[OFFICIAL ENGLISH TRANSLATION]
Date: 20021211
Docket: 1999-2309(IT)G
BETWEEN:
L.D.G. 2000 INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers, J.T.C.C.
[1] This case involves appeals from
two reassessments made by the Minister of National Revenue (the
"Minister") on May 21, 1996, and confirmed on February
8, 1999, for each of the 1993 and 1994 taxation years, and from a
reassessment made by the Minister for the 1995 taxation year,
which was also confirmed on February 8, 1999. The Minister
disallowed the small business deduction claimed by the appellant
for the three taxation years in question as well as a deduction
of $57, 304 on the grounds that this amount was a
non-deductible capital outlay under paragraph 18(1)(b) of
the Income Tax Act (the Act) and not an
operating expense.
[2] To explain the background of the
dispute as it relates to the disallowance of the small business
deduction for the three taxation years, the parties, by
consent, produced in evidence as Exhibit A-2 an
organization chart of the various corporations and their
Shareholders, which I reproduce as follows:
[3] In addition, Bermex owns 100% of
the shares of a corporation called SPEQ Régionale
Maskinongé Inc. (hereinafter "SPEQ") and
80% of the shares of Bermex Construction Inc.
(hereinafter "Bermex Construction"), of which the
other 20% is owned by one Maurice Lafrenière.
[4] It should be noted at the outset
that the appellant company was called
Ébénisterie Cardinal Inc. during the
years at issue and until October 5, 1998. At that time, it
became L.D.G. 2000 Inc., which explains the style of cause
of this case. Since December 17, 2001, the company has been
called Meubles D'Autrey Inc.
[5] During the years at issue, L.D.G.
manufactured furniture from raw materials, but did not apply the
finish. It sent its furniture to Chez Soi or Bermex to have
the desired finish applied. Bermex, in addition to finishing
furniture manufactured by L.D.G., stored the finished products
with a view to their eventual sale to retailers. It also sold
some of the furniture at retail itself. For its part, Chez Soi,
in addition to finishing products manufactured by L.D.G., did
such work for other suppliers.
[6] Richard Darveau testified for
the appellant. He is an accountant by profession and also a
director and vice-president, finance, of Gestion. As we know,
Gestion holds 50% of the appellant's shares. It has owned an
interest in L.D.G. since 1989. At that time, Gestion was looking
for table manufacturers, and André Cardinal and
Stéphane Lamarche, who were operating L.D.G. under
its former name, offered their services and products. Being
interested by the offer and satisfied with the products, Gestion
bought 50% of the capital stock of L.D.G. Messrs. Cardinal
and Lamarche held the other 50%, each having a 25% interest.
After this purchase, Messrs. Cardinal and Lamarche were
assigned to production while Gestion took care of management.
After the years at issue, that is, in 1999, Gestion became the
owner of 100% of L.D.G.'s capital stock and subsequently sold
part thereof and eventually changed the name of that company.
[7] From 1993 to 1995, André
Cardinal was the president of the appellant and, according to
Mr. Darveau, he managed the business. Together with
Stéphane Lamarche, he handled the purchasing,
production and new product development and signed 98% of the
appellant's cheques. Depending on its production cycle, the
appellant could have as many as fifty employees;
André Cardinal was in charge of hiring and firing.
For his part, although he was not an employee of the appellant,
Richard Darveau checked the invoices, ensured that the best
prices were obtained for purchases and paid the bills. As for
Denys Laberge, the other shareholder of Gestion, through
"Promotions", he saw to the development of the products
to be manufactured, assisted by André Cardinal and
Stéphane Lamarche. André Cardinal's wife
did the bookkeeping. According to Richard Darveau, the
day-to-day decisions were made by Messrs. Cardinal and
Lamarche. The shareholders met once or twice a year only to
discuss major investments, as that kind of decision was made
collectively.
[8] Again according to
Richard Darveau, the furniture sent to Bermex for finishing
was purchased by that company. L.D.G. sometimes sold its products
to companies other than Bermex, just as Bermex during the years
at issue, sometimes dealt with suppliers other than L.D.G.
According to Mr. Darveau, L.D.G. had never been indebted to
Gestion.
[9] On March 21, 1992, a
shareholder agreement (A-3) was signed by the following
parties, namely: André Cardinal,
Stéphane Lamarche, Gestion, L.D.G.
