Rousseau Metal Inc v. Minister of National Revenue, [1979] CTC 2681, 79 DTC 467

Guy Tremblay [TRANSLATION]:—The case at bar was heard in Quebec City, Quebec on December 5, 1977.

1. Point at Issue

The question is whether the appellant is entitled to claim a capital cost allowance on the personal automobile of the company sales manager for the 1974 taxation year, and whether the cost of $5,520 paid by the company should be considered part of the manager’s salary and therefore deductible. The Board must also determine whether, for the 1975 taxation year, the appellant is entitled to deduct the amount of $377 paid as an insurance premium on the life of the president of the company, the beneficiary of the policy being Moto Kometik Inc, a company in financial difficulty for which the appellant guaranteed bank loans.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.1 The principle business of the appellant, a company incorporated in 1950, is the manufacture and sale of metal articles.

3.2 The company’s fiscal year ends on the last day of February of each year.

3.3 On July 5, 1973, the appellant paid for a Chrysler Custom automobile and the invoice was made out to Mr Simon Pierre Paré, manager of the company. This payment was in the amount of $5,520 (Exhibit R-1).

3.4 As the company considered itself to be the owner of this automobile, it claimed a capital cost allowance for the taxation year ending February 28, 1974.

3.5 As the result of a discussion during the hearing, it was agreed by the parties (the appellant being represented by its president, Mr André Rousseau) that for the purposes of this case the automobile would be considered Mr Paré’s property.

3.6 The appellant is prepared to admit that the sum of $5,520 constitutes salary and should therefore be allowed as a deduction in the calculation of its income. In addition, Mr Paré was taxed for this amount. However, the Department disallowed the deduction, alleging that it represented a shareholder’s benefit.

3.7 According to Mr Rousseau, Mr Pare, the manager, was not a shareholder in the company. The respondent objected to this gratuitous statement, as the best evidence had not been presented.

3.8 During the same fiscal year, the appellant paid for the gasoline and oil of the car concerned. Furthermore, this automobile had not only been used by Mr Paré, the sales manager, in performing his duties, but by other salesmen as well.

3.9 The appellant’s employees formed a company under the name of Moto Kometik Inc with the objective of manufacturing snowmobiles.

3.10 Mr Benoit Lévesque, an employee of the appellant since 1954, became the president of this new company.

3.11 The appellant was the main supplier of the materials required by Moto Kometic Inc.

3.12 In the course of its operations, Moto Kometik Inc borrowed $100,000 from the Provincial Bank through a loan secured by the appellant’s guarantee. In addition, the bank required an insurance policy to be taken on the life of Mr Lévesque with Moto Kometik Inc as the beneficiary.

3.13 Since Moto Kometik Inc fell into financial difficulty, the appellant acquired its inventory and subsequently its shares.

3.14 The appellant, being guarantor of the debts of Moto Kometik Inc, paid the insurance premium of $377 and claimed it as a deduction for the 1975 taxation year. This payment of the premium was one of the conditions required by the creditor bank to ensure that it would not find itself obliged to pay the balance due of $85,000.

3.15 The Department of National Revenue disallowed this expense, maintaining that it was not incurred for the purpose of earning income.

3.16 The appellant objected to the notices of assessment relating to the 1974 and 1975 taxation years on February 7, 1977 and the Minister upheld the notices of assessment.

3.17 On May 5, 1977, the appellant filed an appeal with the Tax Review Board.

4. Act, Case Law, Comments

4.1 The Cost of the Automobile Paid to Mr Paré

The appellant claimed the cost of $5,520 as a deduction since it represented salary. According to the respondent, it represented a shareholder’s benefit under subsection 15(1) of the new Act, and not salary. Mr Rousseau, however, maintained that Mr Paré was not a shareholder. The respondent objected to this gratuitous statement since it was not the best evidence.

It is true that Mr Rousseau’s statement, though it was under oath, was not the best evidence. He should have produced the minutes register. The Board, however, does not question Mr Rousseau’s credibility.

Moreover, the fact that the amount paid can be considered a shareholder’s benefit does not take away the appellant’s right to the deduction, inasmuch as this benefit constitutes a disbursement for the appellant and is not considered a dividend. It is established that dividends paid cannot be allowed as expenses in the calculation of income. Dividends constitute the distribution of profits obtained after the deduction of expenses. Subsection 15(1) reads as follows:

Section 15. Appropriation of property to shareholder.

(1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction.

(b) funds or property of a corporation have been approporiated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding-up, discontinuance or reorganization of its business, or otherwise by way of transaction to which section 84, 88 or Part II applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of a common shares of the capital stock of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

It was not argued here that the case involves a persumed dividend, as is true under subsection 15(2) where it is provided that a loan to a shareholder where the shareholder is a corporation should be considered as such, unless the loan is reimbursed within the time limits specified in the section.

