The Queen v. Irving Garber Sales Canada Ltd., 92 DTC 6498, [1992] 2 CTC 261 (FCTD)

Joyal, J.:—This Court is seized of an appeal by the Crown from a judgment of the Tax Court of Canada vacating income tax reassessments issued to the defendant. Although proceedings in such respect are known as appeals, it is common ground that before this Court, they constitute a trial de novo.

Some five taxation years are involved, namely 1978, 1979, 1980, 1981 and 1982. In each of these years, the issue is whether income earned by the defendant from an accumulation of certificates of deposit constituted business income on the one hand or investment income or income from property on the other. By reason of the provisions of section 125 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), business income enjoys a preferred tax rate as against straight investment income.

The facts:

The taxpayer-defendant is engaged in the fur business in Montreal. Its income is derived generally from sales’ commissions, sales of raw skins and sales of manufactured fur coats.

The defendant, as its corporate name implies, is controlled by Mr. Irving Garber who also directs the company's operations. Mr. Garber has long been involved in the fur business and although over the years, he might have suffered some more trying experiences, the history of his operations over the taxation years in question indicates a stable and ongoing existence.

A quick breakdown of the defendant's business operations in the course of the foregoing taxation years discloses as follows:

Based on the foregoing gross margins, the defendant earned the following net income before taxes:

During the same period of time, the taxpayer's certificates of deposit as well as the interest earned thereon accumulated as follows:

Further information on the defendant's operations is taken from its annual statements for the disputed years 1978-1982. I reproduce hereunder the defendant's balance sheets and income statements for each of those years.

IRVING GARBER SALES CANADA LTD. Balance Sheet as at May 31

ASSETS
Current	1979	1978 1978
Cash	999	6,590
Term deposits	335,000	285 ,000
Accounts receivable	1,531	—
Inventory	1,760	—
TOTAL ASSETS	339,290	291,590

LIABILITIES

Current

Bank loan	5,000
Account payable	900	500
Income taxes payable	9,394	15,587
Accrued salaries	90,000	40,000
Loan—associated company	111,985	124,895
Advance—Di recto rs	31,506	67,605
	248,785	248,587

SHAREHOLDERS’ EQUITY

CAPITAL STOCK

Authorized:

50,000 Common shares
Issued and Paid Up:	100	100
100 Common shares at $1.
RETAINED EARNINGS	90,405	42,903
TOTAL SHAREHOLDERS’ EQUITY	90,505	43,003
Total Liabilities and Shareholders' Equity	339,290	291,590
IRVING GARBER SALES CANADA LTD.
Statement of Income and Retained Earnings
as at May 31
1979		1978 1978
SALES	438,574	43,719
Cost of sales	422,597	41,076
GROSS MARGIN	15,977	2,643
Add: Commission income	100,080	84,752
Interest received	15,612	17,709
	131,669	105,104
EXPENSES
Travelling	2,890	—
Promotion	3,342	—
Auto rental and expenses	5,660	—
Salaries	50,000
		40,000
Taxes and insurance	1,389	50
Office and general	240	64
Telephone	789	—
Professional	1,164	500
Administrative fees	—
		6,000
Rent	1,200	—
Bank charges	99	—
TOTAL EXPENSES	66,773	46,614
INCOME before income taxes	64,896	58,490
Income taxes	17,394	15,587
NET INCOME	47,502	42,903
Balance—beginning of year	42,903	—
RETAINED EARNINGS—end of year	90,405	42,903
IRVING GARBER SALES CANADA LTD.
Balance Sheet as at May 31
ASSETS
	1981	1980
Current
Cash	34,310	710
Term deposits	508,000	504,000
Accounts receivable	—	14,640
Inventory	14,520	—
	556,830	519,350
FIXED, at cost less accumulated depreciation (note 2)	1,163	1,540
TOTAL ASSETS	557,993	520,890

