Yarmouth Industrial Leasing Ltd. v. The Queen, 85 DTC 5401, [1985] 2 CTC 67 (FCTD)

Walsh, J:—This is an appeal from reassessment of plaintiff’s income tax for its fiscal years ending on March 31, 1976, 1977 and 1978 which added revised taxable income of $89,289, $234,615 and $392,423 for the said years respectively as a result of the disallowance of the deductions claimed for noncapital losses incurred by plaintiff in its 1973 and 1974 fiscal years. Paragraph 111(1)(a) of the Income Tax Act at that time permitted such deduction of non-capital losses for the five taxation years immediately preceding and the taxation year immediately following but it is the Minister’s position that provisions of paragraph 111(5)(a) at the time prevented plaintiff from deducting these losses in the years in question. The said section read as follows:

(5) Subsection (1) does not apply to permit a corporation to deduct, for the purpose of computing its taxable income for a taxation year, such portion of its non-capital loss for a preceding year as may reasonably be regarded as its loss from carrying on any particular business if

(a) control of the corporation has been acquired, before the end of the year, by a person or persons who did not, at the end of that preceding year, control the corporation and the corporation was not, during the year, carrying on that business.

It will be noted that two conditions are necessary to give effect to this subsection—

1. that control has been acquired before the end of the taxation year by a person or persons who did not at the end of the preceding year in which the loss was incurred have control of the corporation and

2. the corporation was not during the taxation year in question carrying on the same particular business.

One question is whether plaintiff was in its 1976, 1977 and 1978 taxation years carrying on the same business as it was carrying on during its fiscal year ending March 31, 1973 when it sustained substantial non-capital loss as a result of its customer Cosmos Imperial Mills Limited going into receiver ship which left unpaid the sum of $1,037,203 and further losses in the fiscal year ending March 31, 1974 is a question of fact. The issue of whether there was a change over control of the company which would affect the 1976, 1977 and 1978 fiscal years is a legal issue and which the parties agree has never been determined by the Courts. The issue did not arise for its fiscal year ending March 31, 1975 during which it earned income and applied part of the loss incurred in the 1973 and 1974 fiscal years.

The factual background of the litigation is that plaintiff was incorporated in 1966 to carry on a textile business in the Province of Nova Scotia, and was wholly owned until March of 1973 by Cosmos Imperial Mills Limited. It built a modern textile mill adjacent to that operated by its parent corporation, the motive being to take adantage of certain industrial incentive grants which were available for that purpose. By June of 1970 the tax advantages had terminated so it transferred its business operation to its parent Cosmos, retaining the building and equipment which it then leased to Cosmos. Cosmos carried on its operations thereafter primarily in plaintiff's mill which was more modern.

Due to weakness in the textile industry Cosmos was obliged to cease its business operations at the end of January 1973. From June 1970 to February 1, 1973 plaintiff’s sole business was the leasing of its building and equipment to its parent Cosmos Imperial Mills Limited.

On March 30, 1973, (the day before the end of plaintiff’s fiscal year) Direct Leasing Limited hereinafter referred to as Direct purchased all of plaintiffs outstanding shares for $50,000. At that date Direct was a wholly owned subsidiary of the Hamilton Group Limited. Plaintiff sold its remaining assets in May of 1973 creating a loss of $21,269 for its 1974 taxation year. By supplementary Letters Patent dated March 7,1974 plaintiffs name which had been Yarmouth Industrial Fabrics Limited was changed to Yarmouth Industrial Leasing Limited and its objects and share capital were changed. It is defendant's contention that in March of 1974 plaintiff began to operate a financial leasing business which is different from that previously carried on. On October 31, 1975, 60 per cent of the outstanding shares of Direct at that time owned by Citicorp Canada Limited which itself was 100 per cent owned by Hamilton Group were sold to Citicorp Leasing International Inc hereinafter referred to as Citicorp with Hamilton Group retaining 40 per cent thereby creating a change in control of plaintiff according to defendant's contentions.

