Date: 01/19/2010

A Business Expense by Any Other Name...?

Providing gifts to clients or prospective clients, whether as a thank you for past business or as encouragement to use one's services in the future is an accepted, even a routine part of doing business. While the types of gifts offered are as varied as the recipients, tickets to sports events or other entertainment venues are frequently chosen. However, it may be necessary for businesses and self-employed taxpayers to re-think their gift-giving strategies from a tax perspective, in light of a decision of the Federal Court of Appeal ("FCA").

The case involved a self-employed real estate salesperson, who worked on commission. During the 2000, 2001 and 2002 taxation years, the salesperson bought gift certificates for food and beverages and tickets to various concerts and sporting events for clients who had purchased or sold homes through his business. The salesperson did not attend any of the entertainment events for which he provided the tickets, nor did he consume any of the food or beverages obtained through the gift certificates.

At tax time, the salesperson claimed a 100% deduction for the cost of all gifts provided to clients, including the gift certificates and the sports and entertainment tickets. However, on re-assessment, the Canada Revenue Agency reduced the deduction claimable by the salesperson to just 50% of the cost of the gifts which involved food and beverages or entertainment. The CRA's decision was challenged by the taxpayer, and the Tax Court of Canada agreed with the taxpayer that a full deduction was allowed. The Minister of National Revenue then appealed to the Federal Court of Appeal.

In reaching its decision, the FCA had to consider two provisions of the Income Tax Act. The first, section 18, provides that a taxpayer may deduct reasonable expenses made for the purpose of producing income from a business. The second, section 67.1, limits the quantum of section 18 deductions with respect to expenditures on food, beverages and entertainment expenses. Specifically, any deduction in respect of such expenses is limited to 50% of the actual cost. The Minister argued that section 67.1 applied to all expenditures on such items, and that the deduction was limited to 50% whether or not the taxpayer who incurred the cost actually used or enjoyed the related food, beverages or entertainment.

The taxpayer, for his part, argued that the purpose of section 67.1 was to limit the deduction to take account of the element of personal consumption. Where, as in this case, there was no such element of personal consumption, the taxpayer argued that the expense was a pure business expense which should be fully deductible under section 18. The taxpayer got a sympathetic hearing from the Court, but no more than that.

The Court agreed with the taxpayer that the purpose of the section 67.1 deduction limitation was to take account of the element of personal consumption and enjoyment. However, the wording of section 67.1 was clear -- deductions for expenditures "in respect of the human consumption of food or beverages or the enjoyment of entertainment" were limited to 50%. The Court was compelled, by the wording of section 67.1 to allow the appeal and affirm the Minister's decision to limit the taxpayer's deduction to 50% of his actual cost.

The Court then took the unusual step of indicating its disagreement with the result in the case, stating that "in its current form, section 67.1 interferes with taxpayers' business decisions and in particular, how they allocate their marketing budgets. It provides them with an incentive to forgo purchasing gifts of food and entertainment for the purpose of building and maintaining their client relationships."

It seems from this decision that where the purpose of a tax provision collides with its actual wording, it's the taxpayer who gets hurt. The only Court that can overturn a decision of the Federal Court of Appeal is the Supreme Court of Canada (assuming for the sake of argument that the SCC would disagree with the conclusions reached by the Federal Court in this case). Generally, appeals can be taken to the Supreme Court of Canada only with permission of the Court. It's unusual for such permission to be given in a tax case, and even rarer for an individual to pursue a tax appeal to that level.

As well, in this case, while the amounts at issue were undoubtedly significant to the taxpayer, the tax savings involved were not such as would justify the cost of a full appeal to the Supreme Court. It is likely that the result in this case will be changed for the future only by an amendment to the Act put forward by the Department of Finance. The Department has given no indication that such an amendment will be forthcoming in the near future.