LIABILITIES
Current
Accounts payable and accrued	600	2,657
Income taxes payable	6,181	27,888
Accrued salaries	90,000	105,000
Advance—Di rectors	734	25,478
	97,515	161,023
SHAREHOLDERS’ EQUITY
CAPITAL STOCK (note 3)
Issued and Paid Up:
200 Common shares	1,600	1,600
250 Class B preferred shares	25,000	—
RETAINED EARNINGS	433,878	358,267
TOTAL SHAREHOLDERS' EQUITY	460,478	359,867
Total Liabilities and Shareholders’ Equity	557,993	520,890
IRVING GARBER SALES CANADA LTD.
Statement of Income and Retained Earnings
as at May 31
1981		1980 1980
SALES	192,651	57,338
Cost of sales	184,977	48,696
GROSS MARGIN	7,674	8,642
Add: Commission income	81,196	165,938
Interest received net	68,971	48,709
	157,841	223,289
EXPENSES	53,549	74,337
INCOME before income taxes	104,292	148,952
Income taxes	28,681	40,627
NET INCOME	75,611	108,325
RETAINED EARNINGS
Balance—beginning of year	358,267	90,405
Contributed surplus	—	159,537
RETAINED EARNINGS—end of year	433,878	358,267
IRVING GARBER SALES CANADA LTD.
Balance Sheet as at May 31
ASSETS
Current	1982
Cash and term deposits	623,264
Accounts receivable	5,500
Inventory	4,000
	632,764
Fixed, at cost less accumulated depreciation (note 2)	8,854
TOTAL ASSETS	641,618
LIABILITIES
Current
Accounts payable and accrued	1,500
Income taxes payable	7,011
Accrued salaries	65,000

Advance—Directors	477
	73,988
SHAREHOLDERS’ EQUITY
CAPITAL STOCK (note 3)
Issued and Paid Up:
200 Common shares	1,600
250 Class B preferred shares	25,000
RETAINED EARNINGS	541,030
TOTAL SHAREHOLDERS’ EQUITY	567,630
Total Liabilities and Shareholders’ Equity	641,618
IRVING GARBER SALES CANADA LTD.

Statement of Income and Retained Earnings as at May 31

	1982
SALES	311,826
Cost of sales	297,989
GROSS MARGIN	13,837
Add: Commission income	85,928
Interest received—net	95,630
	195,395
EXPENSES	64,132
INCOME before income taxes	131,263
Income taxes	24,111
NET INCOME	107,152
RETAINED EARNINGS
Balance—beginning of year	433,878
RETAINED EARNINGS—end of year	541,030

The position of the Crown

In respect of the foregoing capital invested and which increased substantially over the period in dispute, the Crown takes the position that the income earned thereon is fundamentally investment income and should not be treated as business income. The Crown, in particular, makes the following assumptions:

1. There was no business purpose in the defendant holding these investments.

2. The amounts of the investments were not risked in the defendant's business in any substantial manner.

3. The investment or the income therefrom was not related directly or accessorily to the defendant's income earned in carrying on its active business.

4. Further, even if it should be assumed that there was some business purpose in holding these investments, the amounts thereof were vastly superior to the needs of the business.

5. Although the capital structure which is enhanced by these investments might contribute to the defendant's corporate image, it does not follow that such investments are put at risk in the active business and that the income earned from them should be otherwise than investment income.

The case for the defendant

The defendant, of course, takes the opposite view. In his evidence, Mr. Garber recited at length the circumstances in his long business career which prompted him to set up and accumulate the cash reserves which were invested in certificates of deposit. He described a business failure he had experienced in 1960 when his bank had lowered the boom on his company by calling in his notes. His company became bankrupt and he suffered personal bankruptcy as well. As might be expected, he developed an aversion to banks in general as an agency to finance his operations.

Furthermore, stated Mr. Garber, this business failure put him beyond the pale as far as the fur business community was concerned. He lost credibility and was told to keep out of the business. As much of his operations consisted in buying furs at Hudson's Bay Company auctions, he lost credibility with that company. Even the Fur Trade Association, which represents furriers and manufacturers and acts as a sort of clearing house in the fur trade, felt that he should be taught a lesson.

