Section 67

The taxpayer financed its inventory of used automobiles held for resale through unsecured loans from the family Holdcos that were its shareholders. When the ARQ reviewed the deductibility of the loan interest of 10% p.a., the taxpayer provided a very brief letter from Desjardins stating that for an unsecured “cash flow” loan the interest rate in 2015 would fall in the range of 9% to 12%, and then a more detailed letter from its accountants (Deloitte) that, based on Moody’s metrics, concluded that an interest rate for such loans should fall in the range of 7.89% to 12.39%. The ARQ reassessed to deny the claimed interest in excess of 7.89%, having regard to the Quebec equivalent of ITA s. 67 (TA s. 420).

Before reversing the decision below to confirm these reassessments, the Court of Appeal stated (at para. 13, TaxInterpretations translation):

The appellant was not required to make out a prima facie case that the 7.89% rate was unreasonable but, rather, that the assumption, on which the respondent relied in assessing it, that the 10% interest rate deducted from its income for the taxation years in issue was not "reasonable in the circumstances," … was prima facie … unsound.

Since the 10% rate actually used fell within what the above evidence indicated was a reasonable range, such a prima facie case had been established – so that the onus shifted to the ARQ, which had “failed to demonstrate by a preponderance of the evidence that the 10% interest rate was unreasonable within the meaning of TA section 420.”

In order to finance an acquisition, Laurentian Bank issued subscription receipts to two private placement investors (the Caisse for $100 million and a labour fund for $20 million) at a subscription price representing a 2% discount to the market trading price, and with the subscription proceeds being held in trust until the closing of the acquisition, at which point, the subscription receipts were converted, without further payment, into common shares of the Bank. The Bank was required by the subscription agreements to pay “transaction fees” to the investors of 4% of the subscription amounts on the closing.

Ouimet J found that as the Minister, in denying the deductibility of the transaction fees under s. 20(1)(e), had not assumed that the fees were unreasonable in amount, so that the burden was on the Crown to establish that the fees were not deductible under s. 67. In finding that the Crown had not met its burden, he stated (TaxInterpretations translation, paras. 96-97):

Usually, when the value of one or more services is in question, the testimony of one or more experts is required to enable the court to determine the value of each of the services provided. A review of comparable transactions is also usually necessary, especially where the respondent alleges that certain terms of a transaction are unreasonable. This is also useful in order to allow the Court to make, if necessary, to an otherwise unreasonable amount, the necessary adjustments.

The respondent did not do any of these things. In any event, it has not submitted any evidence that this type of analysis was done either by the Minister or at her request.

The taxpayer financed its inventory of used automobiles held for resale through unsecured loans totaling $6 million from its shareholders, bearing interest at 10% p.a. When the ARQ reviewed the deductibility of the interest, the taxpayer provided a letter from its accountants (Deloitte) that concluded, based on Moody’s metrics, that an interest rate for such loans should fall in the range of 7.89% to 12.39%. The ARQ reassessed to deny the claimed interest in excess of 7.89%.

After referring to the Quebec equivalent of s. 67, and in finding that the taxpayer had not met its burden of establishing that such assessments were incorrect, Allen JCQ stated (at paras. 63-64, TaxInterpretations translation):

How can the plaintiff challenge the presumption of correctness of the notices of assessment where the 7.89% rate, considered to be reasonable and adopted by the defendant, falls within the range that its own expert considered to be a reasonable rate based on the current rates in the market for obligations with similar considerations and risks during the period in litigation?

Doubtless, the rate of 7.89% corresponds to the lowest rate in the range, but it nonetheless is within that range and cannot be considered to be prima facie unreasonable.

After quoting from Gabco, and in concluding that the reference is s. 20(1)(c)(i), as it applied for the purposes of computing payments to be made by tax-exempt power companies in lieu of income taxes, to a reasonable rate of interest referred to an arm’s length interest rate, the Court stated (at para. 86):

Gabco frames the inquiry in terms of whether no reasonable business person would have contracted to pay the disputed interest. However, the question is not whether there is some imaginable business person who might have agreed to do so even if 99% of reasonable business persons would not have done so. Therefore, we would refine the test this way: would a reasonable business person have contracted to pay the disputed amount of interest taking into account only the business interests of the borrower? This accords with the requirement in Gabco that the test must be objective and with how that test has been applied in later cases: see e.g. Safety Boss Ltd v Canada, 2000 CanLII 216 (TCC), [2000] 3 CTC 2497 at para 27 (FC); TransAlta Corp v Canada, 2012 FCA 20 (CanLII) at paras 74-78, 426 NR 27. In other words, was the interest paid objectively reasonable? Under the Balancing Pool Payments regime, the answer to this question may also require a court to consider whether the terms of the loan were objectively reasonable to the extent those terms affected the interest rate.

