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Citation: 2003TCC347
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Date: 20030520
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Docket: 2002-248(IT)G
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BETWEEN:
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KELOWNA FLIGHTCRAFT AIR CHARTER LTD.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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____________________________________________________________________
REASONS FOR JUDGMENT
Beaubier, J.T.C.C.
[1] This appeal pursuant to the
General Procedure was heard at Kelowna, British Columbia, on May
5, 2003. Barrie Lapointe, President and Chief Operating Officer
of the Appellant at all material times was the only witness.
[2] The parties filed an Agreed
Statement of Facts, as Exhibit AR-1, which reads:
AGREED STATEMENT OF FACTS (PARTIAL)
The Parties hereto, by their respective counsel, agree that
the following are, for the purposes of this appeal only, facts
upon which the Court can base its decision. The Parties shall be
free to introduce additional facts in evidence at trial provided
that those facts sought to be introduced in evidence at trial do
not contradict in any way the truth of the facts agreed to
herein.
A.
MATERIAL FACTS RELIED ON
Per Diem Allowance
1. The
Appellant is a "taxable Canadian corporation" within
the meaning of the Income Tax Act, R.S.A. 1985, c. 1 (5th
Supp.), as amended (the "Act").
2. The fiscal
year end of the Appellant is December 31 in each year.
3. The
Appellant carries on an aircraft charter business (the
"Business") in Canada from its head office at the
Kelowna Airport in British Columbia.
4. During the
relevant time period, the Appellant owned a Boeing 727 aircraft
(the "Aircraft") and operated an air charter business
providing daily cargo service for Purolator Courier Ltd.
("Purolator") across Canada, daily charter services and
west coast fishing charters.
5. During the
relevant period, the Appellant chartered Aircraft to Greyhound
Canada Transportation Corporation ("Greyhound").
6. In addition
to the Aircraft themselves, the Appellant provided the pilots and
flight attendants (collectively the "Flight Crew") who
operate the Aircraft chartered to the Appellant's
customers.
7. The Flight
Crew were entitled to and were paid a per diem allowance
(the "Per Diem") to compensate them for meal and
incidental expenses which they incurred in the performance of
their duties away from their home base location.
8. The amount
of the Per Diem was reasonable in the circumstances and was
calculated based on the number of hours an employee spent away
from his or her home base location as follows:
Hours
Away
Per Diem
0 -
4
0
4 -
8
$11
8 -
12
$21
12 -
24
$42
9. The Per
Diem was the same regardless of whether travel occurred over the
breakfast, lunch or supper periods.
10. The meal portion of
the Per Diem amounts paid in each year by the Appellant was as
follows:
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1996
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1997
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1998
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Total Per Diem Paid
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$664,654
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$853,669
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$626,000
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Meal Portion @ 81%
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$538,370
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$691,472
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$507,060
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11. Other employees of the
Appellant working at their home base location did not receive the
Per Diem nor have their meals paid for by the Appellant.
Quiet Wing System
12. In 1990, the United
States Congress passed the Aviation Noise Capacity Act of
1990 which required all commercial jet aircraft weighing over
75,000 pounds operating in the United States to meet noise
reduction requirements by December 31, 1999 (the "Stage 3
Regulations").
13. The Stage 3
Regulations were administered in the United States by the Federal
Aviation Authority ("FAA").
14. The Stage 3
Regulations were adopted in Canada and enforced by Transport
Canada.
15. The Appellant's
727 aircraft were jet aircraft weighing over 75,000 pounds.
16. In 1997 and 1998, the
Appellant purchased and installed the Quiet Wing System
("QWS") built by Dugan Air Technologies Inc. (now Quiet
Wing Systems Inc.) ("Dugan") on three of its
aircraft.
17. The primary purpose of
QWS is to enable the aircraft to meet the noise standards
mandated by the FAA and Transport Canada at airports in North
America.