Mr. Garber told himself: Never again would he depend on banks. He slowly recovered. He started to make money again. He put all surplus cash in the company.

He slowly regained his former stature. By 1975 he felt he could approach Hudson's Bay Company again and re-establish his credentials. By that time, his company, which carried the name of Garber Sales Inc., had accumulated some $285,000 worth of certificates of deposit. On the strength of this, Hudson's Bay Company re-admitted him to its sanctuary.

Mr. Garber went on to describe the financial risks involved in the fur auctions in which his company participated. He stressed that although he might be bidding on furs for his buyers on a commission basis, the rules of the auction put him at risk if his buyers defaulted. Hudson's Bay Company, with respect to any successful bid on batches of raw furs, looked to the bidder for payment on the agreed dates and terms. The liquid position of Mr. Garber's company permitted him to take that risk without any loss of sleep.

According to defendant's counsel, one should conclude that these certificates of deposit were necessary for the company's operations in participating at fur auctions and should be considered as part of the company's working capital. Any income accruing from this capital became therefore business income ana should be taxed as such.

Statutory provisions

As was noted by the learned judge of the Tax Court of Canada in his decision reported at [1987] 2 C.T.C. 2117, 87 D.T.C. 427, certain statutory provisions were amended in 1981 applicable to 1981 and 1982 taxation years.

For the earlier years 1978-1979-1980, the relevant provisions of the Income Tax Act are clearly set out by defendant's counsel in his outline of argument and read as follows:

125. (1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation that was, throughout the year, a Canadian- controlled private corporation, an amount equal to 25 per cent of the least of

(a) the amount, if any, by which

(i) the aggregate of all amounts each of which is the income of the

corporation for the year from an active business carried on in Canada,

exceeds

(ii) the aggregate of all amounts each of which is a loss of the corporation for the year from an active business carried on in Canada,

129. (4) In subsection (3)

(a)" Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which the aggregate of such of the corporation’s taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation's allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,

(ii) all amounts each of which is the corporation's income for the year (other than exempt income or any dividend the amount of which was deductible under section 112 from its income for the year) from a source in Canada that is a property (other than a property used or held by the corporation in the year in the course of carrying on a business), determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that property,

(iii) all amounts each of which is the corporation’s income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting ail outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business,

exceeds the aggregate of amounts each of which is a loss of the corporation for the year from a source in Canada that is a property or business other than an active business. . . .

[Emphasis added.]

1981 and 1982 taxation years

Paragraph 125(1 )(a) of the Income Tax Act set out above is also applicable to the 1981 and 1982 taxation years, however, for those years, the following provisions were either added or amended:

(i) Definitions of "Active business" (125(6)(d)) and “Income of the corporation for the year from an active business” (125(6)(e)) read as follows:

125.(6) In this section and section 129,

(d) “active business” carried on by a corporation in a taxation year means the business of manufacturing or processing property for sale or lease, mining, operating an oil or gas well, prospecting, exploring or drilling for natural resources, construction, logging, farming, fishing, selling property as a principal, transportation or any other business carried on by the corporation other than a specified investment business or a non-qualifying business;

(e) “income of the corporation for the year from an active business” means the income of the corporation from an active business carried on by it, including any income pertaining to or incident to that business and amounts deemed by subsection 129(6) to be income from an active business, but does not include income for the year from a source in Canada that is a property (within the meaning assigned by subsection 129(4.1));

129. (4) In subsection (3)

(a) "Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which the aggregate of such of the corporation’s taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation’s allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada, and

(ii) all amounts each of which is the corporation's income for the year from a source in Canada that is a property (other than exempt income, any dividend the amount of which was deductible in computing its taxable income for the year or income from real property of a corporation that is not a Canadian-controlled private corporation) determined after deducting all outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning income from that property,

exceeds

(iii) the aggregate of amounts each of which is the corporation’s loss for the year from a source in Canada that is a property; and

129. (4.1) For the purposes of paragraph 4(a) and subsection (6), “ income” or "loss" of a corporation for a year from a source in Canada that is a property includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada but does not include income or loss

(a) from any other business,

(b) from any property that is incident to or pertains to an active business or a non-qualifying business carried on by it, or

(c) from any property used or held principally for the purpose of gaining or producing income from an active business or a non-qualifying business carried on by it.