A husband-wife team owned and managed a construction firm doing work in the general Vancouver area with the husband managing the business development and construction work and the wife handling the administrative and human resources work. In order to take advantage of her being a status Indian (he was not), the admin office was moved to the reserve which was closest to Vancouver. (Her own band was on a different reserve.)

The Crown did not challenge the Indian Act exemption for the regular salary paid to her (of approximately $100,000 per annum, which approximated her husband’s salary), nor did it challenge the deductibility of the bonusing of all of the firm’s remaining profits to her, including a $2 million bonus in 2008, but did challenge the exemption to her of those bonuses.

In finding that her bonuses were taxable to the taxpayer, Woods J found (at paras 57-58):

[T]here was no evidence…that the bonuses were…intended…to reasonably compensate the Appellant for her duties of employment. …

[T]he Appellant received remuneration through her bi-weekly pay that was roughly equivalent to Mike’s remuneration, except for 2008 when the Appellant’s regular pay exceeded Mike’s. In order for the bonuses to be reasonable in the circumstances, the Appellant should have made a greater contribution to Reel Steel than Mike. As discussed below, I find that the evidence does not support this.

Before finding that interest payable by the appellant on a subordinated intercompany note bearing interest at 11.5% was in a “reasonable amount” as required by s. 20(1)(c) notwithstanding that it may have exceeded an arm’s length rate, Poelman J stated (at para. 117):

The Gabco test adopts the perspective of the borrower’s business considerations… . Thus, it refers to a particular set of circumstances, including the actual legal arrangement establishing the interest obligation. It does not make it impossible for taxing authorities to challenge a deduction, because it limits deductibility to the amounts reasonable business persons would contract to pay. Its phraseology infers, however, that there will usually be a range.

The taxpayer commenced to act as an independent distributor of coffee for a company (“Organo Gold”), which was a multi-level marketing enterprise. As he would be compensated for products sold by his sub-agents, he incurred travel, accommodation and meal expenses (claimed to be $64,142) and deducted these as a business loss on his 2011 return, which also included employment income of $116,849 from his (unrelated) full time job.

Smith stated (at paras. 35, 37):

If the Minister concludes that [expenditures] are unreasonable in the sense that “no reasonable business man would have contracted to pay that amount” (Gabco, supra), then, notwithstanding the business acumen of the business owner, the expenditures may be denied in whole or in part relying on section 67. …

[T]he presumed existence of business acumen should not be treated as absolute, irrefutable or sacrosanct.

Smith allowed the taxpayer’s claim for travel expenses of $30,418, stating (at para. 51):

There is an obvious connection to the source of income, and while the amount is substantial, I am unable to conclude that it was unreasonable in the circumstances… .

The taxpayer also paid U.S.$15,000 to a prospective salesman, supposedly with a phenomenal sales record, mostly as an enticement to become a sub-agent and as an advance on his future commissions.

Smith J stated (at para 62):

I find that “no reasonable business man would have contracted to pay that amount” (Gabco, supra), certainly not without a more detailed business agreement.

A private company with a new home construction business with revenues in the $12M to $16M range had a profitable 2009 fiscal year and when the 2009 accounts were prepared, accrued and paid management fees to its two shareholder-management companies of $1.8M rather than the fees in the $1M to $1.2M range, as had been accrued and paid for nearby years. CRA claimed that the enhanced fee was "merely a profit distribution mechanism," and denied input tax credits on the portion of the fees in excess of $1M under ETA s. 170(2) (an analogue of ITA s. 67, although Favreau J stated (at para. 23) that "the jurisprudence addressing section 67 of the [ITA] is not relevant…because the text of section 67 is different.")

In allowing the appeal, Favreau J referred to the value of the services provided and the resulting profitability of the business, and did not engage with the CRA concern that essentially the same services were provided each year. He also noted that for income tax purposes, what was deductible to the company was includible in the income of the management companies at the same federal rate of income taxation.

See summary under ETA, s. 170(2).