As will be seen there was no change in the immediate control of plaintiff, since Direct owned all of its shares as of March 30, 1973 before the end of the year in which the initial loss occurred and continued to do so throughout the taxation years in question. It is the control of Direct itself which changed from being a corporation wholly controlled by the Hamilton Group to being only 40 per cent controlled by it following October 31, 1975 when 60 per cent of its shares were sold to Citicorp. The question to be decided on the issue of control is whether the word "control" as used in paragraph 111(5)(a) refers only to direct and immediate control or whether one can trace the flow through of control to a corporation or corporations which could indirectly control plaintiff Yarmouth Industrial Leasing Limited through their exercise of control over Direct Leasing Limited which corporation directly controls plaintiff.

When Cosmos became insolvent and ceased operating in 1973 its creditor bank made demands on Yarmouth as a result of cross guarantees which had been entered into between Yarmouth and Cosmos. Hamilton Group's sub- sidiary Direct Leasing acquired the shares of Yarmouth from the receiver. Between the end of March 1973 and the end of March 1974 Yarmouth's creditors bought the plant and equipment for resale, the eventual purchasers being Dominion Textile Limited. Yarmouth was in due course released from any further indebtedness to the bank.

Yarmouth obtained supplementary Letters Patent on March 7, 1974 and before March 31st of that year entered into a lease of heavy equipment which appears to be some sort of a loader transporter, (designation being indecipherable in the exhibit) to J A Moreau and Associates for a total rent of $4,980 payable over an 18-month period. Commencing in May 1974 it entered into a number of leases of memory typewriters in various cities in Canada. There was produced as an exhibit however a list of leases outstanding as of March 31, 1975 which indicates that there was a variety of equipment leased other than memory typewriters. For example a company known as Dilvar Construction in October 1974 leased miscellaneous equipment of which the original cost to Yarmouth was $238,400. Total equipment purchased by Yarmouth for leasing prior to April 1, 1975 cost $1,172,682.47. It is evident that it was in a substantial equipment leasing business for its 1975 and subsequent fiscal years but that for its 1974 fiscal year only one piece of equipment had been leased prior to its termination on March 31, 1974. Nevertheless although it made only one equipment lease before the end of its 1974 fiscal year, this was certainly the same type of business which was Carried out thereafter and the fact that it was dormant during much of its 1974 fiscal year save for negotiations with its creditors was as a result of Cosmos having gone into receivership. A certain amount of paper work was done in connection with preparations for carrying on the equipment leasing business. As was pointed out in cross-examination however much of the negotiations with the receiver must have taken place prior to March of 1973.

The real issue to be determined however is whether the business carried on by Yarmouth in the years prior to 1973 was of the same nature as the equipment leasing business carried on thereafter. In this connection it is instructive although not conclusive to look at its Letters Patent dated March 28, 1966 in which the objects are set out as follows:

to manufacture duck, canvas, cloth, ropes, yarns, fishing lines, sewing thread and all other fabrics, goods, articles and products of every kind and description which can or may be manufactured, either wholly or partly, of cotton, wool, sisal, hemp, flax, manilla or other substance or material capable of being spun, twisted or woven; to dye, bleach, print, convert or otherwise prepare the raw material, yarns or manufactured goods; to buy, sell and deal in any and all manufactured goods and products of the character and description aforesaid and in the substances and materials of which the same or any of them can or may be manufactured or produced and also in the waste material arising during the process of manufacture.

It was only when supplementary Letters Patent were granted on March 7, 1974 that its name was changed to Yarmouth Industrial Leasing Limited and the said objects were deleted and the following substituted therefor:

(1) to buy, sell, acquire by purchase, lease, exchange or otherwise and to rent, leased or let or hire real and personal property of every kind and description; and

(ii) to provide financial services of every kind and description.

It is questionable therefore whether prior to the supplementary Letters Patent it was acting in accordance with its objects when it built and equipped the plant which it ultimately leased to the parent company Cosmos between 1970 and 1973, and ceased becoming a manufacturer of fabrics itself.

Quite apart from the question of whether it was acting beyond its powers following 1970, which is in any event irrelevant in the present proceedings, it appears to me that the leasing of a building and equipment to a single lessee, irrespective of whether that lessee is the parent company or not, is a business of a different nature from purchasing office equipment and heavy equipment and leasing same to a series of lessees throughout Canada. While plaintiff contends for a broad interpretation of “leasing” which would including the leasing of either immovable or movable property I find it difficult to conclude that this would constitute the same business as that being carried on in 1973. The change of name and of the objects of the corporation in its supplementary Letters Patent tend to support this conclusion.