[Emphasis added.]

I would generally agree with defendant's counsel on his analysis of the foregoing amendments that income from an active business includes income "pertaining to or incident to that business” and that the determinative test is quite a generous one. Yet, in any of the taxation years under review, i.e., 1978-82, courts appear to have applied the same tests. The judgments of the Tax Court of Canada in Sanilit Ltd. v. M.N.R., [1987] 2 C.T.C. 2078, 87 D.T.C. 450; Ben Barbary Co. v. M.N.R., [1989] 1 C.T.C. 2364, 89 D.T.C. 242; Transport Lacté Inc. v. M.N.R., [1989] 2 C.T.C. 2281, 89 D.T.C. 606, appear to have imposed the same fact finding mission on the Court, no matter the taxation years in question.

Case law

A review of available jurisprudence makes it fairly clear that there are no firm lines delineating business income from investment income. As Madam Justice Wilson said in Canadian Marconi v. The Queen, [1986] 2 C.T.C. 465, 86 D.T.C. 6526, at page 468 (D.T.C. 6528), "the distinction between the two is a difficult one to make but it is one which the Act compels us to make".

Her Ladyship also stated at page 471 (D.T.C. 6530) that [t]he courts have adopted the difficult task . . . by applying certain set criteria or indicia of trading activity and, in the case of a corporate taxpayer, by applying a presumption in favour of the characterization of its income as income from a business.” She affirmed that the characterization must be made from an examination of a taxpayer's "whole course of conduct incurred in the light of surrounding circumstances". In particular, Madam Justice Wilson, at page 470 (D.T.C. 6529), listed the fields of enquiry in that respect by an examination of the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments themselves.

I should venture to suggest that these fields of enquiry are only helpful in the light of the particular issue facing the Supreme Court in the Canadian Marconi case. That issue was whether the taxpayer was or was not in the investment business which would naturally make of any income earned therefrom business income and not income from property. The taxpayer had investment powers under its corporate charter, a senior officer spent 20 per cent of his time managing the investment portfolio, there were as many as 12 employees involved in its administration and transactions were reviewed on a weekly basis to decide on the business strategy for the following week. It was therefore reasonable for the Supreme Court to conclude that all that activity was a business activity constituting any income earned as business income.

Somewhat closer to home as far as more relevant curial pronouncements are concerned is the case of Ensite Ltd. v. The Queen, [1986] 2 C.T.C. 459, 86 D.T.C. 6251, decided by the Supreme Court of Canada concurrently with the Court's judgment in the Canadian Marconi case. At page 464 (D.T.C. 6525) of her reasons for judgment, Madam Justice Wilson states:

The legislative scheme was thus to draw a distinction between active business income which would fall under sections 125 and 125.1 and other sources of income which would fall under section 129. However, it was clearly arguable that income from property which was immersed in the trading activity of the corporation could qualify as active business income. The aforementioned amendment which added the words "other than a property used or held by the corporation in the year in the course of carrying on a business” in parentheses after the words “that is a property" removed this argument and preserved the distinction between active business income and other sources of income. The rebuttable presumption that corporate income is income from a business (see: Canadian Marconi Co. v. The Queen, released concurrently herewith) is of no application here as it would tend to collapse the distinction between active business income and other sources of income which Parliament clearly intended to preserve in its amendment of s. 129(4) of the Act.

