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Date: 20030116 |
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Docket:2000-4052(IT)G |
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BETWEEN: |
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LOU FERRO, |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
REASONS FOR JUDGMENT
Teskey, J.
[1] The Appellant appeals his reassessments of income tax for the years 1992 and 1995, which includes two 12-month periods, first period ending January 31, 1992 and the second period ending January 31, 1995, as well as the stub period from February 1, 1995 to December 31, 1995.
Issues
[2] The Appellant, in his Notice of Appeal, states that there were four issues, namely, whether the Minister of National Revenue (the "Minister") erred in adding the amounts of $341,428 and $721,698 to the Appellant's income in 1992 and 1995 and in particular:
(a) even if the Minister was correct that amounts in respect of unbilled disbursements were not deductible by Ferro, whether such justified only a denial of the deductions (in the amounts of $126,239 and $222,049 in 1992 and 1995 respectively) rather than an addition of greater amounts to income;
(b) whether the Minister erred in any event by seeking to deny the deduction of disbursements incurred by Ferro and not billable to his clients during the period; and
(c) whether the Minister erred in denying Ferro the reserve to which he was entitled under section 34.2 of the Income Tax Act (the "Act").
[3] The Respondent in her second Amended Reply to the Notice of Appeal (the "Reply"), which was filed on consent at the opening of the hearing, stated that there was only one issue, namely:
The issue to be decided is whether or not the Appellant improperly calculated his gross revenues by deducting amounts that were already excluded from the computation of income by virtue of the Appellant's section 34 election.
Facts
[4] The Appellant is a lawyer practicing exclusively for persons who have suffered personal injury from a motor vehicle related accident.
[5] When a prospective client attends on the Appellant for the first time, the Appellant talks about the case in an attempt to instil confidence and to make the prospective client comfortable and then he discusses what can be done for the client.
[6] The terms of each and every contract that the Appellant enters into with his various clients are identical.
[7] The contract is a contingency contract with no risk to the client. The Appellant advises the client that he does not require a monetary retainer and that he does not keep time dockets. He also advises that he will finance the file and the final bill will be remitted only when the file is finished and will be entirely based on the results. He advises the client of the usual formula but states that it will be adjusted up or down depending on the results.
[8] The client has no risk or obligation to the Appellant. If costs are awarded against the client by a court, those costs are paid by the Appellant personally and not charged at any time to the client.
[9] If a client's claim should be dismissed, there is no bill rendered by the Appellant for a fee or any disbursements.
[10] There are many different ways that a client's claim could end up unsuccessful or the quantum being greatly reduced due to no fault of the Appellant or his client.
[11] When a settlement is being proposed, the client usually will authorize the Appellant to settle on the basis that he or she will receive a set net amount. The Appellant will then attempt to calculate his costs of the file and what a fair fee would be, and then attempt to settle on a gross amount that will pay the client his or her set net amount and pay him his costs and fee. If the Appellant cannot get quite the fee he is seeking or overlooks some cost that he has incurred, that is his responsibility. The client gets the agreed upon set amount. If the settlement is a lump sum plus party and party costs, again the client gets his or her agreed upon amount and the Appellant gets what he can negotiate or tax, whatever that amount might turn out to be.
[12] When the Appellant enters into a contract with a client, he first looks at the no fault benefits under the automobile insurance policy and then, at any employment insurance that may be available through policies with such companies as Canada Life or Great West Life, or through the client's employer. If the injury is serious or permanent, then the Appellant takes a much more aggressive approach and information is gathered.
[13] The information-gathering process is done by staff and outside contractors such as Golden Horseshoe, which is a firm of former police officers who go out, take pictures of the site of the accident, interview all possible witnesses and attempt to get written statements from all witnesses. The staff obtains reports from all treating doctors, the hospital, OHIP and an ambulance report. Certificate of ownership of the various vehicles is also obtained. These costs of getting the file to this point are paid in full by the Appellant.
[14] The next step taken by the Appellant is the retaining of Future Health Inc., in which he has a 33 percent interest. The nurse, Ellen Helden ("Helden"), who also holds 33 percent interest, does a five-point assessment of the client. Although the Appellant and Helden have a personal relationship, it is immaterial to this appeal.
[15] This five-point assessment covers the following five areas:
(i) the physical health of the client;
(ii) the emotional health of the client;
(iii) changes, if any, in the lifestyle of the client;
(iv) any job related financial problems, such as loss of employment, diminished abilities, etc.;
(v) changes, if any to social and family life.
