Norco Development Ltd. v. The Queen, 85 DTC 5213, [1985] 1 CTC 130 (FCTD)

McNair, J:—This is an appeal by the plaintiff from the Minister’s assessment of tax for its 1979 and 1980 taxation years. The issue is whether subsection 129(6) of the Income Tax Act, applies to certain interest payments made by a partnership, Noort Developments, to Noort Bros Construction Ltd on account of the former’s indebtedness so as to constitute active business income which affects the “cumulative deduction account” and thereby disentitles the taxpayer to the small business deduction for the taxation years in question.

The plaintiff, Norco Development Ltd, Fernco Developments Ltd and Lenco Development Ltd are corporate partners in a partnership carried on under the name and style of Noort Developments. They are associated corporations with Noort Bros Construction Ltd, the recipient of the interest payments.

The relevant statutory provisions are section 96, section 125 and subsection 129(6) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

The parties have taken pains to prepare an amended statement of agreed facts which it would be appropriate to reproduce herein.

T-6975-82

IN THE FEDERAL COURT OF CANADA TRIAL DIVISION

BETWEEN:

NORCO DEVELOPMENT LTD

PLAINTIFF

— and —

HER MAJESTY THE QUEEN

DEFENDANT

AMENDED STATEMENT OF AGREED FACTS

The parties hereto by their respective solicitors admit the following facts, provided that the admission is made for the purpose of this action only and may not be used against either party on any other occasion, and provided further that the parties may adduce further and other evidence relevant to the issues and not inconsistent with this agreement.

1. The Plaintiff is a Canadian controlled private corporation carrying on business in the Province of British Columbia.

2. The Plaintiff is associated, within the meaning assigned to that term by the Income Tax Act, SC 1970-71-72, c 63, with Lenco Development Ltd, Fernco Developments Ltd and Noort Bros Construction Ltd which companies are also Canadian controlled private corporations.

3. The Plaintiff carries on business in partnership with Lenco Development Ltd and Fernco Developments Ltd under the name and style, “Noort Developments”. The Plaintiff, Lenco Development Ltd and Fernco Developments Ltd are equal partners in Noort Developments. Noort Developments was engaged in an active business and the allocations of its income to the Plaintiff, Lenco Development Ltd. and Fernco Developments Ltd were reported by those companies for tax purposes as active business income.

4. Noort Bros Construction Ltd advanced loans to Noort Developments during its 1975 to 1979 taxation years, and has reported the interest income therefrom as Canadian investment income in each of the years under appeal. The outstanding loan balance at the end of each year was:

1975	$517,500
1976	$625,815
1977	$657,265
1978	$201,125
1979	$233,302

5. Noort Developments in calculating its income pursuant to the provisions of subparagraph 96(l)(c)(ii) of the Income Tax Act, deducted the interest paid or payable by it to Noort Bros Construction Ltd in the years under appeal. Interest payments were made from a separate bank account operated under the name “Noort Developments”.

6. Noort Bros Construction Ltd was assessed in respect of its 1975, 1976, 1977, 1978 and 1979 taxation years, whereby the amount of interest received by it from Noort Developments for those years was deleted from its Canadian investment income and added to its active business income, pursuant to subsection 129(6) of the Income Tax Act. The amounts of interest in each year are set out below.

YEAR	AMOUNT
1975	$58,771.35
1976	$70,232.09
1977	$64,550.00
1978	$72,960.00
1979	$22,984.00

7. The effect of the assessments of Noort Bros Construction Ltd is to increase the calculation of that company’s cumulative deduction account, with the result that the Plaintiff will lose the benefit of the small business deduction in its 1979 taxation year because its cumulative deduction account for the 1978 taxation year calculated in accordance with the assessments of Noort Bros Construction Ltd will exceed the amount of the total business limit which can be allocated to it.

8. The Plaintiff claimed the benefit of the small business deduction in its 1979 taxation year.

9. The Plaintiff filed its income tax returns for the 1980 and 1981 taxation years on the basis that the small business deduction was not available to it.

10. The Plaintiff has been reassessed in respect of its 1979 taxation year to deny the availability of the small business deduction and its returns for the 1980 and 1981 taxation years have been confirmed by assessment, in accordance with the reassessments of Noort Bros Construction Ltd. The reassessment for the 1979 taxation year and the assessments for 1980 and 1981 have been duly objected to by the Plaintiff, and were subsequently confirmed by the Minister.

The parties hereto by their respective solicitors have by their signatures endorsed hereon agreed to the facts recited above.

DATED at the City of Vancouver, British Columbia, this 26th day of April, 1984.

(Sgd) L Green

Counsel for the Plaintiff

DATED at the City of Vancouver, British Columbia, this 27th day of April, 1984.

