Judgments

Decision Information

Decision Content

T-877-76
Antoine Guertin Ltée (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Dubé J.—Montreal, December 9 and 10, 1980; Ottawa, January 6, 1981.
Income tax Income calculation Deductions Appeal from assessments Whether portion of premiums on life insurance policy pledged as security for a loan is deductible Whether salaries paid to two directors reasonable in view of evidence Whether the use of charitable institution to whom plaintiff and its employees gave donations is a sham created by plaintiff to artificially reduce its income Income Tax Act, R.S.C. 1952, c. 148, s. 11(1)(cb)(ii), S.C. 1970-71-72, c. 63, ss. 20(1)(e)(ii), 245(1).
Plaintiff appeals assessments for the years 1970, 1971 and 1972 with respect to life insurance premiums, salaries and charitable donations. (1) Premiums: it was held that a portion of the premiums on a life insurance policy—a portion which represented the cost of a term policy—pledged as security for a loan was not deductible because these premiums purchased permanent insurance and that plaintiff was acquiring an asset of a capital nature. (2) Salaries: the plaintiff paid to its president's mother and sister (both directors) salaries which were reduced in each case as being unreasonable. (3) Chari table donations: in 1972, the Fondation St-Pie, a charitable organization established by plaintiff's founder, received from the plaintiff and its employees donations (a portion of which came from the latter's bonuses). The question is whether the use of the Fondation was a pure sham created by plaintiff to artificially reduce its income.
Held, the appeal is allowed. (1) Premiums: an amount equal to the premium for term life insurance (without surrender value) corresponding to the debt to be repaid is deductible under section 20(1)(e)(ii) of the Income Tax Act. It is an expense incurred in the year in the course of borrowing money for the purpose of earning income from a business. (2) Salaries: the evidence indicates that the salaries paid to the president's mother were not unreasonable, unlike his sister's whose partici pation and experience were negligible. (3) Charitable dona tions: this case does not involve a series of fictitious operations. All transactions between the plaintiff and the Fondation were entered in the books of both entities and faithfully reported to the taxation authorities. The Fondation is registered as a charity under section 110(1)(a) of the Act, which authorizes the deduction of donations. The principal objective of the operations was not to reduce the income artificially, but rather to realize a practical and generous ideal within the framework of the Act. If there were a presumption of artifice, it has been rebutted.
Equitable Acceptance Corp. Ltd. v. Minister of National Revenue [1964] Ex.C.R. 859, distinguished. Snook v. London & West Riding Investments, Ltd. [1967] 1 All E.R. 518, considered. Minister of National Revenue v. T. R. Merritt Estate [1969] 2 Ex.C.R. 51, considered.
INCOME tax appeal. COUNSEL:
Claude Desaulniers for plaintiff.
Roger Roy and Daniel Verdon for defendant.
SOLICITORS:
Stikeman, Elliott, Tamaki, Mercier & Robb, Montreal, for plaintiff.
Deputy Attorney General of Canada for defendant.
The following is the English version of the reasons for judgment rendered by
DuBÉ J.: The plaintiff, incorporated in Quebec in 1946, operates a feed mill as well as several farms in St-Pie.
It is appealing the Minister's assessments for the 1970, 1971 and 1972 taxation years with respect to premiums for insurance on the life of the Presi dent, Jacques A. Guertin, salaries paid to the President's mother (Mrs. Antoine Guertin) and to the President's sister (Mrs. Andrée Gaudreault) and charitable donations made by the plaintiff and its employees to the Fondation St-Pie.
1. Insurance premiums
In 1969 the plaintiff borrowed the sum of $300,000 from the Industrial Development Bank—to purchase and operate farms—as security for which the Bank required the transfer of $200,- 000 in insurance on the life of the President and $100,000 in insurance on the life of the manager, Émile Cordeau. The Minister allowed the deduc tion of the term insurance premiums for Émile Cordeau, but refused to allow the deduction of the $1,090 in premiums on the President's life on the ground that these premiums purchased permanent insurance and that the plaintiff was thus acquiring an asset of a capital nature.
The plaintiff's accountant explained to the Court, however, that his client had charged only the cost of a term policy to expenses and deducted
the remainder from its surplus. For a 20-year term policy in the amount of $200,000 dated June 15, 1969 for Jacques Guertin, aged 34 at the time, the annual premium was $1,090. The company's inten tion was to charge to expenses only that portion of the premium applicable to the loan. The plaintiff did not charge the full annual premium of $4,022, which represents a premium for life insurance with a surrender value. The figures for 1973 confirm this intention: the $1,090 premium was reduced to $1,030.05 since the $200,000 loan had been reduced to $189,000 at that time.