(Ébénisterie Cardinal), Denys Laberge,
Richard Darveau and Jacques Gagnon. This agreement
contained, inter alia, provisions concerning the transfer
of shares, the conditions of transfer, the voluntary departure of
a shareholder and the exercise of powers. The relevant clauses
are the following :
[Translation]
6. TRANSFER
TO A MANAGEMENT CORPORATION
6.1 Notwithstanding the
provisions of section 5 above, a Shareholder may sell, assign or
transfer all, but not part, of that Shareholder's shares to a
management corporation (hereinafter referred to as the
"Gesco"), controlled by that Shareholder, provided that
the Gesco be bound by the terms and conditions of this agreement,
with necessary changes, and that it participate for that purpose
in this agreement. In addition, no shares of the capital stock of
the Gesco shall be issued unless the issue is first approved in
writing by the Shareholders.
6.2 Similarly, each Owner
may sell, assign or transfer all, but not part, of that
Owner's shares of the capital stock of a Shareholder to a
Gesco that is controlled by that Owner provided that the Gesco be
bound by the terms and conditions of this agreement, with
necessary changes, and that it participate for that purpose in
this agreement. In addition, no shares of the capital stock of
the Gesco shall be issued unless the issue is first approved by
all Shareholders.
6.3 Furthermore, each
Shareholder and each Owner agrees that, notwithstanding the
transfer of their shares to a management corporation as referred
to above, they shall continue to be bound by the provisions of
this agreement that are applicable to them individually, and they
each personally guarantee, jointly and severally, the obligations
of such management corporation under this agreement, and renounce
for these purposes the benefits of division and discussion.
7.
CONTROL
For the purposes of this agreement, a Shareholder or an Owner
controls a management corporation if the Shareholder or Owner
holds or is the recipient, otherwise than by way of guarantee
only, of more than seventy-five per cent (75%) of all voting,
issued and outstanding shares of the capital stock of the
management corporation, thus giving the Shareholder or Owner at
all times the right to unconditionally elect a majority of the
directors of the management corporation in accordance with the
articles of incorporation and by-laws and the shareholder
agreement, if any, governing the rights and obligations of the
Shareholders of the management corporation. In addition, a
Shareholder or an Owner must indirectly control all of the
corporations controlled by the management corporation that the
Shareholder or Owner controls.
8.
CONDITIONS OF TRANSFER
. . .
8.3 Where a Shareholder or
an Owner transfers shares belonging to that Shareholder or Owner
to a management corporation, in accordance with the terms and
conditions prescribed above, and where the control of a
Shareholder changes hands or a Shareholder or Owner loses the
control of a Gesco for whatever reason, without the express
written consent of the other parties to this agreement, the
Shareholder concerned shall immediately offer that
Shareholder's shares for sale to the other Shareholders in
accordance with the provisions of paragraph 13.4 of this
agreement.
. . .
13. VOLUNTARY
DEPARTURE
13.1 Should "Cardinal"
and/or "Lamarche" and/or "Gestion" decide to
leave the Corporation voluntarily, the redemption price for the
shares shall be based on the book value of the corporation as
follows:
- 50% of the book value of the shares of the Shareholder
resigning from the Corporation if "Cardinal" or
"Lamarche" or "Gestion" have been
Shareholders for more than two (2) years and less than five (5)
years.
- 75% of the book value of the shares of the Shareholder
resigning from the Corporation if "Cardinal" or
"Lamarche" or "Gestion" have been
Shareholders for more than five (5) years and less than ten (10)
years.
- 85% of the book value of the shares of the Shareholder
resigning from the Corporation if "Cardinal" or
"Lamarche" or "Gestion" have been
Shareholders for more than ten (10) years.
13.2 The shares transferred by the
resigning Shareholder shall be redeemed by the remaining
Shareholders in proportion to the number of shares in the capital
stock of the Corporation held by each remaining Shareholder.
. . .
13.4 If a Shareholder or the Owner of
the Shareholder makes an assignment of the Shareholder's
property for the benefit of that Shareholder's creditors, if
the Shareholder becomes manifestly insolvent or goes bankrupt, if
the Shareholder is declared to be under an interdiction by a
court of competent jurisdiction, or if the assets of the
Shareholder are seized and not released within a period of
fifteen (15) days, the share redemption price shall be equal to
twenty-five (25) per cent of the book value of the shares of the
insolvent Shareholder of the Corporation.
. . .
19. EXERCISE OF
POWERS
For the purposes of the exercise by the Shareholders of the
powers and rights conferred on them and granted to them under the
Quebec Companies Act, the Shareholders agree that,
notwithstanding the provisions of the by-laws of the Corporation,
the proportion of votes required for the adoption of a resolution
or decision by the Shareholders shall be sixty-six per cent (66%)
of the votes of the Shareholders.