The issue before the Supreme Court in the Ensite case, supra, was not whether the taxpayer was in the investment business but whether certain income earning deposits were property that was employed or risked in the taxpayer's business "to such an extent that the income from it could be characterized as active business income". At page 464 (D.T.C. 6525), the Court went on to say:

But" risked" means more than a remote risk. A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would “have a decidedly destabilizing effect on the corporate operations themselves. . . ."This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset on long term . . . from an investment made in order to fulfil a mandatory condition precedent to trade . ... Only in the latter case would the withdrawal of the property from that use significantly affect the operation of the business. The same can be said for a condition that is not mandatory but is nevertheless vitally associated with that trade such as the need to meet certain recurring claims from that trade.

These observations by the Supreme Court are drawn of course from a number of decided cases where the appropriate tests had to be in sync with the facts in each case, i.e., March Shipping Ltd. v. M.N.R., [1977] C.T.C. 2527, 77 D.T.C. 371, at page 2531 (D.T.C. 374); Bank Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307 (Scot. Ct. of Session); Liverpool and London and Globe Insurance Co. v. Bennett, [1913] A.C. 610; Owen v. Sassoon (1951), 32 T.C. 101 (Eng. H.C.J.); The Queen v. Marsh & McLennan, [1983] C.T.C. 231, 83 D.T.C. 5180 (C.A.).

On the particular facts facing the Supreme Court of Canada in the Ensite Ltd. case, it could conclude, at page 465 (D.T.C. 6525-26), that:

The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfil a requirement which had to be met in order to do business. Such property is then truly employed and risked in the business. Here the property was used to fulfil a mandatory condition precedent to trade; it is not collateral, but is employed and risked in the business of the taxpayer in the most intimate way. It is property used or held in the business.

In Atlas Industries Ltd. v. M.N.R., [1986] 2 C.T.C. 2392, 86 D.T.C. 1756, the shoe was on the other foot. It was a matter of the taxpayer claiming that the income from certain short-term deposits constituted investment income while the Crown took the position that such income was income from a business. The issue revolved around the meaning of the terms "is incident to or pertains to an active business” as these terms are found in paragraph 129(4.1 )(b) of the Act.

In that case, Christie, A.C.J.T.C. reviewed at length a series of cases which had accumulated until that time and to some of which I have previously referred. The Associate Chief Judge, with respect to 1980-81-82 taxation years faced squarely the application of the terms in paragraph 129(4.1)(b) in relation to a taxpayer engaged in the sheet metal fabrication and roofing business. Surplus funds generated by the taxpayer were in short-term deposits and these funds according to the taxpayer were held on the basis that the taxpayer never required more than $100,000 on hand for operating purposes. The money in the taxpayer's current account plus its receivables were regarded as sufficient and the term deposits were in fact never used in operations nor involved in meeting future capital requirements.

At page 2404 (D.T.C. 1764), The Associate Chief Judge said this:

The key question to be addressed is this: were the debts pertaining to the short-term deposits incident to or did they pertain to the appellant's businesses of fabricating sheet metal and roofing? If the answer is yes the appeal fails. If the converse is correct it succeeds.

I am informed that there are no decided cases regarding paragraph 129(4.1)(b) and I have found none. Nor am I aware of judicial authority that is analogically helpful.

The starting point I think must be that where a corporation is carrying on an active business and it has income from a source in Canada that is a property, that property is not necessarily to be regarded as being incident to or pertaining to the business. If that was intended, presumably Parliament would have said so.

Giving the words “incident to or pertains to an active business” their grammatical and ordinary sense, and bearing in mind their context, there must I think be a financial relationship of dependence of some substance between the property and the active business before the exclusion in paragraph 129(4.1)(b) comes into play. The operations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This I regard to be the basic approach to paragraph 129(4.1)(b). Whether income-producing property has crossed the dividing line into the paragraph will depend on the facts of each case. I am satisfied that the facts under consideration do not place the relevant property within it. The relationship between the debts created by the term deposits and the appellant’s businesses was tangential at best. The debts were never resorted to in aid of the appellant's businesses nor was there any real expectation that they would be. The fundamental purpose of these term deposits was unrelated to sustaining the appellant’s businesses, but it was to direct the profits therefrom into the hands of the shareholders, primarily by way of bonuses.