On December 31, 1993, the taxpayer and other parties to a joint venture acquired (through the joint venture operator ("507") the rights to exploit a body of seismic data (which had been previously sold the same day for $805,000 in cash) in consideration for $975,000 cash and a $5,525,000 promissory note (payable only out of 50% of net licensing revenues and 20% of any production cash flow generated out of any petroleum rights acquired by the joint venture) - which the Minister conceded was not a contingent liability. After the receipt of licensing revenues (mostly in the first three years) which (as to 50% thereof) were cumulatively less than the note interest, in 2006 the data was sold for $560,000 resulting in the forgiveness of $7,080,471 of the note balance including accrued interest.

After quoting with approval (at para. 62) a statement in Petro-Canada that "I am unable to agree…that it necessarily follows that paying more than fair market value is unreasonable," Favreau J found that the Minister had not established that the $6,500,000 paid by the joint venture participants for the seismic data was unreasonable, and so could not limit the taxpayer's deduction under s. 67 (the limit the Minister sought was the cash component plus 50% of net licensing revenues received). Given that the transaction had been at arm's length, the onus was on the Minister to establish that the fair market value of the data was lower than the $6.5 million purchase price, which the Minister had not done (para. 64). Favreau J also stated (at para. 65):

The fact that the revenues from the licensing of the Seismic Data amounted to $1.8 million over a three-year period supports a value for the Technical Data at the time of their acquisition by the Joint Venture in excess of $975,000.

After finding that the taxpayer had been carrying on a business of developing pedal and steering systems for adult tricycles, Paris J found that there was no evidence to suggest that $50/hour was unreasonable for the taxpayer to pay its sole director, shareholder and employee, who had a background in business and industrial design, to develop prototypes and perform various development- and patent-related tasks.

The taxpayer was a securities broker for National Bank Financial ("NBF"), and worked there with another investment advisor ("Auger") in the what they styled as the "Auger-Massicolli" partnership. As part of a client retention and lead management strategy, he would mail clippings from newspapers and magazines to clients. These clippings were generated by their spouses, who were the sole employees of a corporation ("Sydwood") whose two equal shareholders were corporations controlled by an Auger or the taxpayer's family trust. The two partners paid fees to Sydwood of 0.15% per month (2% per annum) of assets the two partners "generated," for the Sydwood "research" services.

The taxpayer deducted research fees of $134,697 and $152,199 in computing his employment income for 2003 and 2004 as business expenses, and his commission income for those years was $463,510 and $376,262. Paris J. disallowed the deductions in full under s. 67. Among the reasons listed were that:

• NBF provided similar reports for $20 per mailing, and the taxpayer could not establish that it was reasonable not to use them instead - i.e. that the Sydwood reports were superior, or that the NBF fees would have been greater;
• the research fees were greatly in excess of Sydwood's cost ($50,000 a year for salaries, plus some financial publication subscriptions); and
• the taxpayer's claim that 0.15%-0.40% per month was the competitive rate for similar report-generating services was unsubstantiated.

The taxpayer, a lawyer, was bilked of $400,000 by scam artists, posing as clients, who induced him to pay for "processing " fees in connection with the recovery of a supposed container in the Ivory Coast containing US$8.5 million of cash. Webb J. found that as it was not reasonable in the circumstances for the taxpayer to have believed that the container was real, the amounts expended by him also were not reasonable, and their deduction was denied in full by s. 67.

The individual taxpayer was the principal shareholder of the corporate taxpayer, a canola farm supplier with annual sales in the tens of millions. Sheridan J. found that the taxpayers' expenses in establishing and operating a snowmobile museum were deductible as business expenses and capital cost allowances, because the costs were incurred to promote the canola business. In reaching that conclusion, she noted that the individual taxpayer often used the topic of snowmobiles as a "conversational in" to build a rapport with potential customers (who, being canola farmers, were often snowmobilers themselves), and that the costs in operating the museum were small compared to the taxpayers' revenue. Moreover, given that the costs had a clear connection to earning business income, the Court could not second-guess the taxpayers' business judgment.

The taxpayer, an independently practising lawyer, paid his wife $45,000 in the year as remuneration for bookkeeping and office management services. The Minister disallowed the taxpayer's deduction of the remuneration on the basis that the sporadic manner of its payment suggested an income-sharing arrangement rather than salary. In allowing the deductions, Hogan J. stated (at para 14):

The ITA does not require that a salary be paid on a regular basis.

