T-1480-72, T-1481-72
Jack K. Holmes (Plaintiff)
v.
The Queen (Defendant)
and
T-1476-72, T-1477-72
Douglas L. Crowe (Plaintiff)
v.
The Queen (Defendant)
and
T-1478-72, T-1479-72
Peter C. G. Power (Plaintiff)
v.
The Queen (Defendant)
and
T-1482-72, T-1483-72
John M. Johnston (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Cattanach J.—Calgary, Novem-
ber 6, 7, 8 and 9, 1973; Ottawa, January 24,
1974.
Income tax—Company incorporated by law firm to
manage the administration of its legal practice—Deduction
from income of law firm in amount of fee paid to company—
Deduction permitted under the Income Tax Act, s. 12(1Xa)
and s. 137(1).
The plaintiffs, partners in a law firm, caused the incorpo
ration of a company to take over the physical assets of the
firm and render management services with respect to the
administrative aspects of the firm's law practice. The com
pany paid the overhead incurred by the law firm; the latter
reimbursed the company and, in addition, paid the company
15% of the overhead levy as a management fee.
The Minister, in assessing the plaintiffs for the taxation
years 1968 and 1969, allowed the deduction of the amount
paid to reimburse the company for payment of the firm's
overhead, but disallowed the amount paid to the company as
a management fee.
Held, allowing the appeal, the management fee was an
expenditure laid out in the process of earning income and
not prohibited as a deduction in computing income, under
section 12(1)(a) of the Income Tax Act. The transaction in
question did not artificially reduce the income and hence the
deduction of the fee was not forbidden by section 137(1).
Shulman v. M.N.R. [1961] Ex.C.R. 410 and Grotell v.
M.N.R. 72 DTC 6409 followed.
INCOME tax appeal.
COUNSEL:
B. A. Felesky for plaintiffs.
L. P. Chambers for defendant.
SOLICITORS:
Fenerty, McGillivray and Co., Calgary, for
plaintiffs.
Deputy Attorney General of Canada for
defendant.
CATTANACH J.—The plaintiffs named in the
styles of cause are barristers and solicitors
carrying on their profession in partnership
under the firm name and style of Holmes,
Crowe, Power and Johnston at the City of Red
Deer, in the Province of Alberta.
The present actions, eight in all, are appeals
by the plaintiffs from their respective assess
ments to income tax by the Minister of National
Revenue, for their respective 1968 and 1969
taxation years.
On a motion to which the parties were in
agreement it was ordered that the appeals of the
respective parties should be heard jointly on
common evidence.
In assessing the plaintiffs as he did the Minis
ter disallowed a portion of the expenses claimed
by the plaintiffs in computing their income in
each taxation year in question which had been
paid by the law firm to a company incorporated
pursuant to the laws of the Province of Alberta,
under the name of Irish Management Ltd., with
which company the law firm had entered into an
agreement that the Company would render to
the law firm management services with respect
to the administrative aspects, as distinct from
the professional aspects, of the legal practice
conducted by the law firm. Under this agree
ment the Company paid the expenses incurred
by the law firm, which were described as an
"overhead levy", for which disbursements on
its behalf the law firm reimbursed the Company
and in addition paid to the Company 15% of the
overhead levy as a management fee.
The Minister allowed the amount paid by the
law firm to the Company as reimbursement for
direct overhead expenses but disallowed the
amount paid to the Company as a management
fee.
This can be better expressed, narratively and
visually, in tabular form:
TAXATION YEAR 1968
Amount claimed for direct
overhead expense $68,414.15
Amount claimed for manage
ment fees 9,684.82
Total $78,098.97
Total amount allowed by
Minister 68,299.35
Difference total amount disal
lowed by Minister 9,799.62
The disallowed expense was allocated among
the partners as follows:
Holmes $2,939.89
Crowe 2,743.89
Power 2,547.90
Johnston 1,567.94
Total 9,799.62
(Parenthetically I note that there is a differ
ence between the amount of the direct overhead
expenses claimed by the plaintiffs being
$68,414.15 and the total amount of $68,299.35
allowed by the Minister. That difference is
$114.80. The Minister disallowed the whole of
the management fee which was in the amount of
$9,684.82. It is the disallowance of that amount
which is the issue between the parties. The
disallowance of the additional $114.80 is not in
dispute and I, therefore, assume that it was a
payment by the law firm to the Company which
was not properly an expense and to the disal-
lowance of which the plaintiffs agree.)
TAXATION YEAR 1969
Amount claimed for direct
overhead expense $73,576.44
Amount claimed for manage
ment fees 10,439.74
Total $84,016.18
Total amount allowed by the
Minister 73,564.50
Difference total amount disal
lowed by the Minister $10,451.68
Again I note that there is a difference
between the amount of the direct overhead
expense claimed by the plaintiffs being in the
amount of $73,576.44 and the total amount of
$73,564.50 allowed by the Minister. That differ
ence is $11.94. If my recollection of the evi
dence is correct, it was admitted that certain
amounts were improperly charged to the law
firm as payment by the Company on behalf of
the law firm. In any event the dispute between
the parties is limited to the propriety of the
disallowance of the management fees in the
amount of $10,439.74 in the 1969 taxation year
as a deductible expense.
The disallowed expense was allocated among
the partners as follows:
Holmes $3,030.99
Crowe 2,612.92
Power 3,240.02
Johnston 1,567.75
$10,451.68
The sole issue is whether the management
fees of $9,684.82 and $10,439.74 paid by the
law firm in the 1968 and 1969 taxation years
are deductible in computing the income of the
partners in the law firm in those taxation years. ,
The basis of the Minister's submission that
the management fees are not deductible is predi
cated upon the fact that those fees were a
percentage of the "direct overhead expenses"
which were incurred by the law firm in the
normal conduct of its business and which were
paid by the management Company but for
which payment the Company was reimbursed
by the law firm. In essence it was the submis
sion of the Minister that the law firm could have
paid these expenses directly, without the inter
position of the Company, and that there was no
true business motive for the intervention of the
Company and accordingly the payment of the
management fees served no useful purpose and
was wholly unnecessary.
Following on those basic premises it was the
Minister's contention that the management fees
so paid by the partners in the law firm in their
1968 and 1969 taxation years were not outlays
or expenses made or incurred by the taxpayers
for the purpose of gaining or producing income
and accordingly are precluded as deductions in
computing income by section 12(1)(a) of the
Income Tax Act.
Section 12(1)(a) reads:
12. (1) In computing income, no deduction shall be made
in respect of
(a) an outlay or expense except to the extent that it was
made or incurred by the taxpayer for the purpose of
gaining or producing income from property or a business
of the taxpayer,
If the management fees are prohibited as
deductible outlays or expenses by virtue of sec
tion 12(1)(a) that is an end of the matter and the
appeals by the plaintiffs must be dismissed.
However should it be found that the deduc
tion of the management fees is not so prohibited
the Minister then contended that the manage
ment fees paid by the law partners were dis
bursements or expenses made or incurred in
respect of a transaction or operation that, if
allowed, would unduly or artificially reduce the
plaintiffs' incomes and are accordingly preclud
ed as deductions in computing income by virtue
of section 137(1) of the Income Tax Act.
Section 137(1) reads:
137. (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
operation that, if allowed, would unduly or artificially
reduce the income.
In so contending the Minister did not allege or
argue that the Company was a sham. It was not
disputed that the payment of the management
fees to the Company was not properly made to
the Company under a contractual obligation to
do so.
Again it was the Minister's contention, as I
understood it, that there was no genuine busi
ness reason for the payment of the management
fees but the payment thereof was merely a
means to siphon off income with the result that
the income of each plaintiff was artificially
reduced by his proportionate share of those
payments.
In most provinces of Canada, with the notable
exception of British Columbia, the profession of
barristers and solicitors is required by law, tra
dition or professional code to be carried on by
natural persons. The reason for this is evident.
To qualify as a barrister and solicitor requires a
protracted period of study which can only be
done by a natural person and the personal re
sponsibility of the solicitor to his client is such
that that responsibility must be assumed by a
natural rather than an artificial or fictitious
person. Further, membership in the provincial
law societies, which are the governing bodies of
the profession, is limited to natural persons and
membership in those bodies is a condition
precedent to practising the profession.
While barristers and solicitors are precluded
from incorporating a joint stock company to
carry on that profession, there is no impediment
to one or more barristers and solicitors incor
porating or engaging a management or facilities
company to perform all non-professional ser
vices otherwise provided by the barrister and
solicitor.
The non-professional services so provided are
by such a corporation usually,
1. to negotiate and sign the lease for the
premises from which the practice is carried
on, make the rental and utility payments and
enter into a sub-lease with the barristers and
solicitors;
2. purchase, own, finance, and repair all fur
niture, typewriters and like assets required to
carry on the practice;
3. purchase all supplies required;
4. purchase and supply a full legal library,
keep it up to date by the purchase of new
publications required in the practice and
keeping all periodicals to date;
5. hire, train, pay and maintain employee
benefits for all personnel required by the
practice, other than barristers and solicitors
and students-at-law;
6. provide bookkeeping and accounting ser
vices, render and collect accounts, and like
services excepting the certification of trust
accounts to the law society which is the re
sponsibility of the law firm, and
7. provide janitorial service.
It is also usual that these services are pro
vided on a cost plus basis, that is, the corpora
tion makes all payments on behalf of the law
firm, adds a profit factor, which in the present
instance was 15% and bills the law firm
accordingly.
This is precisely what the plaintiffs herein, as
partners in a law firm, did.
Mr. Peter C. G. Power, who had been the
managing partner of the law firm, at the relevant
times, testified at length and in detail concerning
the reasons which prompted the decision of the
law firm to farm out its managerial and adminis
trative functions to a corporation to be created.
Because of his assumption of the duties of
managing partner he had attended courses and
read many articles on office management of
legal firms. He was aware of the increasing
adoption by many professional firms of the
device of having non-professional functions
done by a management corporation and of the
advantages resulting therefrom. I shall summa
rize at a later stage his exposition of the advan
tages which were peculiarly applicable to the
law firm of which he was a member.
After discussion with the law firm's chartered
accountants and following a probationary period
during which more duties had been assigned to
the office manager of the law firm, who had
agreed to become general manager of the corpo
ration when incorporated, a company was incor
porated under the name of Irish Management
Ltd. on May 8, 1967 with the object of taking
over the physical assets of the law firm and to
carry on the business of office manager together
with many other objects such as dealing in
office furniture and equipment.
The shareholders, in equal holdings, were
Jean Holmes, 'Florence Crowe, Donagh Power
and Shirley Johnston who were the wives of the
partners in the law firm. Each wife, prior to
marriage, had business experience and training.
While the wives shared equally in the Com
pany, the members in the law firm were not
equal partners. Later when a junior unmarried
partner was admitted to the law firm he was
offered the privilege of becoming a shareholder
in the Company if he so desired. Being unmar
ried he personally exercised that option and
became an equal shareholder, but that propor
tion did not apply to his membership in the law
firm.
Upon the incorporation of the Company all
office furniture and equipment owned by the
law firm was sold to the Company at the
depreciated value so that there was no recovery
of capital cost allowance.
The furniture and equipment consisting of
some 215 pieces was then leased back to the
law firm at 2.5% of its cost to the Company, a
figure suggested by the law firm's accountants.
The financing of the purchase of this furni
ture and equipment was by means of bank loans
to the wives without guarantee by their
husbands.
The lease of the premises was entered into
between the landlord and the Company. The
landlord was reluctant to enter a lease with the
Company rather than the law firm but Mr.
Power persuaded the agent of the landlord of
the financial responsibility of the Company. In
effect he negotiated the lease on behalf of the
Company. The law firm then sublet from the
Company.
The law firm and the Company entered into a
management agreement dated May 1, 1967
whereby the Company undertook to supply the
following services to the law firm:
1. the employment of any and all secretarial
and clerical staff;
2. the employment of all maintenance staff;
3. the leasing of all office equipment, furni
ture and fixtures;
4. the purchase of all stationery and legal
forms;
5. the purchase of all periodicals and profes
sional literature;
6. the purchase of all text books and refer
ence materials;
7. the leasing of office space;
8. the management of all secretarial and cleri
cal staff;
9. the management of all maintenance staff;
10. the appointment of any and all auditing
and accounting staff and
11. such other duties as might be agreed upon
by the parties.
In consideration of the performance of those
services the law firm agreed to pay 15% of the
amount paid by the Company on behalf of the
law firm.
These amounts were paid by the law firm to
the Company at the beginning of each month at
the outset because the Company had not built
up the financial resources to discharge those
obligations but had to rely upon the receipt of
advance payment from the law firm.
The percentage of 15% as compensation for
the profit to the Company on the services sup
plied was adopted by the parties on the recom
mendation of the law firm's chartered
accountants.
The evidence was to the effect that this per
centage rate was the prevalent rate in manage
ment contracts of this nature.
The result of this arrangement was that the
law firm paid one monthly lump sum to the
Company for the administrative services per
formed by the Company which would have been
ordinarily performed by the law firm itself and
the income of the law firm distributable among
the partners was reduced by the profit margin of
15% paid to the Company. In effect the income
of the partners was reduced by 15% of all
non-professional services. This 15% payment is
income in the hands of the Company.
In paragraph 2 of the declaration under the
heading "Reasons in Support of Appeal" it is
alleged that
2. The Minister has taxed the Company on the full amount
of its income for 1968 and 1969. It is therefore inconsistent
for the Minister, at the same time, to disallow the fees paid
as an expense to the taxpayer and add the same amount to
his taxable income. This results in double taxation.
The Minister had denied generally all allega
tions in that part of the declaration entitled,
"Reasons in Support of Appeal".
Because an amount may be income in the
hands of a recipient it does not follow necessari
ly that the amount is a deductible expense to the
payor and in any event the assessment of the
Company is not before me so that I am not
obliged to decide if the 15% profit margin paid
by the law firm to the Company is income in its
hands. The issue that is before me is whether
the payment so made is an expense which may
be deducted in computing the income of the
partners in the law firm.
Mr. Power testified that the decision to
entrust the performance of the administrative
function of the law office to a corporation was
reached after long and careful consideration.
Mr. Power, as managing partner, spent from
one to two hours each day on administrative
duties for which no charge could be made. He
felt that his time would be better devoted to
legal problems for which charges could be
made.
He pointed out that the firm was engaged in a
general legal practice at Red Deer, Alberta
which had a population of 25,000 but served an
area in central Alberta which had a population
of 100,000. As a result the firm had many
clients which increased the administrative work.
The expedient was first adopted of assigning
more administrative responsibility to Mrs. Rob-
inson, who had been the bookkeeper for many
years. She was promoted to the position of
office manager.
However it was found that this expedient did
not solve the problem. The staff still looked to
the managing partner as the final arbitrator on
all matters. Salesmen of all merchandise needed
by a law office insisted upon seeing the manag
ing partner rather than Mrs. Robinson to whom
they had been referred.
Also, being in a smaller community, the law
firm was frequently obliged to provide gratui
tous secretarial and other services to many com
munity enterprises and political campaigns.
It was the considered opinion of the partners
that there must be a clean break with the past
and that in the future all such requests and
consultations should be with a corporation. As
Mr. Power put it, there must be a new image.
The firm had occupied premises which they
had outgrown and the lease for which was about
to expire. The firm contemplated moving into
more commodious and modern office space in a
building under construction. The partners, who
were about the same age, were most anxious to
avoid personal liability under the new lease, to
facilitate changes in the composition of the firm.
If a partner wished to leave the firm, difficulties
were experienced in relieving that partner from
his liability under the personal covenant of a
lease. Further in their older premises there was
a defect in the heating and air conditioning
equipment which resulted in many members of
the staff suffering from carbon monoxide poi
soning. This gave rise to a question of legal
liability.
Upon the incorporation of the management
company the lease for the new premises was
between the landlord and the Company. The
partners in the law firm were not personally
liable under a covenant.
The Company assumed the responsibility for
and made leasehold improvements for which it
was eventually reimbursed by the law firm.
All office furniture and equipment, including
the legal library, which had been owned by the
law firm was sold to the Company. There had
been instances where a barrister and solicitor
who had been employed by the firm on a salary
was to be admitted to the firm as a partner. The
many assets owned by the firm resulted in the
prospective partner, who was usually young and
on the threshold of his legal career, being faced
with a substantial cash outlay for his propor
tionate share of those assets which was a hard
ship upon him. The sale of the assets to the
Company did away with the necessity of a pros
pective partner being obliged to purchase a
share of the firm's physical assets.
The office staff employed by the law firm
became the employees of the Company on its
incorporation. The Company was responsible
for their salaries, and it hired and fired the staff.
The Company was also responsible for the
library and office furniture so that all negotia
tions with respect to those items were conduct
ed with the General Manager of the Company.
From the outset it was a key to the whole
arrangement that Mrs. Robinson, in whom the
partners had the utmost confidence, should
become the General Manager of the Company,
which she did. Her functions underwent no
change from when she was office manager of
the legal firm, but she continued to perform
those functions in her new capacity.
At the beginning it was anticipated that man
agement services might be performed by the
Company for clients other than the law firm. It
was understood however that such management
service would not be contracted for with any
other law firm. The directors of the Company,
the wives of the law partners, wrote to all
persons in the City of Red Deer offering the
secretarial and typing services of the Company.
The persons selected to be advised of those
services were persons considered likely to have
a need for them. Advertisements were also
placed in the local newspaper.
These services for persons other than the
legal firm would be done by secretarial staff
who were "floaters" and not continually
engaged in work for the law firm. The revenue
of the Company from this source was minimal.
This was due to the fact that there was no
demand for such services in the community.
The objects of the Company also authorized
it to deal in office furniture. The office furniture
of the law firm, when replaced, was sold by the
Company but very minimal revenue resulted
from this activity.
To all intent the services performed by the
Company were exclusive to the law firm.
Care was taken to ensure that all persons who
had occasion to deal with the law firm in con
nection with its administrative activities were
informed that henceforth all such activities
would be performed by the Company.
However Mrs. Robinson continued to have
her office in the premises of the law firm for
which no rent was paid by the Company. The
name of the Company appeared on the directory
at the main entrance to the building but not on
the door of Mrs. Robinson's office. The Com
pany was listed in the telephone directory and
had its own letterhéad and stationery.
The law firm did exercise control over the
expenses incurred by the Company on its
behalf.
Mr. Power, in addition to being aware of the
advantages in having the administrative func
tions of the law firm done by the Company, to
which he referred in his testimony, was also
aware that there might be certain tax savings.
That tax advantage, as I have mentioned above,
would be that the income of the law firm would
be 15% less, the profit margin payable to the
Company, and would be taxable in the hands of
the Company. To determine if such a tax advan
tage resulted would necessitate a comparison of
an application of the personal tax rates and the
corporate tax rates applicable to the amounts in
the hands of the law partners and the Company.
But over the possible tax saving, which Mr.
Power admitted was a factor along with the
other factors he mentioned in the decision to
place the administrative functions of the law
firm in the Company, I have no doubt that he
and his partners also had in mind the benefit
which would accrue to their wives as sharehold
ers in the Company. In fact dividends were
paid.
Against this background of facts the first con
tention on behalf of the Minister was that the
15% management fee based on the "direct over
head levy" was not deductible in computing the
plaintiffs' income because it was not an expense
incurred for the purpose of earning income.
The well established test in this connection is:
was the expenditure laid out as part of the
process of profit earning?
It is not disputed that the expenses incurred
by the law firm were properly deductible as
made for the purpose of earning income. Those
expenses were for secretarial services, tele
phone rental, janitorial services, city business
tax, utilities, stationery, law books and periodi
cals, office rent and rent for office furniture and
equipment. Those accounts were paid by the
Company for which the law firm reimbursed the
Company.
The position taken by the Minister was that
these expenses would have been incurred in any
event and would have been paid by the law firm
as had been the case prior to the interposition of
the Company. That being so the Minister con
tended that the payment to the Company of a
15% management fee for doing this on behalf of
the law firm was an amount which need not
have been incurred by the law firm.
I am unable to accept the contention thus put
forward. It seems to me that if the expenses
incurred for the services in question are deduct
ible there should be no impediment to the law
firm paying the Company a fee to arrange for,
supply and pay for those services, and that Mr.
Power outlined sound business reasons for
doing so and the law firm, in conducting its
business as it did, conformed to accepted princi
ples of commercial trading and did so in accord
ance with good business practice.
At one stage in the evidence of Mr. Power it
was established that his income showed a
marked increase after the law firm entered into
the management contract with the Company. I
interpreted that evidence as seeking to show
that Mr. Power enjoyed a greater income after
the management contract than before and that
such increase was attributable to that contract.
In my view the evidence did not show that the
increase in Mr. Power's income was attributable
to the law firm entering into the management
contract. It is true that Mr. Power was relieved
of the burden of the tedious chores of the
managing partner. That took one to two hours
of his time each day. He was then free to devote
that time to his professional work. However the
return from professional work depends on the
number of clients who consult the solicitor and
not the time that the solicitor has available to
consult clients. It is more logical to assume that
the increase in Mr. Power's income was attribut
able to an increase in the number of his clients
rather than the time available to him. I might
also mention that Mr. Power had suffered a
protracted illness in the previous year.
The other partners did not enjoy an increase
in income similar to that of Mr. Power. Their
income remained constant.
However the failure to show an increase in
income from an expenditure has no bearing on
the matter. It is not a condition of the deducti-
bility of an expenditure that it should result in
any particular income or that any income should
be traceable to the expenditure and it is not
necessary to show a causal connection between
an expenditure and a receipt. An expenditure
may be deductible even though it is not produc
tive of any profit.
In my view the 15% management fee was an
expense incurred for the purpose of earning
income and it was a reasonable amount to be
paid for the benefits which enured to the law
firm. The partners were relieved of personal
liability under the lease with the landlord. That
liability was assumed by the Company. The
partners were relieved of furnishing gratuitous
services to suppliants therefor no matter how
good the cause. Partners could withdraw or
enter the law firm with greater ease and at less
expense. The assumption of the responsibility
for hiring staff, keeping the accounts and col
lecting them resulted in a more efficient
operation.
I am confirmed in this conclusion by the
remarks of Ritchie D.J. in Shulman v. M.N.R.'
when he said at page 421:
Because the management fee was paid to a corporation of
which the appellant and his wife are the only shareholders
and, so far as the record discloses, the management agree
ment was negotiated between the appellant in his personal
capacity and the appellant in his capacity as the agent of
Shultup does not, per se, preclude the management fee from
being a legitimate operating expense of the law practice.
Later on pages 421 and 422 he said:
A solicitor is not precluded from entering into a contract
with a corporation to perform the non-professional duties
relating to the management of his law office which he, if so
minded, could perform himself. Unless I find fraud or
improper conduct, I cannot disregard the separate legal
existence of Shultup and hold the fee payable under the
' [1961] Ex.C.R. 410.
management agreement is not a legitimate operating expense
solely because the appellant and his wife are the only
shareholders of Shultup and because the appellant, as a
lawyer, negotiated with himself, as the president of the
company. If the re-assessment is to stand, justification for
deduction of the $9,500 fee being brought within either or
both of the sections of the Act upon which the Minister
relies must be found in the procedure by which the terms of
the agreement were implemented and the results flowing
therefrom.
Still later he said at pages 423 and 424:
In view of the uncontradicted evidence of Mr. Shulman, I
am not prepared to find the provisions of section 12(1)(a)
demand the dismissal of the appeal. According to Mr. Shul-
man's testimony the duties he performed as the agent of
Shultup had a direct relation to increasing the income of the
office and his own professional income. In such circum
stances I am unable to find payment of the management fee,
standing by itself, was not an outlay or expense that can be
justified on the ground of having been made in accordance
with the ordinary principles of commercial trading or
accepted business practice.
I have quoted the foregoing remarks of Mr.
Justice Ritchie to emphasize his conclusion that
the payment of a management fee was an
expense incurred for the purpose of gaining or
producing income from the business of a tax
payer and accordingly is not prohibited as a
deduction in computing income by virtue of
section 12(1)(a).
Mr. Justice Ritchie did hold that, in the cir
cumstances of the Shulman (supra) case, the
management agreement with the corporation
and the way the transactions were carried out
unduly or artificially reduced the income of the
appellant and the fee paid to the corporation
was not deductible by virtue of section 137(1).
In Grotell v. M.N.R. 2 the taxpayer was a
medical doctor who carried on his practice in
partnership with three other doctors. The doc
tors formed a management corporation to
supply non-medical services to the partnership.
The shares in the management corporation were
owned by the wives of the three doctors and by
2 72 DTC 6409.
two of the doctors. The doctors provided most
of the non-professional services on behalf of the
management corporation to the medical partner
ship for which they received a salary of $40 per
month from the management corporation. Noth
ing was changed with respect to the non-profes
sional services rendered by the doctors, the
employees were the same performing the same
services, albeit more efficiently. The medical
partnership paid to the management corporation
a total of $13,000 which was claimed as a
business expense. The Minister disallowed
$4,700 of that amount which was paid as a
management fee. The balance was reimburse
ment of expenses of the medical partnership
paid on its behalf by the management
corporation.
My brother Gibson held that all of the
$13,000 (which included the management fee)
paid to the management corporation was prop
erly deductible by the partnership. He found
that the contracts between the medical partner
ship and the management corporation were
bona fide business transactions. He consequent
ly held (1) the management fee (together with
the other expenses) was an outlay or expense
made or incurred by the appellant for the pur
pose of gaining or producing income from the
medical practice of the appellant within the
meaning of section 12(1)(a) of the Act and also
(2) that the payment of the management fee and
other expenses was not a disbursement or
expense made or incurred in respect of a trans
action or operation that, if allowed, would
unduly or artificially reduce the income.
The conclusion reached by Mr. Justice
Gibson that the management fee was not pre
cluded by section 12(lxa) as a deduction in
computing income coincides with the conclusion
I have reached in the present appeal. I am
unable to find any material difference in the
facts in the appeal before Mr. Justice Gibson
and those in the appeals before me. If anything
the facts before me are more favourable to the
plaintiffs herein, because they did not partici
pate in the work of the management Company
or as shareholders. A solicitor who later became
a partner in the law firm became a shareholder
in the management Company but he is not a
plaintiff in these appeals.
I therefore turn to the second contention by
the Minister that the transaction here in ques
tion would unduly or artificially reduce the
income and the deduction of the management
fee in computing income is, therefore, prohib
ited by section 137(1).
Counsel for the Minister did not contend that
the management Company was a sham nor did
he dispute that the payments made by the law
firm to it were properly made pursuant to a legal
contract. What he does contend is that the man
agement fee is not deductible by reason of sec
tion 137(1).
As I understood the basis of that contention it
was that the services performed by the manage
ment Company for the law firm were services
that could have been performed by the law
partners themselves and had in fact been per
formed by them or their own employees previ
ously at a cost to them lower than the cost for
the services provided by the Company by the
amount of the 15% management fee and for
that reason the income of the partners was
unduly or artificially reduced by that amount.
There was evidence adduced that a manage
ment fee of 15% of the disbursements made on
behalf of a customer is the normal and going
rate for services of this kind. For that reason
the payment of a management fee in that
amount would not unduly reduce the income of
the payor if the expense was incurred for legiti
mate business reasons.
In my view the propriety of the deduction of
the management fee falls to be decided upon a
determination of the question whether genuine
business reasons existed for payment of the
management fee under this contract.
In concluding that the payment of the fee was
an expense incurred for the purpose of gaining
or producing income from the plaintiffs' busi
ness, I found that true business motivation
existed with consequent business advantages.
That being the case it follows that payment of
a management fee is a legitimate expense com
mensurate with the commercial and business
advantages which flowed from the performance
of those services and that the payment of the
management fee did not result in an artificial
reduction of the plaintiffs' income.
For the reasons I have given I find that the
plaintiffs, in computing their incomes for their
1968 and 1969 taxation years, are entitled to
deduct their proportionate shares of the sums of
$9,684.82 and $10,439.74 being the amount of
the management fees paid by the partnership in
the respective taxation years and the assess
ments must be revised accordingly.
The appeals herein are, therefore, allowed
and the assessments are referred back to the
Minister for the necessary revision. The plain
tiffs are entitled to their taxable costs. Because
the appeals were heard on common evidence
there shall be but one counsel fee.
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.