In my view this part of the premium ($1,090) should be regarded as 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, in this case a farming business compris ing land, buildings, machinery and equipment. The transfer of $200,000 in insurance on the life of the President, until the debt was repaid, was an essen tial term of the loan.
A sum equal to the amount of the premium for the term life insurance (without surrender value) corresponding to the debt to be repaid is therefore deductible under subparagraph 11(1)(cb)(ii) of the old Act [Income Tax Act, R.S.C. 1952, c. 148, as amended] and subparagraph 20(1) (e) (ii) of the new Act [S.C. 1970-71-72, c. 63, hereinafter referred to as the Act], which reads as follows:
20. (1) ...
(e) an expense incurred in the year,
(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt),'
In Equitable Acceptance Corporation Ltd. v. M.N.R., 2 my brother Cattanach J. ruled that pre miums for insurance policies on the life of the plaintiff Company's president were not deductible,
' The exception in parentheses does not apply here since it is not alleged that the income from the farm purchased by the plaintiff would be exempt from tax.
2 [1964] Ex.C.R. 859.
precisely because this was permanent insurance which was not restricted to the term of the loan but covered the entire life of the insured, with a surrender value, and that therefore such policies were a lasting asset on which the Company could borrow money again once the first loan had been paid off.
Such premiums were of course not deductible; but an amount equal to the premium for term life insurance covering the amount of the loan is deductible both for the President of Antoine Guer- tin Ltée and for the manager, even if in the former case the Company purchased permanent insur- ance—not to avoid tax but to save money—and in the latter case term insurance.
2. Salaries paid to Mrs. Guertin and Mrs. Gaudreault
The plaintiff stated it had paid Mrs. Guertin and Mrs. Gaudreault the following salaries for the taxation years in question, on which they paid tax:
1970
Mrs. Guertin $17,681.81
Mrs. Gaudreault $13,346.83
1971
Mrs. Guertin $12,631.72
Mrs. Gaudreault $ 8,911.95
1972
Mrs. Guertin $12,994.68
Mrs. Gaudreault $ 9,156.95
The Minister reduced the above salaries to $3,000 per year, alleging that they were unreason able in view of the negligible participation of these two directors of the Company, their minimal experience and their almost total absence from the Company's premises.
According to the testimony of Jacques Guertin, which was not contradicted, his mother had taken part in establishing the business alongside his father. She invested some of her own money from her inheritance in it. From the outset she had seen to the financing and management of the Company. Her husband, Antoine Guertin, was concerned more with the mill machinery and technology. It was Mrs. Guertin who met the suppliers and attended conventions.
After the departure of her husband, Mrs. Guer- tin continued to be involved in the operation of the business. She met the new President, her son, every noon for lunch in the family residence locat ed opposite the mill. It was here that the daily problems were discussed and solved. She attended all meetings of the Board of Directors; she went to the office to see how things were going. She was the person who signed cheques in the President's absence. When her husband retired for health reasons and began taking increasingly long vaca tions in Grand Bahama and Maine, the contribu tion of his wife, who had considerable experience, became increasingly important. In the circum stances, I do not consider the salaries paid to Mrs. Guertin to be unreasonable and I think that they should be accepted by the Minister.
The situation seems to me to be different with regard to the salaries paid to Mrs. Gaudreault, however. Mrs. Gaudreault did not even live in St-Pie, but in the suburbs of Montreal. She did attend meetings of the Board of Directors and performed certain services when the Company had things to be done in Montreal, either with sup pliers or involving errands on behalf of the Com pany. The evidence indicated that her participation was in fact minimal. Her experience in the plain tiff's business is also negligible. The reduction of her salary to $3,000 per annum for tax purposes is therefore reasonable and should be confirmed.
3. Donations to the Fondation St-Pie
The Fondation was incorporated on December 23, 1960 under Part III of the Quebec Companies Act, R.S.Q. 1941, c. 276. It is a charitable organi zation recognized by the Department of National Revenue and registered as number 0133801-03-08. It gives all its income to foreign missions.
Antoine Guertin, the founder of the plaintiff Company, also established the Fondation St-Pie. He appears to have been an extremely religious person. He initiated the "Chapelet en famille" (Family Rosary), a program on a Montreal radio station. Two of his daughters became convent nuns. He himself tried to become a priest at the age of 65, a few years before he died. Profoundly
interested in missions, he proved to be a generous donor, especially with respect to the Brazil Mission of St -Hyacinthe, a community in his . diocese. It is this Mission which received the bulk of the reve nues distributed by the Fondation every year. During 1972, the only year in which donations are at issue in this appeal, it received $5,000 of the $7,336 distributed.
