Thomas P Murphy and Abc Steel Buildings Limited v. Minister of National Revenue, [1974] CTC 2176, 74 DTC 1124

A J Frost:—This is an income tax appeal in respect of the appellant’s 1968 and 1969 taxation years. It was agreed at the opening of the hearing that the appeal of Thomas P Murphy, in respect of assessments for the same taxation years, be heard at the same time on common evidence and it was further agreed that the sum of $15,000 referred to in paragraph 7 of the respondent’s reply was not in issue as it related to another year.

Thomas P Murphy (hereinafter referred to as “Murphy”) was the controlling shareholder of ABC Steel Buildings Limited (“ABC”). Prior to November 11, 1968 Murphy owned a building which housed a steel fabrication. plant in the village of Bolton, Ontario and carried on the business of fabrication and erection of steel buildings as a sole proprietorship under the names of “Amalgamated Building Company” and “ABCO Steel”. On April 1,1964 Murphy caused ABC to be incorporated and transferred the said business to his new company; however he retained ownership of the land and buildings which he rented to ABC. During ABC’s 1968 and 1969 fiscal years, Murphy caused an extension to be made to his ‘building and plant comprising an outdoor crane, a plate shop (an extension to the structural shop) and a small joist shop. The assessments levied by the respondent against ABC were based on the assumption that Murphy who, as I just mentioned, held title to the land and buildings, had not fully reimbursed ABC for all costs incurred by it on account of the said extensions and that a taxable benefit had therefore been conferred on Murphy within the meaning of subsection 8(1) of the Income Tax Act. The Minister of National Revenue also levied a 25% penalty pursuant to the provisions of subsection 56(2) of the Act.

On November 11, 1968, as reported in ABC’s 1969 fiscal year, Murphy sold his land and buildings to ABC for a consideration of $453,000 which amount was credited to his account with ABC. In November of 1969, after supplementary letters patent had been granted, ABC issued to Murphy $320,000 par value preferred stock and reduced ABC’s indebtedness by this amount. This transaction was recorded in the books of ABC and clearly indicated that the shares were issued for full consideration. In the reply to notice of appeal, the respondent states:

In the month of November 1969, ABC for no consideration whatsoever issued to the appellant as fully paid up, preferred shares with a par value of $320,000.

The notices of reassessment dated April 30, 1971 issued by the District Taxation Office made the following adjustments to Murphy’s declared income for 1968:

Notices of reassessment dated April 30, 1971 issued by the District Taxation Office adjusted ABC’s declared income for the taxation year 1968 as follows:

The reassessments in respect of Murphy were confirmed by the Minister on June 22, 1972 and in respect of ABC confirmed on July 20, 1972 after the respective taxpayers had filed notices of objection in due course.

According to the evidence adduced, Murphy built his extensions during slack periods in order to keep his workers fully employed. Murphy stated it would have been uneconomical to lay off workers during slack periods because of the difficulty of rehiring when business picked up. ABC kept accurate cost records and Murphy paid for all labour, steel and other materials, and provincial sales tax. However, Murphy was not charged with indirect overhead or a contract profit which might have been charged to an outside customer. Only those costs were taken into account which were incurred by ABC and which would not have been incurred had the extensions not been built. Murphy testified that if. he had personally, rather than through ABC, purchased all the material and hired all the same workers to build the same extensions, he would not have expended any more than the $55,386 charged by ABC. In fact, he said he might have expended less on labour.

An important factor in the case was the amount of steel used and its cost which was attributable to the fact that 17 tons of steel out of a total of 73 tons used for structural purposes had been obtained at salvage cost. The source of the salvage steel was a structure which had collapsed during a wind storm. The purchaser of the structure which collapsed rejected the steel and the supplier provided new steel. The purchaser’s cost in respect of the original steel was defrayed by insurance thus providing the appellant, a steel fabricator, the opportunity to obtain 17 tons of steel at nominal cost. The evidence indicated that all the structural steel was accounted for in the records of the company and charged against the appellant’s account at cost. The only omission was salvage costs amounting to about $1,000 which costs were incidental to the removal of steel from the the said structure. With respect to steel other than structural steel comprising some 40,000 square feet used as siding and roofing material, the evidence indicated that this steel was acquired at no cost to ABC. as it had been rejected by the rolling mill. Other steel material. had been rejected by the Department of Highways. To further reduce costs, the taxpayer poured his own cement and did not subcontract for lighting and heating. As a result of these “savings”, the taxpayer was able to build his extensions for approximately $55,000 or about one-third of what a customer might have had to pay for a similar job.

After the extensions were completed, ABC applied for a loan to the Ontario Development Corporation (“ODC”) to help finance the extensions and thus place ABC in a sounder financial. position. For this purpose the appellant gave the ODC estimates of costs based on what a customer would have been charged for similar work. This memorandum showing the cost estimates fell into the hands of the. special investigator for the Department of National: Revenue who assumed that the costs shown were the correct costs and that ABC and Murphy had knowingly understated their income for the taxation years. He reached this conclusion without, in my opinion, conducting a proper investigation.

When ABC filed its notice of objection on July 21, 1971 it enclosed a letter from Murphy as president of ABC and attached thereto an independent survey report by Mr H Kirss, professional engineer. The letter states:

Costs have been entered accurately against the buildings and our later estimate of these costs as shown in our letter dated October 26, 1970, (copy enclosed) substantiates this.