It is instructive to look at Interpretation Bulletin IT-376 in this connection, paragraph 7 of which reads as follows:

Whether the corporation carried on "That business” is a question of fact. Factors to be considered in determining whether “that business” was being carried on include the following;

(a) location of the business carried on before and after change of control,

(b) nature of the business,

(c) name of the business,

(d) nature of income-producing assets,

(e) existence of a period or periods of dormancy,

(f) extent to which the original business constituted a substantial portion of the activities of the corporation in the allocation of time and financial resources.

If it is established that “that business” is being carried on the operation of one or more other businesses by the loss corporation is immaterial.

While Interpretation Bulletins are not of course binding on the Court they are frequently based on the findings of known jurisprudence at the time, and in this case I find myself in agreement with the factors which should be considered, as set out clearly in the said Bulletin. Applying them to the facts in the present case, it would appear that the location of the business has always been in Hamilton, but in practice its operations were carried out solely in Yarmouth prior to 1973 while it would appear to be operating from Hamilton since March 1974. I have already concluded that the nature of the business has changed. The name of the business and the nature of income producing assets changed. It was nearly dormant save for some paper work for nearly a year before making its first lease of industrial equipment to Moreau in March 1974, followed by rapidly increasing business activity in 1975. The busienss of leasing its plant and equipment to Cosmos constituted the entire activity of the company in 1973.

On the issue of same business therefore plaintiff's appeal would fail save with respect to its 1974 loss, as a result of the lease to Moreau before the end of its 1974 fiscal year which might be considered as a commencement of the same business carried on in the 1976, 1977 and 1978 taxation years under consideration.

On the issue of control, while there have been no cases dealing with paragraph 111(5)(a) of the Act there have been a number dealing with section 256, the associated corporations section. Plaintiff attempts to distinguish these cases, which would not be helpful to it, on the grounds that different considerations should apply with respect to paragraph 111(5)(a) which is intended to discourage trading in a loss company. Since it must be a similar business which is being carried on, in addition of course to other activities if necessary, this is a disincentive to acquiring control of a business purely for a tax loss. It was argued that in other sections of the Act where control is an issue, for example paragraph 95(1 )(a) dealing with a controlled foreign affiliate the word “control” is followed by the words “directly or indirectly in any manner whatever”. In paragraph 125(6)(a) the definition of a Canadian controlled private corporation again uses the words “controlled directly or indirectly in any manner whatever”. Paragraph 54(i) in defining superficial loss again refers to a “corporation controlled, whether directly or indirectly in any manner whatever”. Subsection 85(4) dealing with loss from disposition of property to a controlled corporation again uses these words. It was argued that the absence of them in section 111 means that that section would only apply to changes in direct control of a corporation, rather than tracing indirect changes of control to determine whether or not there was, as in the present case, a change in indirect control.

Furthermore it was argued that section 256 of the Act was amended by adding subsection 7 by 26 Elizabeth II, c. 1 in 1977 which subsection specifically provides, for the purposes inter alia of section 111, conditions under which a person shall be deemed not to have acquired control by virtue of a share acquisition. This subsection is applicable however only to acquisitions after March 31,1977 so it has no direct bearing on the present case.

The question of flow through of control was dealt with at length by Justice Cattanach in the case of Vineland Quarries and Crushed Stone Limited v MNR, [1966] CTC 69; 66 DTC 5092 dealing with the word “controlled” in paragraph 39(4)(b) of the Act (now section 256). In it he referred at 78 (DTC 5096) to the case of British American Tobacco v IRC, [1943] 1 All ER 13 stating: “It was held that Company No 1 can have a controlling interest in Company No 3 by owning all the shares in Company No 2 which in turn owns all the shares in Company No. 3.” At page 15 in that case Lord Chancellor Viscount Simon stated:

I think the conception of “controlling interest” may well cover the relationship of one company towards another, the requisite majority of whose shares are, as regards their voting power, subject, whether directly or indirectly, to the will and ordering of the first-mentioned company.

Justice Cattanach at 81 (DTC 5097) adopts this reasoning stating that the British American Tobacco case is authority for the proposition “that where the registered shareholder is a body corporate it is permissible, for certain purposes, to look beyond the register and seek the individuals who themselves control that body corporate. At 82 (DTC 5098) he states:

In my view the word “controlled” in section 39(4)(b) contemplates and includes such a relationship as, in fact, brings about a control by virtue of majority voting power, no matter how that result is effected, that is, either directly or indirectly.

