The reasonableness of reasonable

March 9, 2023 | Raymond G. Adlington

The word “reasonable” has been part of Canadian tax lexicon for over a century.  The 1917 Income War Tax Act allowed at para. 3(1)(a) a deduction in the computation of income for “such reasonable allowance as may be allowed by the Minister for depreciation, or for any expenditure of a capital nature for renewals, or for the development of a business …”.  Interestingly, ss.  3(4) of the Income War Tax Act provided that, for the purpose of the supertax only,[1] the income of a taxpayer included undivided or undistributed gains and profits of an entity in which the taxpayer held an interest to the extent that such gains and profits were not “in excess of what is reasonably required for the purposes of the business.”

A word search of the February, 2023, version of the Income Tax Act (Canada) reveals that the word “reasonable” and its derivatives appear 1,291 times.  The Income Tax Regulations add 496 to the tally and the Income Tax Application Rules a further 19.  The starring role for reasonableness has historically been the limitation found in s. 67 of the Income Tax Act (Canada) (further statutory references are to the Income Tax Act (Canada)) that in the computation of income, no deduction may be made “except to the extent that the outlay or expense was reasonable in the circumstances.”  Strong supporting roles are played by the para. 20(1)(c) interest deduction that permits the deduction of the lesser of the actual interest or ”a reasonable amount in respect thereof” and the ss. 247(2) transfer pricing test of if a transaction with a related non-resident can “reasonably” be considered to have been entered for bona fide purposes other than obtaining a tax benefit.

Reasonableness is found in the eye of the beholder.  “Reasonable” is not a defined term in any of our taxing legislation, so we must examine the judicial eye in our noble attempt to seek certainty for Canadian taxpayers.  The primary question is whether reasonableness is measured on an objective or subjective standard.  The answers provided – reasonably cohesive.  In a leading interpretation of the predecessor to current s. 67, the Exchequer Court stated in Gabco Ltd., 1968 CanLII 1268:

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.

Subsequently, the Federal Court of Appeal stated at para. 28 of their decision in Mohammad v.  Canada, 1997 CanLII 6356, that:

When evaluating the reasonableness of an expense, one is measuring its reasonableness in terms of its magnitude or quantum.  Although such a determination may involve an element of subjective appreciation on the part of the trier of fact, there should always be a search for an objective component.

Continuing along the judicial path searching for an answer to the question of the standard to be applied to reasonableness, we encounter the Federal Court of Appeal again where they stated in Petro-Canada v. Her Majesty the Queen, 2004 FCA 158 at para.  64:

Reasonableness, like value, is a question of fact.  In this case, it is a fact upon which the Judge made no finding.  While it may be true, as suggested in Mohammad, that paying fair market value for something is prima facie reasonable, I am unable to agree with the Crown that it necessarily follows that paying more than fair market value is unreasonable.  There may be circumstances in which a decision to pay more than fair market value for something is a reasonable decision.

The Federal Court of Appeal had the opportunity to consider the reasonableness test in the context of a challenge under s. 68 to a price allocation.  The Court held in Transalta Corporation v.  Her Majesty The Queen, 2012 FCA 20:

The concept of reasonableness under section 68 of the Act is similar to that used for the purpose of section 67 of the Act.  Consequently, for the purpose of section 68 of the Act, I conclude that an amount can reasonably be regarded as being the consideration for the disposition of a particular property if a reasonable business person, with business considerations in mind, would have allocated that amount to that particular property.  In this context, long-standing regulatory and industry practices, as well as auditing and valuation standards and practices, are relevant.

Marrying these four passages together suggests that reasonableness is to be measured on a subjective standard, taking into account objective criteria where available.  The search seems to be for a single reasonable businessperson who would have made the decision at question, not for whether the mythical reasonable person of common law fame would make the same decision.  Also worth noting is that for a taxpayer to succeed, all that must be shown is that such a reasonable person exists on a balance of probabilities.

What lessons can be drawn from judicial interpretations of the over 1,800 instances of the word reasonable and its derivatives in our tax legislation? First, the sheer number of decisions interpreting what is or is not reasonable suggests that certainty for taxpayers does not yet exist.  Second, reasonableness is a question of fact making the finding at the Tax Court of Canada level crucial.  Third, objective evidence of standards and practices will be relevant in the assessment where they exist.  Fourth, above or below fair market value does not equate with the concept of unreasonable particularly where secondary considerations exist.  Fifth and most importantly, neither the Minister nor the Courts are to substitute their judgment for that of a taxpayer but instead must examine whether any reasonable taxpayer would make the same decision in the same circumstances.

In a leading administrative law decision, Dunsmuir v. New Brunswick, 2008 SCC 9, the Supreme Court of Canada made the following comments on reasonableness:

Reasonableness is one of the most widely used and yet most complex legal concepts.  In any area of the law we turn our attention to, we find ourselves dealing with the reasonable, reasonableness or rationality.  But what is a reasonable decision? …

Reasonableness is a deferential standard animated by the principle that underlies the development of the two previous standards of reasonableness: certain questions that come before administrative tribunals do not lend themselves to one specific, particular result.  Instead, they may give rise to a number of possible, reasonable conclusions.  … A court conducting a review for reasonableness inquiries into the qualities that make a decision reasonable, referring both to the process of articulating the reasons and to outcomes.  … But it is also concerned with whether the decision falls within a range of possible, acceptable outcomes which are defensible in respect of the facts and law.

In their next foray into the morass that reasonableness had become in the administrative law context, the Supreme Court of Canada observed in Canada (Minister of Citizenship and Immigration) v. Vavilov, 2019 SCC 65:

… reasonableness review finds its starting point in judicial restraint and respects the distinct role of administrative decision makers. Moreover, … reasonableness review considers all relevant circumstances …

… the focus of reasonableness review must be on the decision actually made by the decision maker, including both the decision maker’s reasoning process and the outcome.  The role of courts in these circumstances is to review, and they are, at least as a general rule, to refrain from deciding the issue themselves.

… a reasonable decision is one that is based on an internally coherent and rational chain of analysis and that is justified in relation to the facts and law that constrain the decision maker.  The reasonableness standard requires that a reviewing court defer to such a decision.

Recognizing the difference in context, many of the principles expressed in these statements from the Supreme Court may be applied to the interpretation of reasonableness for tax purposes.  Certain questions that come before taxpayers, such as how much to pay a family member employed in a business, accepting a price allocation proposed by a counterparty to conclude a deal, or whether to ‘overpay’ to acquire a key parcel of land for immediate use, do not lend themselves to one, particular result.  Instead, a number of possible, reasonable conclusions may emerge.  In such complex business settings, deference to rational decisions made by taxpayers who have considered all relevant circumstances seems reasonable.

If you have any questions or concerns, please do not hesitate to reach out to a member of Miller Thomson’s Corporate Tax group.

[1] Applicable to income in excess of $6,000.


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