In addition, in the Board’s opinion, inasmuch as the shareholder’s benefit constitutes a disbursement for the company, it may be allowed as a deduction. This would not be the case, for example, with a company which put a summer home at the disposal of an employee-shareholder for a period of three months. The benefit could perhaps be assessed at $1,200 for the employee but would not thereby justify a disbursement, and thus an expense, allowed as a deduction of $1,200 for the companny.

In the case at bar, the expense of $5,520 must be allowed as a deduction in the calculation of the appellant’s income for 1974.

4.2 The Life Insurance Premium of $377

At first sight, the appellant’s payment of a life insurance premium on the life of the former president of Moto Kometik Inc does not seem to be an expense incurred for the purpose of earning income.

However, the relations existing between the two corporations should be closely examined.

The appellant is guarantor of the debts of Moto Kometik Inc. This guarantee was given as Moto Kometik Inc was the appellant’s customer: in fact, the appellant supplied it with materials. These two companies had corresponding interests.

The insurance on the life of the president of which Moto Kometic Inc was the beneficiary is clearly an important protection not only for the beneficiary corporation but also for the corporation which guaranteed the debts, namely the appellant company.

In Equitable Acceptance Corporation Limited v MNR, [1964] CTC 74; 64 DTC 5045, Cattanach, J affirmed a judgment rendered by the Tax Appeal Board (25 Tax ABC 225; 60 DTC 576) to the effect that the payment of insurance policy permiums on the life of the president of the company (who with the appellant company was the guarantor of the sum of $200,000, borrowed by the appellant company from Triarch Corporation Limited) was not allowed as a deduction in the calculation of the income of Equitable Acceptance Corporation Limited.

On page 79 [5048] the judge, after citing paragraphs 11 (1)(cb) and 12(1)(a) and (b) of the old Act, that is paragraph 18(1 )(a) and 20(1(e) of the new Act, observed:

In my view the cost of the purchase of the two life insurance policies and the maintenance in force thereof by the payment of premiums is not an expense incurred in the year in the course of borrowing money used by the taxpayer for the purpose of earning income from a business. While it is true that the purchase of these life insurance policies and their assignment to Triarch was a condition imposed by Triarch before making the loan to the appellant, nevertheless the true nature of the transaction was that the appellant acquired an asset which could be used, and was in fact used, as a collateral security necessary to borrow money to be used in the business. In short, the appellant, by the purchase of the two insurance policies, merely enhanced its position as a reliable lending risk.

If the insured, Emil E Schlesinger had died while the policies were in force and before the repayment of the loan, the appellant would then be in the position of the loan being fully paid from the proceeds of the insurance policies and the amount of the loan received by the appellant would become part of the appellant’s assets without any corresponding debit entry. Again if the proceeds were in excess of the amount required to repay the loan, then any such excess would have accrued to the appellant’s assets. Further when the loan was repaid, as it was, there was nothing to prevent the appellant from securing another loan from the same or different source on the strength of the security of the life insurance policies, if the necessity arose.

It might be argued that the position of Rousseau Metal Inc is different from that of Equitable Acceptance Corporation Ltd. Thus, Rousseau Metal Inc is not the borrowing company, but a third party which guaranteed the loan of the borrowing company because of a business association.

The death of Mr Lévesque would immediately confer an increase of capital assets on Moto Kometik Inc, as in the case cited above. Owing to this increase of capital Moto Kometik Inc would not be entitled to deduct the premium of financial difficulties did not prevent it from paying its debts.

Besides, wouldn’t Mr Lévesque’s death not also make the appellant richer? The answer must be that it would. There would be an increase in its credit as well as the value of its assets, namely its accounts receivable with respect to Moto Kometik Inc and the inventory which also guarantees the debt to the bank.

Moreover, if Mr Levesque does not die and Moto Kometik Inc continues to be in the same financial difficulties, who will pay the bank? The appellant will.

Due to a business association which was the very basis of the decision to guarantee the debt, the sums paid by the appellant to reimburse the debt would therefore be allowed as a deduction in computing the appellant’s income. Furthermore, the capital sums paid by Moto Kometik Inc would not be allowed as a deduction. Inter alia, it did receive the loan without including it in its income. As for the appellant, it did not receive anything, it only assumed the risk of standing as guarantor for the purpose of earning income. In addition, it would not receive the insurance indemnity in the event of Mr Lévesque’s death. Should not the payment of the insurance policy premium be considered in the same way as the payment of the debt? Could it not be said that the payment of the premium is for the guarantor, the collateral security for payment of the debt? The Board holds that it is and believes that the payment of the premium is allowable as a deduction just as the payment of the debt would be.

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above-stated reasons for judgment.

Appeal allowed.