence in fact shows that it was an expense.

Throughout the history the company has been owned by the Appellant and the father has been an employee in an assisting capacity. In 1991 a special situation arose with additional workload placed on the Appellant and the father. The Appellant alleges that he was in reality in business personally, with a reasonable expectation of profit to the company it was profit to the Appellant and John Foley was an expense which made and produced income for Michael J. Foley through the company. The Appellant knew what John Foley was going to charge, therefore, he knew his profits. Both their efforts increased profits to the company.

In considering the assumptions of facts upon which the Minister based his decision the Appellant admits the employee and shareholder relations of the parties. He denies that he received a management bonus and it was not intended to be, and he alleges that the $19,260 was in fact paid by the Appellant to his father for purported management services. He alleges that the defining of the payment to John Foley in his 1991 income tax return as “interest expenses and carrying charges” was an error created by the accountant and that the payment of $18,000 was reasonable if one considers the effort and responsibilities taken by the father for the year in question.

The Respondent emphasises that all the evidence must be looked at in concluding this question.

The Appellant is the sole shareholder president and controls management of the corporation. In the year in question, the company was involved in a considerably larger amount of business and construction. Therefore more time and effort was needed to look after the two properties but what was the objective in the action of the Appellant in invoicing the company for extra “consultation” work and the invoice from the father ostensibly for services rendered personally to the son personally rather than the company?

An examination of the evidence would seem to indicate that the invoice by the taxpayer was based on the increase of profits in 1991 and similarly the demand for an invoice from the father reflected this situation. The argument that the invoices reflected increased work is very general and there was no specific evidence with which to relate the increase in work and what was paid other than the generalisations. There is no evidence of different efforts by either party with the exception of the father who guaranteed loans, but in reality the evidence generally reflected the continuation of similar work and duties that continued between the parties and their relationships during the existence of the corporation, albeit considerably more.

What in fact was the relationship of the parties to the corporation? In both instances they were employees and then for some reason seek to become independent contractors.

There is nothing in the evidence that would bring the situation within the provisions of subparagraph 8(l)(z)(ii) of the Income Tax Act that reads as follows:

office rent, or salary to an assistant or substitute, the payment of which by the officer or employee was required by the contract of employment

There is no suggestion that John Foley was an assistant or a substitute; nor does the evidence disclose that John Foley was an employee requiring a salary especially in view of the fact that subsection 8(10) of the Income Tax Act was not complied with.

There is no evidence that the alleged agreement between the Appellant and his father established the father as an independent contractor throughout the year and the amount to be paid was not apparently reduced to writing. There is nothing to show that it was due and payable in 1991, and in fact not invoiced or paid till 1992.

As is stated quite clearly in paragraph 18(1)«) of the Income Tax Act - General limitation “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” precludes the payment to John Foley because I find the Appellant was not in the business of providing services outside his employment as an independent contractor under contract to Fridel and therefore if his actions were for the purpose of gaining income, it could only be for his employer Fridel Limited.

As referred to above, the expectation of the taxpayer, Appellant, that the father’s services would allow the earning of additional income would only apply on an indirect basis to benefit the Appellant as shareholder in Fridel. Whatever money was paid to John Foley enhanced the income of Fridel and not directly and personally for the taxpayer, Appellant.

On the basis of the evidence before me it is clear that the monies paid on the invoice to John Foley by the Appellant was in reality payment for services rendered to the corporation to enhance its ability to earn its income. Therefore it is clear that the Appellant cannot deduct from his income the expense of the father John Foley. R. v. MerBan Capital Corp., (1989), 89 D.T.C. 5404 (Fed. C.A.), at 5409, “...the issue of separate existence of MerBan from its subsidiaries is important because of the basic rule that a taxpayer can deduct only expenses that it incurred to earn its income.”

An appreciation of the evidence indicates quite clearly that the Appellant gave himself a bonus albeit evidenced by an invoice based on the profitability of the company, an action for which he was entitled without question. However, it is untenable to consider that the company would pay an employee of the company to render services that were properly available to the company without a contract to clearly establish the services were beyond those for which he was hired.

The father rendered services for the year 1991 the same as he had for the previous years in his capacity as employee of the company. It is true that he performed more of the duties and an additional amount to be considered for the granting of security for bonding but that all these services were for the benefit of the company and as before and were not for the taxpayer. The money he received was in recompense for complying of these duties, additional as they were and would be considered to be either a bonus or increase in salary from the company.

It is clear from the statements of the taxpayer that he looked at the profits and felt that he was entitled to more money and gave himself a bonus possibly hoping that the taxes thereon could be diminished by finding an expense that might be charged against it.

As a result, I find that the Appellant has not been able to alter the decision of the Minister and I dismiss the appeal.

Appeal dismissed.