[16] Depending on the result of these five point assessment reports, the Appellant may arrange for his client to be examined by any number of medical specialists, such as a neurologist, psychiatrist, psychologist or orthopaedic surgeon. Any of these may order further X-rays, MRIs or cat scans. Also, Future Health may be asked to do a further in-depth assessment. All this work is ordered by the Appellant and it is his responsibility to pay for these services. Because of cash flow problems, they are not paid until a settlement is obtained. Most of these people charge interest on their accounts, which is also the Appellant's responsibility.
[17] Attached to the Appellant's 1992 T1 general tax return is form T2032, being a statement of professional fees excluding work-in-progress and a calculation that shows the amount of unpaid disbursements at the start of the year and the amount at the end of the year. The difference being the amount the Appellant incurred during the 1992 fiscal year, namely $314,428 - $215,189 = $126,229, which was expensed against income resulting in a net professional income of $64,790. That is all of the 1992 incurred expenses in the fiscal period and expensed against income to produce the net taxable income.
[18] The Minister, in his 1992 reassessment, disallowed the deduction of the unbilled disbursements incurred in 1992 in the amount of $126,229 and added to the income of $64,790 the sum of $314,428, being the total disbursements outstanding at the year-end of the 1992 fiscal period, which figure included disbursements of $188,199 incurred prior to the 1992 fiscal period, notwithstanding that the Appellant only deducted from income those monies whose debt was incurred in 1992 of $126,229.
[19] As a result of amendments to the Act that requires all professional individuals to have a December 31 year-end, the Appellant's 1995 T2 general tax return contains two fiscal periods, namely the period February 1, 1994 to January 31, 1995 and the stub period of February 1, 1995 to December 31, 1995. Attached to the return are two statements of professional activities (T2032), one for each period. In both statements, these costs are shown at the start of the period and at the end of the period, giving the amount incurred for the period, namely $117,869 for the first period and $104,180 for the second period, which were both deducted from income.
[20] The Minister, in his reassessment, added to the Appellant's calculated income the total amount of outstanding disbursements as of December 31, 1995 of $1,063,126 less the disallowed unbilled disbursements reassessed for 1992, in the sum of $341,826, the calculation being $1,063,126 - $341,826 = $721,698, notwithstanding that the Appellant only deducted from income those debts incurred in the two fiscal periods covered by the return, namely the sum of ($117,869 + $104,180) $222,049.
[21] Certain questions and answers given on the examination for discovery of Lou Zavagos ("Zavagos"), the auditor involved in the reassessments demonstrates that several of the assumptions alleged to have been made at the time of the assessment were in fact not made and, in any event, they were irrelevant. Zavagos, when being questioned on assumption Q, did not know how a figure of $478,896 was arrived at or where it came from but, in any event, the evidence of the Appellant demonstrates what the proper amount was. In regard to the assumptions in subparagraphs N, O, P and R, Zavagos relied upon any of the facts contained therein.
[22] This is all immaterial as the evidence of the Appellant is accepted by me in full. He gave his evidence in a straightforward manner without equivocation in-chief and in cross-examination. His oral evidence was not challenged in any way by counsel for the Respondent while he was in the witness box.
Appellant's Position
[23] The expenses at issue are incurred by the Appellant personally and not on behalf of a client, they are to assist him to obtain a more favourable result. The client has no risk for these services or for these costs. If and only if a settlement is negotiated or an award is obtained at trial which is sufficient to put these expenses back into the Appellant's pocket. Will he recover the expenses incurred for that particular file?
[24] These costs at the time they are incurred are neither receivable from the clients nor payable by the clients to the Appellant.
[25] The expenses are deductible in the year in which they were incurred. The average client file can last from two and a half years to four years. These expenses occur at the outset and continue to settlement or arbitration and settlement or to trial. The expenses are the absolute responsibility of the Appellant, and they continuously occur, some are paid in full at the time, and some payment is deferred. These costs are incurred for the purpose of earning income and are deductible in the year in which they are incurred. If a successful conclusion is not reached, no fee is received and the expense remains that of the Appellant.
[26] The Appellant's election under section 34 of the Act allows him not to include work in progress in the calculation of income. Paraphrased, this provision reads: In computing the income of a lawyer, if he or she elects in his or her return, there shall not be included any amount in respect of work in progress at the end of the year.