The engineering survey fully supported the taxpayer’s position.

Early at the hearing of the appeal the proposed filing of the said engineering report by counsel for the appellant was so strenuously objected to by counsel for the respondent as hearsay evidence that the Board sustained the objection. The next day apparently, after he had obtained his own expert advice as to the quantities of steel used, the respondent filed the survey as his exhibit (R-3) which, in my opinion, indicates that the respondent had not built his case on very solid ground and that the taxing authorities had never really considered the merits of the notice of objection filed in July 1971, although they had over one year to do so.

The memoranda of cost records relied upon by the respondent were not integrated with the financial records and were not part of its cost accounting system. In levying the assessments against which this appeal is launched, the taxing authorities did not rely on the audited records of ABC, but rather on an unofficial memorandum of costs prepared to support a loan application showing what a customer would have to pay for a similar job. No evidence was adduced to show that the financial records did not reflect the true and correct position of ABC’s affairs and of the results of its operation for the years in issue, or that its cost system was incomplete or inadequate. The evidence indicated the authorities ignored all evidence favourable to the taxpayer and relied only on one piece of unfavourable evidence. The auditor for the Department of National Revenue, by his own admission under cross-examination, said that he did not conduct a proper examination under the circumstances and on being questioned from the Bench could not support his re-allocation of costs between taxation years. In my opinion, if the auditor had approached his task professionally with a fair and just mind he could readily have obtained all the explanations he required. According to the evidence, the seizure of records, the startling assessments and ail the embarrassment which often flows from a special investigation resulted in the taxpayer’s loss of business, his money and his credit.

The assessments under review show a serious deficiency ab initio in so far as the respondent’s case is substantially based on memoranda of records prepared by the company in order to obtain a loan from ODC. Evidence was adduced to show that ODC knew the circumstances and had agreed on a level of capital expenditures which would ‘reflect intrinsic or market values and not on incurred expendi- tures. The costs shown for purposes of the loan application were clearly not the costs as reflected in the books of account and cost records, but were estimated costs as would have been incurred by an outsider. The evidence showed that the costs used were customerbased less about 10%. I see nothing sinister in what the company did. They applied for a loan based on what a customer would have to pay for similar construction using new materials and normal cost charges. ODC knew that ABC was in the steel fabricating and construction business and could build an extension to the plant for less than customer cost. All ODC wanted was security for their loan.

What Murphy paid for were the actual laid-down costs without imputed profit elements and indirect overhead costs. Is this a benefit under subsection 8(1) of the Act? If Murphy had had the same resources available to him as an independent contractor he could, according to his testimony, have constructed the extension for the same amount of money and, if he had not incorporated his business, he could have achieved the same result. As a matter of fact, by following this course, the taxpayer served the interests of ABC and of those whose livelihood depended upon the company’s continued existence. If a taxpayer is able to save money through his own efforts or the instrumentality of a company he controls, he should not be taxed on an imputed benefit which is the result of his personal efforts to limit his expenses to the actual costs incurred. ABC did not confer any benefit which affected its financial position. It was reimbursed for all direct costs, except for a very minor item which was brought to the attention of the Board by the appellant, not by the respondent. In that respect, the appellant presented the respondent’s case for them and gave the only solid ground the respondent had for levying any assessments.

Indirect costs are usually apportioned and charged against individual jobs on some realistic basis but, in this case, Murphy took the position, and rightly so, that these costs should not necessarily be charged against him as work was undertaken during slack periods and the company did not incur any expenses which it would otherwise not have made. Like the estimated $1,000 for removal of salvage steel the unabsorbed burden is miniscule in the overall picture. The amount of benefit is what a reasonable man in a similar position to Murphy might have been willing to pay for labour, materials, etc in excess of what he actually paid. It seems improbable that a reasonable man would charge himself for actual savings he effected through his own efforts or through a company he controlled.

Counsel for the Minister submitted that the books and records of the appellant company were cooked up and that the appellant, Murphy, was coming before the Board with “dirty hands”. He said: ‘‘We have the evidence of Murphy who quite frankly is coming here seeking equity with dirty hands.” He further suggested that the figures on which the assessments were based were those of the company itself and that the only reasonable figures were those used by the Minister. The truth of the matter is that the respondent was unable to establish anything of the sort. In my opinion, Murphy was sincere and candid and said or did nothing which reflected on his personal integrity or the reputation of his company and further I find that the records of the company which were certified by the auditor, a qualified chartered accountant who carried out a continuous audit of ABC’s affairs, had to be considered correct in the absence of any evidence to the contrary.

The words spoken by counsel for the respondent during his argument were disconcerting to the Board as they were not, in any meaningful way, supported by the evidence adduced. This weighed even more heavily as lawyers for the Crown are expected to treat all taxpayers at all times with respect and courtesy. Any failure to do so is a serious reflection on the administration of justice.

Admonition belongs to the Board.

In conclusion, I do not find any specific benefit conferred by ABC on the appellant within the meaning of subsection 8(1) of the Income Tax Act as it read at the relevant time. Further, I find that the adjustments made by the Minister to the taxable income of ABC were made for no reason whatsoever.

Appeals allowed.