18. The cost of purchasing
and installing the QWS varied between each aircraft as
follows:
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Aircraft
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C-GKFN
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Total
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C-GKFC
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Total
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C-GKFT
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Total
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1997
Mixer purchase
Deposit on winglets
Final on winglets
Subtotal
Exch @ 1.37
CAD Total
1998
Misc parts
Deposit on winglets
Misc parts
Subtotal
Deposit on winglets
Instalment on kit
Subtotal
Exch @ 1.40
CAD Total
Labour*
Total
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155,294
200,000
395,000
750,294
277,609
63,690
25,476
45,000
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1,027,903
89,166
________
1,162,069
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50,000
439,940
75,500
565,440
226,176
45,000
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791,616
_________
836,616
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38,690
50,000
100,000
188,690
75,476
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264,166
___________
264,166
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* estimate of labour cost made by CCRA auditor.
19. The component parts of
the QWS are affixed to the aircraft and have no function
independent of the aircraft on which they are installed. Once
installed, the QWS forms an integral part of the aircraft.
20. The Appellant
purchased and installed the QWS on its aircraft to meet the Stage
3 Regulations in Canada and the U.S.
21. The aircraft on which
the QWS were installed could not have operated in Canada or the
United States in compliance with the Stage 3 Regulations without
the QWS or some similar noise abatement system.
22. In filing its return
of income for each of its 1996, 1997 and 1998 taxation years, the
Appellant deducted the full amount of the Per Diem and deducted
the cost of the QWS as a current expense in calculating its
income both for accounting and for tax purposes.
23. By Notices of
Reassessment dated June 7, 2000 for each of its 1996, 1997 and
1998 taxation years (the "Reassessments"), the
Minister of National Revenue ("Minister") reassessed
the Appellant by:
(a) attributing 81%
of the Per Diem to the consumption of food or beverages and
reducing the amount deductible in respect of that 81% portion of
the Per Diem paid to the Flight Crew by 50% thereby disallowing
the following deductions:
1996
$269,185
1997
$345,736
1998
$253,530; and
(b) treating the
costs of the QWS as a capital expenditure by adding them to its
Class 9 assets and denying them as a current expense as
follows;
1997
$1,072,903
1998
$1,189,948; and
(c) increasing the
Appellant's capital cost allowance deduction in respect of
its Class 9 assets.
24. The Appellant filed a
Notice of Objection to each of the Reassessments in prescribed
form and within the time prescribed by the Act.
25. By Notice of
Confirmation dated October 23, 2001, the Minister confirmed the
Reassessments.
[3] In addition, the issues described
by both parties are summarized in Section D of the Notice of
Appeal which reads:
D. ISSUES
TO BE DECIDED
There are two issues to be decided in this appeal. They
are:
I. Per Diem
Allowance
Is the deduction by the Appellant of the full amount of the
Per Diem limited by any provision of the Act, and in particular,
section 67.1?
II. Quiet
Wing System
Are the costs of installing the QWS a current expense
deductible in calculating income in the year incurred or are they
expenditures incurred on capital account to be added to a class
of depreciable assets of the Appellant.