Respondent's Position
[27] The Respondent referred to section 9 of the Act concerning profit and paragraphs 12(1)(a), and (b), the inclusion sections, and argues that these costs are receivables in the hands of the Appellant even though they are contingent receivables, that is they are client disbursements until the Appellant forgives them. Thus, the Appellant should declare each year as receivables, the year's expenses that he has incurred for client files.
[28] This was argued notwithstanding the only issue raised in the Reply was the deduction of these costs.
[29] The first position of the Respondent is that the 1992 assessment is correct even though the Minister added to income the total outstanding costs of $341,418 and not just the amount that was incurred in 1992 in the amount of $126,428, being the amount the Appellant expensed. This position is so obviously wrong it deserves no comment by me.
[30] The first alternative position would be the example that a $300 expense is incurred in year one and a fee of $1,000 is earned and billed in year two. The $300 should be shown as a receivable and added to income in year one, and in year two, the $300 is expensed, the fee of $1,000 declared as income, thus tax is paid on the net amount of $700.
[31] The next alternative position is in using the same $300 expense in year one and a fee of $1,000 in year two. In year one, the $300 is not expensed, and in year two the $300 is expensed and both the fee and the expense brought into income with tax paid on the net amount of $700.
[32] The Respondent points to the wording in the financial statements, such as: "Unbilled disbursement receivable from clients."; "Disbursement made on behalf of clients are recorded as unbilled disbursements pending subsequent reimbursement" and argues this properly characterized the monies in issue. The Appellant was not cross-examined on this point.
The Law
[33] The Exchequer Court decision of M.N.R. v. John Colford Contracting Company Limited, dated June 16, 1960 ([1960] Ex., C.R. 433 (Q.L.)), which was upheld on appeal to the Supreme Court of Canada, dealt with a contract that required an architect's certificate of completion before the taxpayer was entitled to any money.
[34] Kearney J., said in paragraph 22 thereof :
22 As "amount receivable" or "receivable" is not defined in the Act, I think one should endeavour to find its ordinary meaning in the field in which it is employed. If recourse is had to a dictionary meaning, we find in the Shorter Oxford, Third Edition, the word "receivable" defined as something "capable of being received." This definition is so wide that it contributes little towards a solution. It envisages a receivable as anything that can be transmitted to anyone capable of receiving it. It might be said to apply to a legacy bestowed in the will of a living testator, but nobody would regard such a legacy as an amount receivable in the hands of a potential legatee. In the absence of a statutory definition to the contrary, I think it is not enough that the so-called recipient have a precarious right to receive the amount in question, but he must have a clearly legal, though not necessarily immediate, right to receive it. A second meaning, as mentioned by Cameron J., is "to be received," and Eric L. Kohler, in A Dictionary for Accountants, 1957 edition, p. 408, defines it as "collectible, whether or not due." These two definitions, I think, connote entitlement.
and in paragraphs 29 and 30:
29 It is provided in article 3 of the Dominion Bureau of Statistics contract that the amount of the holdback is to be 15 per cent of the progress payments, and the article concludes in these words:
Final payment to be made within 30 days after satisfactory completion of the entire building and acceptance by the architect.
Although it does not add that such completion and acceptance by the architect are conditions precedent which must be fulfilled before the taxpayer is entitled to final payment of the holdback, in my opinion, under the jurisprudence such meaning is to be implied. As a corollary, I consider that the holdback does not, as far as the taxpayer is concerned, take on the quality of a receivable until the work has been accepted by the architect. This does not, however, dispose of the issue in regard to the contract under consideration.
30 Ross, Patterson, Townsend and Fish, as appears by the contract, had been named by the owner as the "architect;" and on March 9, 1953, the above-mentioned firm, per J.K. Ross, certified that all the work in connection with the Dominion Bureau of Statistics, which totalled some $6,000,000, had been completed by the prime contractor according to plans and specifications; and that no holdback was to be retained. The above-mentioned certificate, of course, covered the work done by several sub-contractors, including the taxpayer. It will thus be seen that the condition precedent ceased to exist before the termination of the taxpayer's fiscal year 1953 and the holdbacks payable under it acquired the quality of a receivable as of the date of the certificate. It is to be recalled that final payment was to fall due thirty days after the issuance of the certificate which would bring it into the taxpayer's subsequent fiscal year, and it was in fact paid on April 11, 1953. I do not think that the latter can rely on the delay allowed for payment as justification for bringing the amount of the holdback into the fiscal year in which it fell due. In my opinion, a term or instalment account must be included in the taxation year in which it could be said that it had the quality of a receivable since Section 85B(1)(b) provides that it shall be thus included "notwithstanding that the amount is not receivable until a subsequent year."
