Although many Canadians may disagree when reading various media reports or when filling out their own returns, the government and the Department of Finance generally consider our tax system to be reasonable. The term "reasonable" shows up with surprising frequency in our tax legislation and jurisprudence.
Is That Deduction Reasonable?
The Income Tax Act (ITA) limits deductions to amounts which are reasonable in the circumstances (ITA Section 67). This concept is often expressed in conjunction with other requirements, such as whether an expense was incurred to earn income, or whether it was personal in nature. However, this is an independent test, not of the nature of an expense, but of its magnitude.
As a simple example, it seems that any business must maintain and clean its premises. Therefore, engaging an individual to, say, sweep and mop the floor on a weekly basis seems to be a legitimate expense, incurred to earn income. The business owner might well hire his or her child to perform this service without jeopardizing the deductibility of the expense. However, the business owner should anticipate a challenge if the compensation for two hours a week of cleaning services is set at a $150,000 annual salary. This seems an amount in excess of what is reasonable. In applying this restriction, many court decisions cite the following statement, from a 1968 decision (Gabco Limited v. Minister of National Revenue (MNR), 68 DTC 5210):
It is not a question of the Minister or his Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind. Many cases deal with the reasonableness of amounts paid on a non-arm's length basis, such as payments to family members, or between related parties. For example, one Federal Court of Appeal decision (Les Produits pour Toitures Fransyl Inc. v. Her Majesty the Queen (HMQ), 2006 FCA 112, upheld a lower court conclusion "that no reasonable business person would have made these payments, which were almost three times the normal rental payments that could be obtained for the properties under ordinary circumstances".
However, these questions do not always deal with related parties. In one case (William Hammill v. HMQ, 2004 TCC 595), the court denied expenses paid to an unrelated third party on the...