The plaintiff gave the Fondation a cheque for $12,400 as a charitable donation for the taxation year in question. During this period the plaintiff also gave its employees bonuses in the amount of $111,653.60 and the employees gave the Fonda- tion a total of $39,155 out of these bonuses as charitable donations. The Company generally gave each employee only one bonus cheque each year. For 1972 the accountant St-Onge took the initia tive of dividing the bonuses into three parts, one part for the Fondation, one as a loan to the plaintiff to be paid into a pension fund for the employees and the third part representing the bal ance of the bonus to be kept by the employees. St-Onge thus gave each employee three cheques for that year.
According to the defence, [TRANSLATION] "the use of the Fondation St-Pie, with the employees' complicity, was a pure sham created by the plain tiff for the purpose of artificially reducing its income". The defence added that the sums of $39,155 and $12,400 [TRANSLATION] "constitut- ed disbursements in respect of a transaction or operation that, if allowed, would unduly or artifi cially reduce the income of the plaintiff, contrary to section 245(1) of the Act". This section reads as follows:
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 opera tion that, if allowed, would unduly or artificially reduce the income.
According to his son, the idea of paying bonuses came to Antoine Guertin when he was reading an article in the Digest describing the merits of this system in encouraging employees to participate in the progress of a business. Bonuses are still being paid to employees by the plaintiff. According to the current President, the results are convincing:
there has never been a labour dispute at the mill and profits are increasing every year.
The list of bonuses is prepared by the Board of Directors. According to the President the amounts of the individual bonuses are based on three fac tors: the increase in the cost of living, the number of years of service and individual performance. The total sum to be divided depends on the Com- pany's profits (1972 was an excellent year).
Antoine Guertin would then take the list and visit all the employees. With his ardent missionary zeal he succeeded in convincing them to give gen erously. It is not impossible, in fact even probable, that he lured them with the possibility of bonuses based on the generosity of the donations. For the year in question a series of Antoine Guertin Ltée cheques dated November 30, 1972 (the end of the Company's fiscal year) payable to the employees were thus endorsed by the latter [TRANSLATION] "Deposit to the Fondation St-Pie fund". These cheques totalling $39,155 (together with the Com- pany's cheque for $12,400) were forwarded to the Fondation St-Pie's account on that date and depos ited by the latter on December 22, 1972.
These funds totalling $51,555 were immediately lent by the Fondation to the plaintiff, which gave it a new promissory note for the same amount bearing interest at the rate of 7 per cent. The Fondation had lent the donations it received in previous years to the plaintiff on promissory notes in the same manner. The practice was repeated from year to year, in November, when the total amount of the donations was lent to the plaintiff on a promissory note. In return the plaintiff paid the Fondation 7 per cent interest, and it was these revenues that were then distributed to the missions.
The Fondation regularly files financial reports and other forms required by the Department of National Revenue. Any donor may become an active member of the Fondation once accepted by the Directors. The Directors are not employees of the Company, with the exception of Émile Cor- deau, who was formerly the plaintiffs manager, and now of Jean St-Onge, his successor as manag er of the plaintiff and also secretary of the Fonda-
tion. The founder Antoine Guertin did not remain a Director of the Fondation after its incorporation.
The capital of the Fondation reached $485,000 in 1977 and then remained stable. All this money is still being lent to the plaintiff and the 7 per cent interest is still being distributed to the missions. Cordeau left the plaintiff in 1972 and the Fonda- tion in 1973. His successor testified that he fol lowed the tradition established by Cordeau, including the practice of the donations and loans. The meetings of the Fondation take place in St-Onge's office in the plaintiff's mill, and this is where the Fondation's books are kept.
The Fondation has no premises, offices or employees. Its only expenses are $10, which it pays every year to the Quebec Department of Financial Institutions. The balance of the receipts (the inter est on the plaintiff's loan) is distributed to the missions.
According to the testimony of Jacques Guertin, Yvon Boyer, the Company's chartered accountant and auditor, and Jean St-Onge, the only three witnesses at the hearing, the system of employee bonuses and donations to the Fondation reflects the intentions of the founder of both bodies, who was striving for both industrial peace at the plant and a realization of his spiritual views through the Fondation.
According to his son, toward the end of his life Antoine Guertin wanted to give all the Company's revenues to the Fondation. Jacques Guertin, who readily admits to being much less religious than his father, was careful not to agree to this proposal.
We must therefore determine whether the use of the Fondation constitutes a pure sham created by the plaintiff and its employees for the purpose of artificially reducing income, as the Minister main tained, or whether the bonuses are legitimate cur rent expenses, incurred in the course of the Com- pany's business in order to earn income, and whether the donations to the Fondation are allow able deductions.
Unfortunately the two witnesses who could best have shed light on the situation, the founder and his wife, are both dead. It is nonetheless evident
from the testimony of the plaintiff's three wit nesses that Antoine Guertin's essential aims were achieved: the bonus system guarantees the Com pany a loyal and efficient staff and the Fondation now has a constant amount of capital, the annual income from which is given to the missions. This successful formula also produces two other benefi cial results for the plaintiff. First, the payment of bonuses increases the Company's expenses and consequently reduces the tax payable; secondly, the Company benefits from a source of borrowing at a highly favourable rate.
