J & J Hotels Ltd. (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Sheppard D.J.—Vancouver,
March 20 and 21; Ottawa, April 3, 1973.
Income tax—Expenses of company—Agreement by hotel
to pay employee of associated garage for washing cars—
Profits used to write off losses of prior years—Not bona fide
business expenses—Not deductible—Income Tax Act (1965),
secs. 12(1)(a), 12(2), 137(1).
A hotel company (the appellant) and a garage company
were controlled by the same person. Under an agreement
between the two companies in 1964 the garage company
washed cars of hotel guests at the rate of $2.00 a car on the
basis of 80% of the hotel's occupancy. The garage company
had no premises of its own and only one employee (who had
formerly been employed by the hotel company). In comput
ing its income for 1964 and 1965 the garage company
applied its profits against losses of $32,000 incurred by it in
the years 1959 to 1962. In the year 1967, the appellant
deducted as an expense the sum of $25,342 it paid to the
garage company for washing automobiles. The Minister
disallowed the deduction.
Held, the amount paid by the hotel company to the garage
company in excess of its employee's wages was not for the
purpose of gaining income and that excess was therefore
prohibited from deduction by the hotel company under
section 12(1)(a) of the Income Tax Act, as well as under
section 12(2) as not being "reasonable in the circum
stances", and also under section 137(1) because it would
"unduly and artificially reduce the income" of the taxpayer.
INCOME tax appeal.
COUNSEL:
W. A. Esson and P. Webber for appellant.
T. E. Jackson, Q.C. for respondent.
SOLICITORS:
Bull, Housser and Co., Vancouver, for
appellant.
Deputy Attorney General of Canada for
respondent.
SHEPPARD D.J.—The issue is whether the
appellant, J & J Hotels Ltd., is entitled to
deduct, as an expense for the income tax year
1967, the sum of $25,342.00, as paid to Vernon
Motors Ltd., for washing automobiles. The sum
was disallowed by the Minister in his assess
ment and was argued for the respondent to be
excluded by sections 137(1), 12(1)(a), and 12(2)
of the Income Tax Act.
In 1945, Vernon Motors Ltd. was incorporat
ed and operated at Vancouver, B.C. a repair
garage and sold some used cars. Of its outstand
ing 500 shares, 499 shares were held by Everett
James Vernon, and a remaining one share held
by his wife. Later, there was incorporated J & J
Hotels Ltd., the appellant, which built and ope
rated the Biltmore Hotel, at the corner of Kings-
way and 12th Avenue, Vancouver, B.C. Ninety-
eight of the outstanding 100 shares were held by
Everett James Vernon, one share by his wife,
and one share by his lawyer. Under date of the
15th of July, 1964, J & J Hotels Ltd. and
Vernon Motors Ltd. entered into an agreement
in the following terms:
WHEREAS the Hotel and the Company have mutually agreed
that the Company shall wash the automobiles of guests of
the Hotel upon the terms hereinafter set forth.
NOW THEREFORE THIS AGREEMENT WITNESSETH and the par
ties hereto mutually agree as follows:-
1. The Company shall wash with due care and despatch, at
the request of the Hotel, automobiles delivered by the
Hotel, to the Company for this purpose.
2. The Company shall employ such persons as may be
necessary to carry out its duties under this Agreement,
provided that the Hotel shall provide all facilities and
materials used or required in connection therewith and in
particular water, cleaning and polishing supplies, and power,
electrical or otherwise.
3. The Hotel shall pay the Company monthly on the 6th day
of each month commencing the 6th day of August, 1964, a
sum equal to TWO ($2.00) DOLLARS for each automobile
washed, computed on the basis of Eighty (80%) per centum
of the Hotel's room occupancy during the month in respect
of which payment is made, and the Hotel shall deliver to the
Company concurrently with a payment a statement showing
the manner in which the payment was calculated. Either
party can call upon the other to consider a revision of the
rate per automobile and the method of calculating the remu
neration to which the Company shall be entitled, in the
event the method of calculation set forth herein proves
inequitable to the party seeking the revision.
4. Either party to this agreement may terminate the agree
ment upon one month's written notice to the other
addressed to the other at its last known place of business.
5. This agreement shall take effect from the 6th day of July,
1964.
The seal of each company was witnessed by
the said Vernon as Director of each company.
E. J. Vernon stated in his evidence that he
had discussed the probable contract with the
solicitors and the accountants and that they
were in favour of the contract because of the
previous losses of Vernon Motors Ltd.
Before the contract of the 15th of July, 1964,
the appellant, J & J Hotels Ltd., had built the
Biltmore Hotel on the outside of the area of
Vancouver usually occupied by hotels, and to
induce customers had sent out circulars offering
a courtesy car wash to all customers in the hotel
(Exhibits 3, 4, & 5), with a parking area in the
basement and on the roof of the hotel.
In this period, Vernon Motors Ltd. was not
operating. It had no business and no business
premises, no telephone or entry therefor, and no
employees, other than E. J. Vernon, its Director
and President, who made no charge, but it had a
loss amounting to $32,550.06, incurred in the
years 1959-1962 inclusive.
The appellant, to wash as advertised,
employed Willie Lee for some eight or nine
months before the agreement. It was then that
E. J. Vernon, the active Director of the appel
lant and of Vernon Motors Ltd., had learned of
the ability of Lee in washing automobiles.