[4] Paragraph 10 of the Reply to the
Notice of Appeal reads:
10. In so reassessing the
Appellant for the 1996, 1997, 1998 Taxation Years, the Minister
relied on, inter alia, the following assumptions of
fact:
a) the
Appellant operates an air charter business, providing daily cargo
service for Purolator Courier Ltd. across Canada, local charter
services and west coast fishing charters. In 1996 and 1997, the
Appellant provided aircraft, services and personnel to Greyhound
Air;
b) the
Appellant's head office is at the Kelowna Airport ("Home
Terminal") in British Columbia;
c) at the
material time, the majority of the Appellant's travelling
employees were pilots and flight attendants (the "Flight
Crews");
d) the work
location of the majority of the Flight Crews was the Home
Terminal;
e) the Flight
Crews were entitled to a per diem when travelling on business
(the "Per Diem");
f) the
typical trip for a member of a Flight Crew was four days
long;
g) the Per
Diem was calculated based on the number of hours an employee
spent away from his or her permanent place of residence;
Hours
away
Per diem
0 - 4
0
4 -
8
$11
8 -
12
$21
12 -
24
$42
h) the Per
Diem was the same regardless of whether travel occurred over
breakfast, lunch or supper periods;
i) 81%
of the Per Diem was for meals;
j) 19%
of the Per Diem was for incidentals;
k) the meal
portion of the Per Diem amounts paid in each Taxation Year by the
Appellant was as follows:
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1996
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1997
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1998
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Total Per Diem amount paid
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$664,654
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$853,669
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$626,000
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Meal portion @ 81%
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$538,370
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$691,472
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$507,060
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l) other
employees of the Appellant working at the Home Terminal did not
receive Per Diems or have their meals paid for by the
Appellant;
m) the Appellant did
not identify the cost of meals in the invoices issued to its
customers;
n) the
Appellant billed its primary customer, Purolator, monthly, on the
basis of air miles flown;
o) a typical
monthly invoice set out number of miles flown, rate per mile and
the aggregate amount billed;
Quiet Wing System (QWS)
p) in 1997 and
1998, the Appellant installed QWS kits complete with winglets on
some of its Boeing 727 aircraft;
q) the primary
purpose of the QWS is to reduce the engine noise of aircraft to
meet lower noise standards mandated by regulation and required by
airports in North America;
r) QWS
installation uses new technology that improves and upgrades an
aircraft by changing its aerodynamic qualities to make it quieter
and increase fuel efficiency, range, payload capacity and
altitude;
s) the
installation of QWS is a substantial addition to an aircraft;
t) QWS
provides a benefit lasting more than one year;
u) QWS
installation is a one-time transaction that has a significant
cost relative to the cost of an aircraft;
v) QWS is a
one-time expenditure as opposed to a recurring expenditure for
replacement or renewal of a specific item;
w) QWS enhances the
performance and economically extends the useful life of an
aircraft by improving the aircraft to make it quieter and more
aerodynamic as opposed to merely restoring the aircraft to its
original condition;
x) QWS has a
long useful life relative to the entire aircraft and does not
require frequent replacement or repair due to wear or damage;
y) QWS has its
own operating certification from the FAA;
z) the QWS
installation does not constitute a repair;
aa) the QWS installation
does not constitute replacement of an existing component in the
aircraft;
bb) the QWS installation
does not restore aircraft to their original condition;
cc) Canadian aviation
regulations define "repairs", "major repairs"
and "major modifications";
dd) pursuant to the
Canadian aviation regulations, the QWS installation is a
"major modification";
ee) the Appellant
purchased the QWS with the intention of earning income for many
years.
[5] Assumptions 10 a), b), c), d), e),
f), g), h), j), k), l), m), n), o), p), q), w), cc), dd) and ee)
were not refuted by the evidence.
[6] In the portion that follows, these
reasons will deal with the issues in the order in which the
parties have set them out - first, the per diem
("Per Diem") and second, the Quiet Wing System
(the "QWS").
[7] The Per Diem question turns on
subsection 67.1(1) and paragraphs 67.1(2)(c) and
(e) of the Income Tax Act (the
"Act") as they read for the 1996, 1997 and 1998
years. They read:
67.1(1) Expenses for food, etc. - For the
purposes of this Act, other than sections 62, 63 and 118.2 an
amount paid or payable in respect of the human consumption of
food or beverages or the enjoyment of entertainment shall be
deemed to be 50% of the lesser of
(a) the amount
actually paid or payable in respect thereof, and
(b) an amount in
respect thereof that would be reasonable in the
circumstances.
(2) Exceptions - Subsection (1) does not apply to
an amount paid or payable by a person in respect of the
consumption of food or beverages or the enjoyment of
entertainment where the amount ...
(c) is an amount for
which the person is compensated and the amount of the
compensation is reasonable and specifically identified in writing
to the person paying the compensation;
...