This judgment was sustained in the Supreme Court (67 DTC 5283) the judgment adopting both Justice Cattanach’s reasons and conclusion.

Plaintiff attempts to distinguish this case by again looking at the purpose of section 111 which is said to be to discourage acquisition of tax losses, and not to discourage acquisitions which have a business purpose, quite apart from that, as in the present case. It was argued that if it had been a subsidiary of Hamilton Group which had acquired control of the shares of Direct Leasing, then, even considering the question of flow through there would have been no change of control after the 1973 fiscal year. The present situation only arose because it was a new “player” namely the Citicorp which ended up with 60 per cent control of Direct Leasing thereby raising the issue of change of control. Nevertheless that is what took place and the motives for the change of indirect control are irrelevant.

In the case of Atco Ltd et al v Calgary Power Ltd et al, 140 DLR (3d) 193, although it is not a tax case the question of control was dealt with by the Supreme Court at 202-3. At 202 reference is made to the judgment of the Supreme Court in Covert et al v Minister of Finance of Province of Nova Scotia, [1980] 2 SCR 774; [1980] CTC 437:

The majority concluded that, for the purpose of interpreting and applying a taxing statute, the parent company was “beneficially entitled” to the assets held by its wholly-owned subsidiary.

It is of interest to note that the courts have gradually moved from the rather strict view of direct and indirect ownership or control to a more comprehensive view based upon the entire statutory pattern and the factual elements of control in reality. In Buckerfield's Ltd et al v Minister of National Revenue, [1965] 1 Ex CR 299 at p 303, [1964] CTC 504, 64 DTC 5301, Jackett P stated:

"I am of the view, however, that in section 39 of the Income Tax Act, the word ‘controlled’ contemplates the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the Board of Directors.”

That decision reflected the comments of the House of Lords in British American Tobacco Co Ltd v Inland Revenue Com'rs, [1943] AC 335 at p 339, where Viscount Simon states:

“I find it impossible to adopt the view that a person who (by having the requisite voting power in a company subject to his will and ordering) can make the ultimate decision as to where and how the business of the company shall be carried on, and who thus has in fact control of the company's affairs, is a person of whom it can be said that he has not in this connexion a controlling interest in the company.”

The process so far as then s 39 of the Income Tax Act was concerned was completed by Cattanach J in Vineland Quarries & Crushed Stone Ltd v Minister of National Revenue, [1966] CTC 69; 66 DTC 5092:

“In my view the word 'controlled' in section 39(4)(b) contemplates and includes such a relationship as, in fact, brings about a control by virtue of majority voting power, no matter how that result is effected, that is, either directly or indirectly.”

In the light of this jurisprudence I find it difficult to conclude that the absence of the words “or indirectly" in paragraph 111(5)(a) is sufficient to prevent the Court from looking at the question of indirect control as was done in the jurisprudence under section 256 in which the words "or indirectly" do not appear either, but for which section the jurisprudence has nevertheless concluded that actual control can be looked at and exercised indirectly by a corporation which controls another corporation which itself controls the third corporation, control over which is the subject of the inquiry.

I therefore find that a change of control of plaintiff did in fact take place on or about October 31, 1975 so that the second condition of paragraph 111(5)(a) also applies in addition to the conclusion already reached that plaintiff was not during its 1976, 1977 and 1978 fiscal years carrying on the same business as it was in its 1973 fiscal year in which most of the loss sought to be carried forward occurred. While for its 1974 fiscal year the business may have been the same, the change of control following October 31, 1975 would prevent deduction of this loss in the 1976, 1977 and 1978 taxation years under consideration.

In further support of these conclusions it should be noted that subsection 111(1) is a deduction section, with paragraph 111(5)(a) setting forth the conditions under which deduction cannot be made, and it is constantly held that a deduction section must be strictly construed against the taxpayer, (see for example in this connection the case of Lumbers v MNR, [1943] Ex CR 202; [1943] CTC 281). Furthermore the reassessments are based on the assumptions made by the Minister as set out in paragraph 3(l) and (m) of the statement of defence and the burden of proof is on plaintiff to destroy these assumptions and this it has failed to do.

Plaintiff’s action is therefore dismissed with costs.

Appeal dismissed.