[35] McDonald J.A., in Argus Holdings Limited v. The Queen, 2000 DTC 6681, said in paragraphs 14, 15, 23 and 24 :
[14] Moreover, there is well established authority for the proposition that it is not the accounting treatment of an amount which governs deductibility, but rather the true nature of the amount deducted. The fact that the Appellant's books of account do not describe the amounts in question as a reserve does not mean that the Appellant did not in fact take a reserve. See, for example, Dixie Lee (Maritimes) Ltd. v. The Queen, 88 DTC 6108 (F.C.T.D.); Mr. Muffler Ltd. v. The Queen, 74 DTC 6615 (F.C.T.D).
[15] In Mr. Muffler Ltd., Walsh, J. made the following comments with respect to the significance of the designation assigned to an entry in the financial statements:
The fact that the plaintiff in its financial statements refers to the amounts set aside as (translated): "reserve for merchandise sold and not delivered" when it is perhaps not properly speaking a true reserve in the sense in which the use of this term is recommended by accounting authorities is not too significant. It is not the designation given to the amount which is set aside but the purpose for which it was so set aside which is important.
[emphasis added].
...
[23] It would be a gross distortion of the Appellant's picture of income if the balance remaining in the "Deferred Initiation Fee" account were taxed in the 1992 taxation year. This is because portions of that balance were earned in tax years prior to 1992. The Appellant neither earned nor received the entire $441,154 in question in its 1992 taxation year. Portions of that amount are referable to taxation years other than 1992. In other words, the amount in question does not represent profit from the 1992 commercial activities of the Appellant, but represents profit from the 1982 to 1991 taxation years inclusively. Accordingly, it would not yield an accurate picture of income if the entire $441,154 were taxed in the hands of the Appellant in its 1992 taxation year.
[24] With the greatest respect, the Tax Court Judge erred in seeking to rectify the Appellant's under-reported income from 1982 to 1991 by adding those amounts into the Appellant's income in its 1992 taxation year. The Tax Court Judge failed to consider whether, by adding the entire $441,154 into income for the 1992 taxation year, an accurate picture of income would result.
[36] MacGuigan J.A., in West Kootenay Power and Light Company Limited and The Queen, 92 DTC 6023 said on page 9:
In my view, it would be undesirable to establish an absolute requirement that there must always be conformity between financial statements and tax returns, and I am satisfied that the cases do not do so. The approved principle is that whichever method presents the "truer picture" of a taxpayer's revenue, which more fairly and accurately portrays income, and which "matches" revenue and expenditure, if one method does, is the one that must be followed.
Decision
[37] I am satisfied that the Appellant's position in law and interpretation of the facts herein, is the correct position.
[38] It appears in light of recent decisions that the "matching" principle is no longer a determinating factor.
[39] The arrangement the Appellant had with each of his clients was a contingency arrangement until a successful outcome was obtained. Until then, there was no liability on the client and therefore cannot be a receivable until the right to collect the amount occurs, that is a negotiated settlement or a court judgment, and if a motion or trial is lost with costs, the client still pays nothing and the Appellant is out not only his costs but costs awarded against the client.
[40] The monies in issue are exclusively expenses of the Appellant, whether paid or not paid is immaterial and should be expensed during the period in which they are incurred and when the Appellant closes and bills the file, the total recovery is included in income.
[41] The appeals are allowed with costs and the two assessments are referred back to the Minister for reconsideration and reassessment in accordance with the reasons herein.
[42] Counsel for the Appellant shall prepare a draft judgment, obtain the approval of counsel for the Respondent and submit the same for a final judgment to be issued.
Signed at Toronto, Ontario this 16th day of January 2003.
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"Gordon Teskey" |
J.T.C.C.
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COURT FILE NO.: |
2000-4052(IT)G |
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STYLE OF CAUSE: |
Lou Ferro and Her Majesty the Queen |
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PLACE OF HEARING |
Toronto, Ontario |
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DATE OF HEARING |
January 13, 2003 |
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REASONS FOR JUDGMENT BY: |
The Honourable Judge Gordon Teskey |
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DATE OF JUDGMENT |
January 16, 2003 |
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APPEARANCES: |
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Counsel for the Appellant: |
Roger Taylor |
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Counsel for the Respondent: |
Marie-Thérèse Boris |
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COUNSEL OF RECORD: |
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For the Appellant: |
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Name: |
Roger Taylor |
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Firm: |
Couzin Taylor Ottawa, Ontario |
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For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |