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  • Kelly Ehler, CPA, CA, LPA, TEP

Reasonableness - how has it been interpreted?

In the 18.7.2017 draft legislation one term or concept that has been questioned and analyzed by the tax profession with respect to the draft legislation is "reasonableness". This concept of reasonableness has been raised on several issues by the tax community. In particular the draft legislation relative to “income sprinkling” would be subject to "reasonableness testing". As a reminder, in broad general terms, income sprinkling relates to a business or trust paying dividends or salaries to family members who may or may not be active in the business. The reasonableness test will also apply to the capital gains allocations in certain scenarios.

Reasonableness is subjective and requires judgement. There is considerable debate on this terminology and rightly so. How does one define it? There are many scenarios which result in this debate. Take salaries as an example. Is what’s reasonable in expensive cities like Toronto and Vancouver the same as small town Canada? As I’ve heard in so many courses, the phrase "it depends" comes up a lot!

I receive a lot of tax news releases and do my best to keep up with what’s going on in the tax world. Just recently I came across a court case, Peach v The Queen. The case dealt with "reasonableness of business expenses". It made reference to section 67 of the income tax act that requires an expense to be reasonable. That’s fine, but doesn’t answer much. A couple points made were that S. 67 is a mechanism to reduce or eliminate an expense but not to second guess business decision making. This was affirmed in a Supreme Court Ruling in Stewart v. The Queen, 2002.

So having read the above, I dug a little deeper. Unfortunately, there was not a specific answer. I found references to court cases such as Moloney v. the Queen concluding there is no mathematical or scientific formula to answer the question. In Safety Boss Ltd v. the Queen the judge stated it required judgement and common sense of an objective and knowledgeable observer. In tax ruling 9520875 one of the lines states “There is no standard or gauge to determine reasonableness and thus the courts may freely determine what is reasonable in any assessment that is appealed. Clearly what is reasonable in any situation can only be determined on a case by case basis.”

So what does it mean? First you determine whether the expenditure, at any level, is a business expense. Then it’s a judgment call as to what’s reasonable. Unfortunately, from what I see the scope for what is reasonable is going to be very widely interpreted according to one’s objectives. Thus what will be reasonable to the Canada Revenue Agency will likely be at odds to what the business owner considers reasonable. No doubt, this will become a source for numerous tax rulings, interpretations and court cases down the road.

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