(e) is incurred by
the person for food, beverages or entertainment generally
available to all individuals employed by the person at a
particular place of business of the person and consumed or
enjoyed by such individuals.
[8] This case falls into the
exceptions in both paragraphs (c) and (e)
because:
(c) The amounts of compensation were
reasonable. They were paid to the flight crew while travelling
away from their home base pursuant to arm's length contracts
negotiated with the employees who received payment and pursuant
to arm's length contracts with Purolator Courier Ltd.
("Purolator") and Greyhound Canada Transportation
Corporation ("Greyhound"), both of which reimbursed the
Appellant for the amounts paid to the employees under contract to
do so. In circumstances where the Appellant has such contracts on
both sides, it ill behooves a Court to find it other than
reasonable. The Respondent agreed that there was no entertainment
factor in the amounts. The Appellant paid the employees (who
totalled a few hundred) and then billed Purolator and Greyhound
for the lump sum paid out at the end of each calendar month in
gross bills with accompanying accounts of "food" et
cetera. The Respondent's position is that this does not
specifically, identify in writing to Purolator or Greyhound the
amount for which it is to be compensated. The billing states what
it is for, the time period it is for, and the amount due pursuant
to the contract. That constitutes specific identification in
writing. The ultimate proof of that is that the bills were paid
by Purolator and by Greyhound.
(e) Similarly, these
expenditures were for food and beverages for employed flight
crews away from home base, but in the Appellant's aircraft
which was the Appellant's place of business. In this mobile
day and age, particularly in the transport business, one does not
expect that the old-fashioned cook house or construction camp or
a similar permanent establishment constitutes the only
"place of business" as that is meant in the modern
Act. A place of business is a place where the Appellant
earns income or expects to earn income. These aircraft and crews
were earners; they were not pushing paper in some secondary or
tertiary way back in an office to produce income for the
Appellant. Rather, they were pushing the product itself - the
aircraft that did the transporting, that earned the income, that
produced the profit. The flight crew themselves had no other
premises that they were to be at than the Appellant's
aircraft at the points where the amounts in question were
incurred by them.
[9] Therefore, the Appellant is
allowed to deduct as an expense the full amounts in respect of
Per Diems which it claimed. They were specifically excepted from
any limitation by the provision of paragraphs 67.1(2)(c)
and (e) and this matter is referred to the Minister of
National Revenue (the "Minister") for reconsideration
and reassessment accordingly.
[10] The second issue is whether installing
the QWS is a current expense deductible in calculating income in
the year incurred.
[11] This system consists of three
components:
1. The Mixer - This
is simply a titanium ring, or pipe, bolted into the tail pipe of
the central (#2) engine of a Boeing 727. Due to the tremendous
heat at this point, it has had to be replaced from time to time.
It mixes some cool air with the hot exhaust air and further
focuses the exhaust so as to burn hydrocarbons and so as to
restrict the breadth of the "footprint" of sound,
particularly during take off, landing and approach.
2. Winglets - These
consist of small new wing tips that were replaced on the outside
one-foot or so of each wing and which direct more air over the
wing surface so that, in essence, the air does not fall off the
end of the wing. They provide added lift to the wing and thereby
reduce drag. In at least one instance a winglet had to be
replaced when it was struck while one of these aircrafts was on
the ground.
3. Flaps - This was
a change of approximately 2 degrees to the flaps. The flap system
then allowed the aircraft to climb at a higher rate and a slower
speed. In this way it got out of the "footprint" faster
at lower engine RPMs.
[12] The sole purpose of the QWS and its
purchase and installation by the Appellant was to reduce the
aircrafts' noise level on take off, approach and landing. If
it had not been installed, the Appellant could not have flown
these aircraft to earn money. Pursuant to "Stage 3
Regulations" the Boeing 727's flown by the Appellant
under contracts were required to reduce their noise pollution on
take off, approach and landing over a designated
"footprint" by an accumulative 2 to 3%. This was
required to be done in stages, commencing with 25%, of the fleet
in the first stage. It is this 25% or three aircraft, which is
the issue in this case.