(Sgd) W Heinrich

Counsel for the Defendant

The agreed statement of facts largely tells the tale. I might only add that the underlying rationale of the assessment was the Minister’s assumption that the interest payments received by Noort Bros Construction Ltd must be deemed by subsection 129(6) of the Act to be active business income of that company. In the result, the Minister concluded that:

. . . the taxpayer had no business limit and total business limit within the meaning of subsection 125(2) and subsection 125(3) and accordingly the taxpayer is not entitled to a deduction under subsection 125(1) of the Act from the tax payable.

Subsection 129(6) was enacted by SC 1973-74, c 30, section 19, and reads:

[Sec 129 . ..]

(6) Where any particular amount paid or payable to a corporation (in this subsection referred to as the “recipient corporation”) by another corporation (in this section referred to as the “associated corporation”) with which the recipient corporation was associated in any particular taxation year commencing after 1972 would otherwise be included in computing the income or loss, as the case may be, of the recipient corporation for the particular year from a source that is property or a business other than an active business, the following rules apply:

(a) for the purpose of subsection (4), in computing that income or loss, as the case may be,

(i) there shall not be included any portion (in this subsection referred to as the “deductible portion”) of the particular amount that was or may be deductible in computing the income or loss, as the case may be, of the associated corporation for any taxation year from an active business carried on by it in Canada, and

(ii) no deduction shall be made in respect of any outlay or expense, to the extent that that outlay or expense may reasonably be regarded as having been made or incurred by the recipient corporation for the purpose of gaining or producing the deductible portion; and

(b) for the purposes of this subsection and section 125,

(i) the deductible portion shall be deemed to be income of the recipient corporation for the particular year from carrying on an active business in Canada, and

(ii) any outlay or expense, to the extent described in subparagraph (a)(ii), shall be deemed to have been made or incurred by the recipient corporation for the purpose of gaining or producing income.

The purpose of the subsection, as I see it, is to deem what would otherwise have been regarded as investment income to be income from an active business in the situation where it was received from a payer corporation with which the recipient corporation was associated to the extent that the amount thereof was or might have been deductible from the payer corporation’s active business income for the particular taxation year.

The plaintiff says that subsection 129(6) applies only to amounts paid or payable to a corporation by another corporation so that it cannot possibly apply to the interest payments received by Noort Bros Construction Ltd from the partnership, Noort Developments. It necessarily follows that these interest payments do not form part of the active business income of Noort Bros Construction Ltd so as to increase its cumulative deduction account. The allocation impact of subsection 125(3) of the Act in respect of associated corporations is thus minimized to the point that the plaintiff can rightfully claim the small business deduction in the years following 1978.

The plaintiff places much reliance on section 96 of the Act which deals with the computation of income for tax purposes of partnerships. The argument goes like this. The plaintiff says that a partnership is not a taxpayer per se but rather a special, notional entity. The partnership, Noort Developments, deducted as a legitimate expense the interest amounts paid to Noort Bros Construction Ltd, the corporation associated with the three corporate partners, Norco, Lenco and Fernco. Noort Bros Construction Ltd is engaged in the business of renting property and dealing in investments. All of its income is passive. In this sense, the interest payments received by it from the partnership should not be regarded as active business income but rather should be treated as investment income.

Simply stated, this is how the plaintiff saw it. But the Minister came to see the matter in another light, although he had been inclined initially to agree with the plaintiffs view. He invoked in aid subsection 129(6) and added the interest payments to the active business income of Noort Bros Construction Ltd which had the effect of increasing that company’s cumulative deduction account to such a level in 1978 that the plaintiffs cumulative deduction account exceeded the total business limit allocated to it as one of the group of associated corporations with the result that the plaintiff became disentitled to claim the small business deduction in subsequent taxation years.

The defendant contends that the interest payments were paid to the recipient corporation, Noort Bros Construction Ltd, by the corporate partners, Norco, Lenco and Fernco and the mere funnelling of these payments through the conduit of the partnership does not in any way alter the result because a partnership by law is not a separate, juristic person but only a contractual relationship subsisting between persons carrying on business in common with a view to profit. In other words, the members of the partnership do not form a collective whole distinct from its individual members and the fact that the Act does not specifically define partnership lends support to this proposition.

In my view, the key to the whole case turns on whether the Minister can pierce the partnership veil to such extent as to properly conclude that the words “by another corporation” in subsection 129(6) refer to the individual corporate partners in the context that the interest paid to the recipient corporation, Noort Bros Construction Ltd, was actually paid by them and not by the intermediate partnership.

In Northern Sales (1963) Limited v MNR, [1973] CTC 239; 73 DTC 5200, Mr Justice Collier affirmed the definition of partnership in these words:

. . . Partnership is the relation which subsists between persons carrying on a business in common with a view of profit. That definition is in most of the provincial partnership Acts and merely states the former common law.