In a more recent case, McCutcheon Farms Ltd. v. Canada, [1991] 1 C.T.C. 50, 91 D.T.C. 5047, Strayer, J. of this Court was seized with a corporate taxpayer engaged in grain farming operations as well as in producing and in selling certified seed and selling fertilizers and chemicals supplied by the Cargill Company and Cominco. The taxpayer had considerable surplus funds which it invested in negotiable paper with Cargill, with the Saskatchewan Wheat Pool and with its banker. Over the taxation years 1981-1982-1983, the income earned from these funds represented 15 to 20 per cent of the gross income of the taxpayer and over 50 per cent of the net income before taxes.

The taxpayer had taken the position that these funds were necessary to pay expenses. They were also necessary, it was said, to provide for replacement of expensive farm machinery and to permit the acquisition of additional lands.

On the facts, Strayer, J. found that these funds had not in fact been used for the alleged purposes, with the exception of one transaction of a relatively minor nature which had occurred prior to the taxation years in question. At pages 53-54 (D.T.C. 5051), he adopted the words of Christie, A.C.J.T.C., in the Atlas Industries case, supra, that the relationship between the surplus funds and the taxpayer's business “was tangential at best”. He also relied on the observation of Wilson, J. in the Ensite case, supra, where she stated that the business purpose for the use of property is not enough and where she regarded that profits held by a business in order to achieve some collateral purpose such as replacement of a capital asset in the long run as not being “employed or risked in the business” and therefore not"property used or held . . . in the course of carrying on a business”.

It is made abundantly clear from the foregoing review of cases on the subject that the determination of whether income is income from property or business income is essentially one of fact in which regard must be had to all surrounding circumstances. It can truly be said that in that field precedent is an unruly horse.

It can also be said that in providing for a preferential tax treatment for business income in section 125, Parliament imposed a somewhat more artificial or legalistic distinction between the kinds of income which a business may earn. The more traditional doctrine that all income earned by a business is business income might give rise to the rebuttable presumption expressed by Wilson, J. in the Canadian Marconi case, supra, but it seems to me that what a Court must determine is whether such income is from a business and not by a business.

Findings

The main thrust in the defendant's position was that in its business of bidding for furs at Hudson's Bay Company auctions, the costs of its purchases were always at its risk. The terms and conditions of the auction imposed by the auctioneer were such that the latter looked to the "Purchaser" for payment. Hudson's Bay Company would not presumably be chasing all over the North American map for payment from the taxpayer's customers or clients.

In the Tax Court of Canada, Judge Tremblay noted particularly that in 1979, the defendant had $335,000 in certificates of deposit and in that year, the defendant bid $400,000 worth of goods. The honourable judge concluded that these certificates became part of the capital structure and financial credibility of the taxpayer to acquire fur pelts at auction sales and to carry on the fur business. The interest earned was therefore part of the normal business activity of the defendant and inextricably linked with an active business.

It is certain that in his evidence, Mr. Irving Garber made much of the particular risks involved in purchasing furs at auctions. To hear him describe it, for any purchase of fur lots on behalf of a purchaser, he required an equivalent amount of liquid funds to pay for them. I am somewhat concerned, however, with the inferences which might be drawn from other parts of his evidence and from reams of documents filed by defendant's counsel. I would list my concerns as follows:

1. Although Hudson's Bay Company looked to the defendant for payment, it must be recognized that at no time would the defendant lose possession or control of its furs in the event a customer defaulted. The furs were kept by the auctioneer until payment, but if the defendant ever had to make good because of default by any of its customers, it obtained ownership and delivery of the furs which it would then be at liberty to sell on its own account. The risK would not be eliminated but would be considerably attenuated.

2. Although Mr. Garber stated that for 1979 some $400,000 worth of furs were purchased at these auctions, there is evidence that the income from that whole series of transactions was some $13,450. If I follow Mr. Garber's reasoning on the element of risk in that respect, one might well wonder how an astute and experienced trader such as the witness could possibly put $400,000 at risk for a gross return of about three per cent.