[10] An addendum to this agreement was
entered in evidence as Exhibit A-4. According to the
addendum, it was signed on May 28, 1992, and it amends
clauses 13.2 and 2.4 of the agreement as follows:
[Translation]
ADDENDUM TO THE AGREEMENT BETWEEN THE SHAREHOLDERS
OF EBENISTERIE CARDINAL INC. DATED MARCH 21, 1992
The parties unanimously agree that article 13.2 of this
agreement is revoked.
The parties agree that, if Cardinal sells his shares, Lamarche
shall redeem Cardinal's shares and, if Lamarche sells his
shares, Cardinal shall redeem Lamarche's shares.
The parties also agree to amend the definition of the term
"invalidity" in article 2.4 and elsewhere in the
agreement. The term "invalidity" shall be replaced by
the words "permanent invalidity". In addition, the
parties agree to add, at the end of article 2.4, the phrase
"for an indeterminate duration".
[11] The date of signature of the addendum
was questioned by the respondent. Richard Darveau does not
remember where the addendum was signed, but he does remember
where the agreement was signed because there were several people
present. I shall come back to this matter later.
[12] With regard to the expenses relating to
the roof, Richard Darveau explained that L.D.G. had leased
the building in question until August 17 1992, when it purchased
it for $285,000. Since the former owner had neglected to repair
the roof, there was water leakage every spring to the point that
there were plastic sheets hanging just about everywhere. They
accordingly obtained an estimate for the cost of the repairs,
which would consist of removing the sheet metal and mineral wool
and redoing the trusses. They finally decided to put a new roof
on top of the existing one so that the old roof would serve as a
partition. This also made it possible to alter the slope of the
roof.
[13] They also built an addition to replace
a factory called Industrie Gervais that had been demolished
by a hurricane in 1991. Since the two projects were not carried
out at the same time, L.D.G.'s financial statements indicate
that the cost of the new part, that is, the addition, was
capitalized and the cost of the repairs was recorded as an
operating expense: this is one of the points in dispute. Property
taxes rose from $244,100 in 1991, that is, before the
construction, to $575,300 for the triennial roll for 1993, 1994
and 1995. However, the property tax bill for the period from 1993
to 1995 predated the construction of the new roof.
[14] On cross-examination, Mr. Darveau
explained that Gestion was involved in the manufacture of
furniture through Bermex and through its subcontractors before it
purchased L.D.G. In addition, as we know, Bermex had been
wholesaling its production to merchants since its creation in
1983. L.D.G., whose shareholders were Messrs. Cardinal and
Lamarche, was one of the subcontractors of Bermex whose
manufacturing component was less than 3%. Mr. Darveau
admitted that, following the purchase by Gestion, Bermex
subcontracted, on average, 50% of its orders to L.D.G. He also
admitted that Gestion, at the time it purchased 50% of
L.D.G.'s shares, created "Chez Soi" to finish
the furniture manufactured by L.D.G. and Bermex's other
subcontractors. The shareholders of Chez Soi were Richard
Darveau's two brothers who each held 15% of the shares, and
Gestion, which held the rest.
[15] Two other companies were mentioned
during the cross-examination, namely,
Bermex Construction Inc. (hereinafter
"Bermex Construction") and SPEQ Régionale
Maskinongé Inc. (hereinafter "SPEQ").
Gestion held 80% of the shares of Bermex Construction which
was the company that rebuilt the plant destroyed by the
hurricane. As for SPEQ, Gestion held 100% of its shares. SPEQ was
a corporation that manufactured wood panels, whose production
and, ultimately, whose machinery, were sold to L.D.G. The witness
acknowledged that Gestion was merely a holding company.
[16] The appellant's financial
statements for the taxation years at issue contain the following
note: [TRANSLATION] "the sales figures for L.D.G. come
almost entirely from two affiliated companies, one of whose
shareholders is also a shareholder of the corporation". The
witness Darveau explained, however, that in 1995 a little more
than 75% of the sales, not almost all of them, were accounted for
by those companies. In fact, the appellant's financial
position went from loss to profit due to the fact that it sold
its production to Bermex and Chez Soi and had increased its
volume of production. When asked why L.D.G. could not obtain
financing from the banks, Mr. Darveau stated that 100% of
L.D.G.'s production was sold to only two companies. Mr.
