Sheppard, DJ:—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, as paid to Vernon Motors Limited, for washing automobiles. The sum was disallowed by the Minister in his assessment and was argued for the respondent to be excluded by subsection 137(1), paragraph 12(1)(a) and subsection 12(2) of the Income Tax Act.
In 1945, Vernon Motors Ltd was incorporated and operated at Vancouver, BC a repair garage and sold some used cars. Of its outstanding 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 operated the Biltmore Hotel, at the corner of Kingsway and 12th Avenue, Vancouver, BC. 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 July 15, 1964, J&J Hotels Ltd and Vernon Motors Limited 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 parties 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 remuneration 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 agreement 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 Limited.
Before the contract of July 15, 1964 the appellant, J&J Hotels Lid, had built the Biltmore Hotel on the outside of the area of Van- couver 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 and 5), with a parking area in the basement and on the roof of the hotel.
In this period, Vernon Motors Limited 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 1959-62 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 appellant and of Vernon Motors Limited, 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 Limited. Vernon Motors Limited had no premises, 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 evidence of a brush and two hoses (one of 100 feet in length and the other of 200 feet in length), and rubber pants and shoes worn by Lee being the property of Vernon Motors Limited 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 Limited.
Lee’s association with the appellant did not cease on the transfer of his employment to Vernon Motors Limited. Lee was the sole employee of Vernon Motors Limited, 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 am, 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 hotef 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 Limited was the amount paid by the appellant, J&J Hotels Ltd allegedly for washing the autos and that washing was performed by Willie Lee, a former employee of the appellant, or, in Lee’s absence, by an employee of the appellant.
The appellant paid to Vernon Motors Limited, in the appellant’s taxation year of 1965, for auto wash expenses, $18,726, and in the appellant’s taxation year of 1966 $32,647. These amounts were com- puted on the basis of occupancy 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 Limited $2 per auto. In the 1967 taxation year the appellant paid to Vernon Motors Limited, for washing automobiles, $25,342, at the rate of $2 per auto for each auto washed. This vast increase paid by the appellant to Vernon Motors Limited for washing autos resulted in considerable profit to Vernon Motors Limited, which was applied against the losses which had previously been incurred by Vernon Motors Limited. In the return T2 by Vernon Motors for 1964, the losses from 1959-62 were shown at $32,550.06, and Vernon Motors Limited 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 Limited 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 February 28 and that of Vernon Motors Limited on August 31.
The appellant charged as an expense of earning its income the sums paid to Vernon Motors Limited, which sums were then set off by Vernon Motors Limited against its previous losses, all to the advantage of E J Vernon, who held control of both the appellant and of Vernon Motors Limited.
The sum of $25,342 paid by the appellant to Vernon Motors Limited in 1967 was in excess of the expense of Vernon Motors Limited in washing autos, and resulted in a profit to Vernon Motors Limited. 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 moneys to Vernon Motors Limited and, in doing so, for the appellant to deduct such sum as an expense from its taxable income, and for Vernon Motors Limited 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 Limited, a controlled company, for the auto washing, the circulation of Lee as an employee, first of the appellant, and secondly of Vernon Motors Limited, and thirdly of the appellant after the auto washing had finished, the profits of Vernon Motors Limited had from auto washing its only business and the offset by Vernon Motors Limited of profits against past losses from which E J Vernon benefited through his control of both the appellant and Vernon Motors Limited.
It follows that the money in excess of the wages of Willie Lee was not paid by the appellant to Vernon Motors Limited as required by paragraph 12(1)(a) of the Income Tax Act “for the purpose of gaining or producing income from the property or a business of the taxpayer”, and that such excess paid by the appellant. to Vernon Motors Limited was not “reasonable in the circumstances” within subsection 12(2) of the Income Tax Act. Further, such profit “would unduly or artificially reduce the income” of the appellant, contrary to subsection 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 the expense of Vernon Motors Limited in employing Lee for the period that $25,342 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 involving 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.