3. Documentary evidence discloses that the defendant's purchases of furs at auctions were made at different auctions. At each auction, several purchases were made and these were for the account of several principals. It is in evidence that over the years Mr. Garber had developed a large and widely dispersed list of customers in both Canada and the United States and on behalf of whom he would bid on several fur lots over several auctions. It is inconceivable, in my view, that the total of these purchases in any one year would have been for the account of customers all of whom would have successively defaulted in that same year.

4. Again on the issue of risk, the defendant's receivable for each of the years in question are set out in its financial statements:

On the foregoing, it could not be contended that a high level of working capital would have been required for the defendant's operations.

5. Mr. Garber testified that he had to have access to ready cash to finance his customers' auction purchases and in so doing also increase the commission rate otherwise payable to him. The evidence discloses, however, very limited exposure in that respect over the taxation years in question. Furthermore, whatever the accommodation provided to customers, it was for relatively small sums and for relatively short terms. This evidence is of course consistent with the information disclosed in the defendant's balance sheet for each year.

6. I should also note Mr. Garber’s admission in his evidence that during the years in issue, the debt collection rate was good.

I should perhaps repeat here what was said by Madam Justice Wilson in the Ensite Ltd. case, supra, that the business purpose for the use of property is not enough. If it is not employed or risked in the business, it is not property used or held in the course of carrying on business. In the matter before me, I can well appreciate the purpose of the defendant's surplus funds or the intention of Mr. Garber in accumulating them. Such an intention, however, must be analyzed or considered in the light of more objective facts gathered through the experience of the defendant's operations from year to year. I should therefore find that on the whole, the defendant's income-producing certificates which grew from $285,000 in 1978 to $623,000 in 1982 cannot be said to have been required in or necessary to the defendant's operations or to have been part of its working capital or to have been incidental or pertaining to its active business.

It is especially in connection with what appears to be a cumulative approach to the defendant's exposure or risk that I find myself, with respect, in disagreement with the finding of the learned judge of the Tax Court of Canada as disclosed in his reasons. I find no correlation between the total amount of many purchase contracts executed over several auctions for the account of several customers and the total amount of reserves required to cover the risk.

And yet, such a finding should not necessarily bring the enquiry to a full stop. If a court be required to look at all the facts and circumstances of the case, the evidence discloses that throughout the period under review, the defendant had nothing but its certificates of deposit to give it continuity and stability or to meet shorter or longer term liabilities. It had no fixed assets, no work in hand, and little, if any, inventory. More than that, the defendant, for reasons of its own, did not operate through a fat current bank account. It preferred obviously to keep a relatively low, fluctuating margin of credit balances, investing any surplus into liquid short-term, income-producing certificates.

It is trite to say that if any taxpayer is to set up and organize a business to make profits, concurrent business risks, market fluctuations and contingencies require that some funds be available to meet unexpected downturns or unexpected liabilities or to replace equipment or maintain an adequate cash flow. A business cannot be operated on a hand-to-mouth basis and it is evident that any business operation without some kind of cash reserves is going to be short-lived.

The Income Tax Act has long recognized liquidity problems inherent in a business activity and has taken steps to alleviate them. The Act allows reasonable reserves for bad debts. It allows non-cash expenditures through depreciation allowances. It also allows for interest expense on business loans and it could be said in that regard that it is a converse situation to one where the taxpayer, as in the case before me, accumulates an appropriate amount of reserves and, if invested, adds the income to his business profits.

In the case at bar, I have already referred to the evidence of Mr. Garber when he described his uphill struggle to re-establish his credit rating so as to enable him to be accepted as a purchaser at Hudson's Bay Company fur auctions. Unfortunately, there is no hard evidence as to what was actually required by the Company in that respect and indeed, the evidence indicates that no actual audit of the defendant's books was made nor financial statements produced. As a matter of fact, as I have already indicated, the evidence produced by the defendant as to significant exposure either through auction purchases or through other business activities relating to sales of fur garments is not as convincing as it might otherwise have been.