A firm of architects of which the taxpayer was a partner was entitled to deduct the full amount of management fees that it paid to a management corporation of which the taxpayer was the sole shareholder equal in amount to the cost of the administrative and management services rendered to the firm plus a 15% surcharge thereof and a further charge of 3% of all amounts invoiced by the management corporation to the firm's clients.

The taxpayer was assessed for amounts that she embezzled from her employer in 2000, declared bankruptcy because of this claim against her and, after her discharge (without having paid any of the assessment), began paying back to her employer the amount she had taken pursuant to a court order.

In finding that the taxpayer was not entitled to deduct amounts paid by her pursuant to the court order by virtue of s. 67, Bowman C.J. indicated (p. 2734) that under "a textual, contextual and purposive interpretation", it would be "unreasonable for her to be able to deduct the repayments of amounts on which she has never paid tax."

Directors' fees that were paid to children of the taxpayer's shareholders for serving as directors of the corporation, with the amount paid to them being related to their personal expenses and being unrelated to any level of services provided by them to the corporation (which mostly were minimal) were deductible only to the extent of $1,500 per year per director, with the exception of one of the directors who was capable of making a more significant contribution to the taxpayer's business.

Before going on to find that the purchase price for seismic data acquired by the taxpayer did not exceed its fair market value, Little J. indicated (at p. 229) that "since this was an arm's length transaction, and the expense was reasonable this is not an issue of fair market value" and that "given the highly speculative nature of the oil and gas exploration industry, the fact that seismic data is very difficult to value as well as the experience of Mr. Sapieha [the promoter] in the oil and gas exploration industry, this is not an appropriate case to question the participant's business judgment".

Bonuses paid to children of the taxpayer's controlling shareholders that clearly were unreasonable in amount in relation to the services rendered by them were not deductible notwithstanding a position of the taxpayer (that was not accepted by Lamarre Proulx T.C.J.) that the bonuses should be attributed to the parent managers pursuant to s. 56(2) and, as a result, considered reasonable in relation to the services rendered by such managers.

After finding that expenses incurred by the taxpayer in connection with a trip to Las Vegas by him and six other people including his wife and some Amway distributors were not deductible by virtue of not being incurred for an income-producing purpose, Lamarre J. went on to indicate that even if s. 18(1)(a) had not prohibited the deduction of the expenses, the expenses were so excessive as to be unreasonable and therefore non-deductible by virtue of s. 67, given that the expenses incurred for the trip represented one-third of gross income for the year.

A family trust was established which employed, on a part-time basis, three individuals previously employed full-time in the taxpayer's dental practice, and charged an administration fee to the taxpayer equal to four times the cost to it of employing the three individuals.

Miller T.C.J. found that the 15% mark-up allowed by the Minister was reasonable, whereas the deduction of the full amounts by the taxpayer was not.

Before finding that expenses incurred by the taxpayer were deductible, Bowman TCJ. stated (at p. 849):

"Expenses are not unreasonable simply because they are substantial. Here, they were commensurate with the anticipated returns. For an expense to be unreasonable it must, based upon objective criteria and comparison, be one that a reasonable businessperson would not have incurred having in mind only the commercial advantage sought ... ."

Lease performance guarantee fees paid by the taxpayer to an affiliated corporation ("CMM") resident in the Dutch Vigin Islands were found to be deductible, in the face of an argument of the Crown that the non-resident affiliate had little or no assets, given that back-up guarantees given to ("CMM") constituted a valuable asset of CMM, even if a contingent one.

The taxpayer, who was a partner in a law firm, deducted that portion of the expenses attributable to a condominium in a ski area represented by the days of alleged business use (i,e., making the condominium available to clients or potential clients) divided by the total number of days the condominium was in use. After finding that the expenses were not deductible by virtue of paragraph 18(1)(h) and by virtue of their failure to satisfy the requirements of paragraph 18(1)(a), Margeson TCJ. went on to note that the expenses claimed were unreasonable in amount (asking, at p. 868, "what reasonable businessman would incur such a capital expenditure as this, merely on the unfounded expectation that he might attract some new clients, without having any idea of the level of success of such action"), and went on to indicate that if the expenses were deductible, the most reasonable apportionment formula was that proposed by the Crown (i.e., the number of days of business use divided by 365).

With respect to the statutory predecessor of s. 68, Cattanach J. stated (p. 5028):

"I should think that 'reasonable' as used in the context of section 20(6)(g) does not mean from the subjective point of view of the Minister alone or the appellant alone, but rather from the point of view of an objective observer with the knowledge of all the pertinent facts."