In Income Tax Commissioners for City of London v Gibbs, [1942] AC 402, Viscount Simon, LC, said at 415:

... As a strict proposition of English law, there is no doubt at all that a partnership is not, as such, a single juristic person. As Farwell LJ said in Sadler v Whiteman [1] (♦): “In English law a firm, as such, has no existence; partners carry on business both as principals and as agents for each other within the scope of the partnership business; the firm name is a mere expression, not a legal entity, although for convenience under Order 48A it may be used for the sake of suing and being sued.’’ And again: “It is not correct to say that a firm carries on business; the members of the firm carry on business in partnership under the name or style of the firm.”

The rule in Sadler v Whiteman was cited with approval by the Ontario Court of Appeal in Kaltenback v Frolic Industries Ltd, [1948] 1 DLR 689. There is no doubt in my mind that the rule has gained full acceptance in Canada.

The question is this — what is the proper interpretation test to be applied to the words “‘by another corporation” in subsection 129(6) of the Income Tax Act!

The plaintiff relies on the rule of strict interpretation to resolve in favour of the taxpayer any ambiguity or doubt arising from the use of these words.

Mr Justice Estey lucidly canvassed the whole broad spectrum of statutory interpretation in the Supreme Court of Canada case of Stubart Investments Limited v The Queen, [1984] CTC 294; 84 DTC 6305 where he said at 315-16 [6322- 23]:

In all this, one must keep in mind the rules of statutory interpretation, for many years called a strict interpretation, whereby any ambiguities in the charging provisions of a tax statute were to be resolved in favour of the taxpayer; the taxing statute was classified as a penal statute. See Grover & lacobucci, “Materials on Canadian Income Tax”, 5th ed, (1981), pp 62-65.

At one time, the House of Lords, as interpreted by Professor John Willis, had ruled that it was “not only legal but moral to dodge the Inland Revenue” (51 Canadian Bar Review 1 at p 26), referring to Inland Revenue Commissioners v Levene, [1928] AC 217, at p 227. This was the high water mark reached in the application of Lord Cairns’ pronouncement in Partington v Attorney-General (1869) LR, 4 HL 100 at p 122:

I am not at all sure that, in a case of this kind — a fiscal case — form is not amply sufficient: because, as I understand the principle of all fiscal legislation, it is this: if the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute, what is called equitable construction, certainly such a construction is not admissible in a taxing statute where you simply adhere to the words of the statute.

cited with approval in this Court in The King v Crabbs, [1934] SCR 523 [1 DTC 272] at p 525.

The converse was, of course, also true. Where the taxpayer sought to rely on a specific exemption or deduction provided in the statute, the strict rule required that the taxpayer’s claim fall clearly within the exempting provision, and any doubt would there be resolved in favour of the Crown. See Lumbers v MNR (1943), 2 DTC 631 (Ex Ct), affirmed [1944] SCR 167, [2 DTC 652]; and W A Sheaffer Pen Co Ltd v MNR, [1953] Ex CR 251 [53 DTC 1223]. Indeed, the introduction of exemptions and allowances was the beginning of the end of the reign of the strict rule.

Professor Willis, in his article, supra, accurately forecast the demise of the strict interpretation rule for the construction of taxing statutes.

Gradually, the role of the tax statute in the community changed, as we have seen, and the application of strict construction to it receded. Courts today apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge he may be held liable. See Whiteman and Wheatcroft, supra, at p 37

While not directing his observations exclusively to taxing statutes, the learned author of “Construction of Statutes”, 2nd ed, (1983), at p 87, E A Dreidger, put the modern rule succinctly:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

In my opinion, the partnership, Noort Developments, is not a legal entity. Section 96 of the Act provides rules for the computation of partnership income. The partnership is envisaged as a separate person solely for the purpose of measuring the flow of income to the individual partners, which is then taxed in their hands. It is the partners and not the firm itself which are the alleged subject of taxation. In one breath, the plaintiff seeks through the interposition of the partnership to convert the active business income represented by the interest paid to Noort Bros Construction Ltd into investment income. In the other, it claims the benefit of the small business deduction as one of a group of Canadian-controlled private corporations associated together for tax purposes in the sense that the group is to be regarded as a single corporation. In my view, the statutory milieu of section 125 and subsection 129(6) of the Act is corporate in scope with the manifest “object and spirit” of preventing the very result that the plaintiff seeks to accomplish. In the result, it is my opinion that the plain meaning of the words “by another corporation” in subsection 129(6) is patently broad enough to reach the plaintiff as the payer of the interest to the recipient corporation, Noort Bros Construction Ltd.

Accordingly, the plaintiffs appeal is dismissed, with costs.