Nevertheless, a finding that the total reserves at issue were not necessary to the defendant's operations nor incidental or pertaining to its business activities does not necessarily mean that no reserves fill these conditions. As was stated by the Honourable Judge Rip of the Tax Court of Canada in Sanilit Ltd. v. M.N.R., supra, at page 2083 (D.T.C. 454):

It is clear that a company needs a reasonable financial reserve to carry on business; usually the reasonable reserve has a direct or ancillary relation to the business.

[Emphasis added.]

In the Sanilit case, however, Rip, J., after finding the reserve amounts as being too high, felt obliged to dismiss the taxpayer's appeal “ because there was no evidence that the said reserve amounts would be reasonable in the circumstances".

The issue of reasonableness was also raised by my colleague Strayer, J. in the case of McCutcheon Farms Ltd., supra, where the reserve amounts claimed were regarded as too high but where it was argued that some reserves were essential to the taxpayer's operations. In that regard, Strayer, J. said this, at page 55 (D.T.C. 5050):

But there is a basic problem in that the plaintiff has not shown clearly what would be a reasonable reserve nor does the evidence indicate any rational relationship between the principal sums accumulated and the reserves required.

In both the Sanilit and the McCutcheon cases, it appears to me that the investments under dispute were segregated from the normal operations of the taxpayers' businesses. Whether the parties liked it or not, the issue was to be decided on a black or white basis.

I should find that such is not quite the situation before me. The amounts in dispute were integrated in the defendant's operations and, apart from any valuation placed on goodwill, constituted substantially the whole of the defendant's assets. I admit that argument at trial was not specifically directed to the questions of reasonableness. Nevertheless, that issue was raised in the plaintiff's pleadings and there is, in my view, sufficient oral and documentary evidence on record to make a finding on it.

As will readily be observed in the defendant's financial statements, there were only nominal amounts of receivables and inventory from year to year. Under both heads, there were none in 1978, there was a total of some $3,300 in 1979, $14,640 in 1980, $14,520 in 1981 and $9,500 in 1982. These same statements also clearly show practically a complete absence of fixed assets. This situation might be readily ascribed to the nature of the trade in which the defendant was engaged but, nevertheless, it gives strength and substance to the need of some correlation between business risks on the one hand and reserve requirements on the other.

It follows that although the reserves claimed by the defendant are indulgent and excessive, there are nevertheless operation requirements reflected in the following factual summary:

1. The defendant was always open to some degree of contingent liability under the terms of its auction bids with Hudson's Bay Company;

2. Mr. Garber's prior misadventure required him to create and maintain financial stability if his business operations were to be regarded as respectable in the trade;

3. There is evidence that banking accommodation was required from time to time and this accommodation was made available by reason of the defendant's reserves;

4. There is evidence that no tangible assets were available to the defendant as pledged security for any such accommodation;

5. There is evidence that some individual purchases at auctions were substantial;

6. Although the risks involved in fur auctions were not, as I have found, cumulative, there is evidence of the defendant having to extend some lines of credit to some of its customers with a concomitant financial risk.

After taking all the foregoing factors into consideration, including the volume of the defendant's operations, its contingent liability to Hudson's Bay Company, a need for financial stability as well as a perceived requirement for it as far as the trade is concerned, I would fix a reasonable amount for reserves at the sum of $200,000. In all other respects, the plaintiff's assessments for the taxation years in question are confirmed.

Conclusion

I should therefore direct that the assessments for the years 1978 to 1982 made by the plaintiff be varied so as to include in the defendant's business income for each of those years the income earned on $200,000. The balance of the income earned by the defendant is income from investments.

I have considered the matter of costs. I should conclude the parties should bear their own.

I should also leave it to the parties to agree on the terms of a formal judgment and submit it to me for my endorsement. If necessary, I may be spoken to and in the meantime I remain seized of the case.

Appeal allowed in part.