After the agreement, Lee was transferred by
the appellant to become an employee of Vernon
Motors Ltd. Vernon Motors Ltd. had no prem
ises, no soap, no cloths to shine the windows or
white metal work of the autos washed, and the
washing of autos was done at the premises of
the appellant, with the cold water supplied by
the appellant, which drained from the parking
area of J & J Hotels Ltd. There is some evi
dence of a brush and two hoses (one of one
hundred feet in length and the other of two
hundred feet in length), and rubber pants and
shoes worn by Lee being the property of
Vernon Motors Ltd., but if so, these articles
were for eight or nine months used by Lee in
washing automobiles for the appellant, when in
the employment of the appellant, and without
payment by the appellant to Vernon Motors
Ltd.
Lee's association with the appellant did not
cease on the transfer of his employment to
Vernon Motors Ltd. Lee was the sole employee
of Vernon Motors Ltd., and Francis Hubbard,
bookkeeper, employed by the appellant, looked
after Lee's payroll and paid it to him weekly.
Lee's hours of employment were from midnight
to 8:00 a.m., and if the washing of the cars did
not keep him busy, he acted as janitor for the
appellant for the remainder of his shift. At
times, particularly in January and February, the
customers at the hotel were few, not exceeding
twenty, and Lee was able to wash the autos and
then spend the balance of his shift acting as
janitor for J & J Hotels Ltd. When Lee was
absent, on his days off or when sick, then one
of the other janitors of J & J Hotels Ltd. was
used to wash the cars. Soon King Yee, who
remained an employee of the appellant at all
material times, was described in the ledger sheet
of the appellant as "Dept. maintenance, car
washer."
After the agreement, the only real income of
Vernon Motors Ltd. was the amount paid by the
appellant, J & J Hotels Ltd., allegedly for wash
ing the autos and that washing was performed
by Willie Lee, a former employee of the appel
lant, or, in Lee's absence, by an employee of the
appellant.
The appellant paid to Vernon Motors Ltd., in
the appellant's taxation year of 1965, for auto
wash expense, $18,726,00, and in the appel
lant's taxation year of 1966, $32,647.00. These
amounts were computed on the basis of occu
pancy of 80% of the appellant's hotel rooms,
irrespective of the number of autos washed for
customers, and on that basis, the appellant paid
Vernon Motors Ltd. $2.00 per auto. In the 1967
taxation year, the appellant paid to Vernon
Motors Ltd., for washing automobiles, $25,-
342.00, at the rate of $2.00 per auto for each
auto washed. This vast increase paid by the
appellant to Vernon Motors Ltd. for washing
autos resulted in considerable profit to Vernon
Motors Ltd., which was applied against the
losses which had previously been incurred by
Vernon Motors Ltd. In the return T2 by Vernon
Motors for 1964, the losses from 1959-1962
were shown at $32,550.06, and Vernon Motors
Ltd. deducted from the net income of $7,-
329.52, prior losses of 1959. The balance of the
losses were carried forward to 1965. In 1965,
the net income of Vernon Motors Ltd. is shown
as $26,123.91, from which is deducted prior
years' loss of $25,220.54, the balance of profit
then carried forward, leaving a taxable income
of $903.37. Also, it should be kept in mind that
the income tax year of the appellant ends on the
28th of February, and that of Vernon Motors
Ltd. on the 31st of August.
The appellant charged as an expense of earn
ing its income the sums paid to Vernon Motors
Ltd., which sums were then set off by Vernon
Motors Ltd. against its previous losses, all to
the advantage of E. J. Vernon, who held control
of both the appellant and of Vernon Motors
Ltd.
The sum of $25,342.00, paid by the appellant
to Vernon Motors Ltd. in 1967 was in excess of
the expense of Vernon Motors Ltd. in washing
autos, and resulted in a profit to Vernon Motors
Ltd. The year 1967 was the final year in which
the agreement existed, in that the appellant then
ceased washing autos for customers. Therefore,
Lee was returned to the employment of the
appellant, and continued in the appellant's
employment as a janitor until 1969, when he
ceased working.
The agreement of July 15, 1964, was entered
into for the purpose of permitting the appellant
to pay these monies to Vernon Motors Ltd.,
and, in doing so, for the appellant to deduct
such sum as an expense from its taxable
income, and for Vernon Motors Ltd. to avoid
paying income tax to the extent of offsetting its
previous losses.
E. J. Vernon stated in his evidence that the
Union's demands made it advisable for him to
separate the employees of the Hotel Company
from the auto washing, but that cannot be, as it
does not explain the reasons for the choice of
Vernon Motors Ltd., a controlled company, for
the auto washing, the circulation of Lee as an
employee, first of the appellant, and secondly of
Vernon Motors Ltd., and thirdly of the appel
lant after the auto washing had finished, the
profits of Vernon Motors Ltd. had from auto
washing its only business and the offset by
Vernon Motors Ltd. of profits against past
losses from which E. J. Vernon benefited
through his control of both the appellant and
Vernon Motors Ltd.
It follows that the money in excess of the
wages of Willie Lee was not paid by the appel
lant to Vernon Motors Ltd., as required by
section 12(1)(a) of the Income Tax Act:
... for the purpose of gaining or producing income from the
property or business of the taxpayer.
and that such excess paid by the appellant to
Vernon Motors Ltd. was not "reasonable in the
circumstances" within section 12(2) of the
Income Tax Act. Further, such profit "would
unduly or artificially reduce the income" of the
appellant, contrary to section 137(1) of the
Income Tax Act.
For these reasons, the appeal is dismissed
subject to the assessment of income tax being
referred back to the Minister to deduct from
$25,342.00 the expense of Vernon Motors Ltd.
in employing Lee for the.period that $25,342.00
was paid by the appellant.
The costs of the appeal will be paid by the
appellant to the respondent.
At the trial it was agreed that the issue involv
ing pension plan expense need not be tried. In
default of a settlement being finalized, leave is
granted to the appellant to apply for a new
hearing on that issue.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.