[13] The QWS was advertised as reducing fuel
consumption, increasing range and other reputed advantages in
relation to the use of the F17 engine. That is not the engine
that the Appellant had on its Boeing 727's. The Appellant,
which was not using its aircraft for long hauls, except between
Hamilton, Ontario and Winnipeg, Manitoba, did not experience any
of these advantages from the QWS except the required reduction in
noise. Moreover, its contracts with customers required the
customers to reimburse the Appellant for fuel consumed.
[14] The installation of the QWS system did
not change the value of the three aircraft on which it was
installed or alter their operating life. The system merely
allowed the aircraft to maintain their normal values and to
continue operating under the new noise regulations in the same
way as they had done in the past. They enabled the then current
operations of the aircraft on which they were installed to
continue. The expenditure was not a one-time occurrence since
some of the parts of the QWS have since had to be replaced and
the noise regulations in force to date, in Stages 1, 2 and 3,
have since been followed by the proposed Stage 4 which may make
the Stage 3 components completely obsolete (Stage 4, as it is now
enforced in Europe prevents any of the aircraft in question in
this case being flown in Europe because these Stage 3
installations are after-market equipment.) Based on the testimony
of Mr. Lapointe, the Court finds that the Stage 3 modifications
had no intrinsic value on the aircraft once they were installed.
However, the components can be dismantled from an aircraft and
installed on another aircraft. The Appellant has done this on an
aircraft which it sold for service in Africa. But in any event,
the installation of the Stage 3 components on an aircraft does
not have any permanent value beyond the life and value of the
aircraft itself. Each of these aircraft could have continued
operating just as well without the Stage 3 installation, but they
could not, at that time, have operated in Canada or the United
States. The actual productivity of the aircraft did not change.
The total amount of weight that Stage 3 added to each aircraft
amounted to 200 or 300 pounds total in addition, in the case of
the Model 100 aircraft, to a gross weight of 132,000 pounds and a
maximum take off weight of 169,500 pounds. (The Model 200 has
8,000 pounds more maximum weight, but the Stage 3 QWS for it
apparently weighs the same as that for the Model 100.)
[15] The relative dollar figures respecting
the aircraft in question are summarized in the following
table:
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GKFN
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GKFC
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GKFT
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1. Original cost of aircraft to Appellant
(second-hand)
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$3,480,000
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$3,926,000
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$3,900,000 (approx.)
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2. Approximate Net Book Value
December 31, 1996
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$3,000,000
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$3,000,000
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$2,800,000
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3. Cost of Stage 3 installation
(Agreed Facts)
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$1,162,069
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$836,616
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$264,166
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However, it appears from the Agreed Statement of Facts
(Exhibit AR-1), that these can be averaged among these three
aircraft, since the Appellant was the first to install the QWS in
the world. The average cost to install the QWS was $754,284 for
the three aircraft - about 25% of their net book values at the
time the QWS was installed as described in the Agreed Statement
of Facts.
[16] Finally, the QWS has no function at all
without the Boeing 727 aircraft. The Boeing 727 could, and does,
function without the QWS. After installation of the QWS the
entire structure and operability of each of these aircraft
continued, as before, as an operating aircraft with a slightly
reduced sound "foot print".
[17] In the foregoing circumstances, the
installation of the QWS constitutes an operating expense. (See
Canada Steamship Lines Limited v. Minister of National
Revenue, [1966] C.T.C. 255, Johns-Manville Canada Inc. v.
Her Majesty the Queen, [1985] 2 S.C.R. 46, and Canaport
Limited v. Her Majesty the Queen, [1993] 2 C.T.C.
2830.)
[18] The appeal is allowed in its entirety.
These matters are referred back to the Minister for
reconsideration and reassessment pursuant to these reasons.
[19] The Appellant is awarded party and
party costs.
Signed at Ottawa, Canada, this 20th day of May, 2003.
J.T.C.C.
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