None of the above transactions is concealed or illegal. The Fondation has letters patent incor porating it as a corporation whose objects are to administer funds and contributions to assist chari table institutions. In the event of the Corporation's dissolution its net assets are to be transferred to organizations having similar aims. The Fondation is registered as a charity under paragraph 110(1)(a) of the Act, which authorizes the deduc tion of donations.
With the exception of Cordeau in 1972 (and now St-Onge), the Directors are not attached to the Company. The donors do not come exclusively from the ranks of the Company either; the founder had also canvassed farmers in the area as well as suppliers and other clients. There is nothing to prevent the Fondation from lending its money elsewhere and it is free to increase its rates once the promissory note expires. The charter of incor poration provides that in the event of dissolution the assets will not go back to the Company but will go to other organizations dedicated to supporting missionaries. The Fondation's assets have now reached a plateau and there is no longer a dedicat ed worker to collect donations from the employees or elsewhere.
The money given to the employees in 1972 as bonuses is entered in the Company's books as such and appears on the T-4 Forms of these employees as income. Their charitable donations are also reported as such. It appears that the founder dis cussed with each employee, and with the account ant, the maximum deductible amount that each employee could give to the Fondation. There is
nothing reprehensible, of course, in informed tax payers taking maximum advantage of the deducti- bility of their donations.
Although the donations of the Company and its employees reduced the plaintiff's income, this does not mean that these expenses are unreasonable and unlawful. Analyzed in light of the principal objec tives initially pursued by the Company and the Fondation, these donations do not seem to me to have been made primarily in order to reduce income, even though this was the result, but chief ly in order to achieve the objectives already men tioned. This reduction in income is therefore not necessarily unrealistic and artificial. 3
The oft-cited passage from Lord Diplock's judgment 4 in Snook v. London & West Riding Investments, Ltd. is relevant in this context:
As regards the contention of the plaintiff that the transac tions between himself, Auto-Finance, Ltd. and the defendants were a "sham", it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejora tive word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create.
In my view the present case does not involve a series of fictitious operations, or shams, or eva sions. It must be remembered that all transactions between the plaintiff and the Fondation were entered in the books of both entities and faithfully reported to the taxation authorities. The principal objective of these operations, in my view, was not to reduce the income artificially but rather to realize the ideal, both practical and generous, pur sued by Antoine Guertin, within the framework of the Act. It has not been shown, moreover, that the plaintiff has gained thereby in income, since it must not be forgotten that the capital of $485,000 remains the property of the Fondation: the plain tiff will have to repay its loan some day.
Learned counsel for the defendant also raised the argument that since the plaintiff and the Fon- dation are not dealing at arm's length, there is a
3 See Sigma Explorations Ltd. v. The Queen [1975] F.C. 624, at pp. 634-635.
4 [1967] I All E.R. 518, at p. 528.
presumption that these transactions between the two are artificial, a presumption which it was up to the plaintiff to rebut. 5 He referred in particular - to a passage from a judgment of my brother Cat- tanach J. in M.N.R. v. T. R. Merritt Estate: 6
In my view, the basic premise on which this analysis is based is that, where the "mind" by which the bargaining is directed on behalf of one party to a contract is the same "mind" that directs the bargaining on behalf of the other party, it cannot be said that the parties are dealing at arm's length. In other words where the evidence reveals that the same person was "dictat- ing" the "terms of the bargain" on behalf of both parties, it cannot be said that the parties were dealing at arm's length.
Once again, even though at the outset the person of Antoine Guertin dominated both entities, the situation was no longer the same in the period we are concerned with. In 1972 the only real tie between the Company and the Fondation was Émile Cordeau, who was not a shareholder of the plaintiff. There is certainly no reason to believe that he dictated the terms of any bargain between the two Companies. Moreover, even if there were a presumption of artifice, it has been rebutted to my satisfaction by the evidence, which establishes clearly the genuine existence of charitable dona tions made for a specific and legitimate purpose.
In the circumstances the appeal should be allowed and the reassessments issued by the Department of National Revenue in respect of the plaintiff for 1970, 1971 and 1972 should be vacat ed, with the exception of the reduction to $3,000 of the salary paid to Mrs. Andrée Gaudreault, which is confirmed; the whole with costs.
5 See Mulder Bros. Sand & Gravel Ltd. v. M.N.R. 67 DTC 475; Spur Oil Ltd. v. The Queen [1981] 1 F.C. 461; Robson Leather Co. Ltd. v. M.N.R. 77 DTC 5106.
6 [1969] 2 Ex.C.R. 51, at pp. 62-63.
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