Darveau explained that L.D.G. had just two customers, had no
receivables and was dependent on Bermex. This meant that L.D.G.
could not obtain bank financing. Richard Darveau admitted
that Bermex had financed L.D.G. during the years at issue, but
qualified this by wondering whether it was financing or the
payment to L.D.G. of an account payable. However, at the
examination for discovery, he admitted that Bermex had obtained
bank loans because it was the only corporation that had accounts
receivable. In fact, he said that Bermex was the only corporation
that had taken out loans and that it had a $4 million line of
credit. He added that L.D.G. and the shareholders had guaranteed
part of Bermex's debt, but he did not specify what percentage
of the debt.
[17] L.D.G. had agreed with Bermex and
Chez Soi that the price on sales to those two companies
would be grossed up by 15% to ensure a gross profit margin for
them, according to Mr. Darveau. The sale price was therefore
adjusted to ensure that return, and the adjustment was often made
at the end of the year. Mr. Darveau admitted that he could
do this with L.D.G. because it was an affiliated company, whereas
he could not do the same with his other subcontractors.
[18] On October 31, 1994, Bermex
Construction signed an agreement with L.D.G. in which it
undertook to provide labour to help L.D.G. renovate its
Berthierville building. The agreement did not provide for any
payment in consideration of this service, except the billing of
L.D.G. for the actual cost of the renovation.
[19] In 1997, André Cardinal
left L.D.G., and Gestion became the majority shareholder of that
company by purchasing Mr. Cardinal's shares.
[20] The appellant also called
Jacques Gagnon, CA, to testify. Mr. Gagnon said he was
not an employee of L.D.G., but held 25% of the shares of Gestion
through his company AJMEH. At the time, Mr. Gagnon was in
charge of personnel at Bermex. He supervised the accounting and
examined L.D.G.'s monthly and interim financial statements.
According to Mr. Gagnon, L.D.G.'s bookkeeping was done
in-house; personnel management was handled by Messrs. Lamarche
and Cardinal; and purchasing was done by Mr. Lamarche.
[21] Mr. Gagnon produced a chart
(Exhibit A-10) showing L.D.G.'s long-term debt and to
whom it was indebted. From the chart it can be seen that the
percentage of debt held by the Bermex group during the years at
issue was nil in 1992, 36% in 1994 and 66% in 1995. A second
chart (Exhibit A-11) was filed showing the percentage of
L.D.G.'s sales to the other members of the group. In 1993,
95% of L.D.G.'s sales were made to Bermex and Chez Soi;
in 1994, 85%; and in 1995, 79%.
[22] The shareholder agreement (Exhibit
A-3) was drafted by Jacques Gagnon. He explained some
of its clauses and added that, at the request of
Messrs. Lamarche and Cardinal, the addendum (Exhibit A-4)
was prepared in order to enable either of the two to purchase the
shares of whoever of them should leave, so as to retain 50% of
the shares. According to Mr. Gagnon, the addendum was signed
in May 1992.
[23] On cross-examination, Mr. Gagnon was
asked to compare his chart (Exhibit A-10) with excerpts
from L.D.G.'s general ledger (Exhibit I-2).
L.D.G.'s debts to Bermex for the years at issue shown on Mr.
Gagnon's chart corresponded to the excerpts from the general
ledger, with the exception of the debts dated February
28, 1993: for that date the general ledger indicates a total
of $507,643.90 whereas Exhibit A-10 does not show any debt.
The explanation provided by Mr. Gagnon with respect to this
was that the general ledger was not definitive, and that he had
prepared his chart on the basis of L.D.G.'s audited financial
statements. He admitted that the first debt on the list, namely,
the debt owing to
Garage Côté Laroche Inc., an
unaffiliated company, was a non-interest-bearing loan, with no
repayment terms, in the amount of $300,000 taken out during the
years at issue. He also admitted that a $75,000 debt owed by
L.D.G. in 1995, was owed to a company called
Servan RDAJ Inc., 66% of the shares of which were owned
by Richard Darveau and the other 33% were held by the wife
of Denys Laberge. Mr. Gagnon added, however, that he
considered that debt in the percentage of debts owed to the
Bermex group.
[24] Also on cross-examination,
Mr. Gagnon acknowledged that, further to a conversation in
August 1998 with Irène Lalonde, an auditor with
the respondent, he had promised to send her documents, which she
apparently did not receive until September 24, 1998. Those
documents were the shareholder agreement and addendum. The letter
faxed by Mr. Gagnon with the documents explained that, in
1992, when they met with a notary, the notary had had them amend
the agreement so that L.D.G. would not be affiliated with Bermex.
Mr. Gagnon could not explain, however, why the addendum was
not sent until September 24, 1998, and no longer recollected what
he had told Ms. Lalonde about the signing of the two
documents.
[25] Stéphane Lamarche stated
that he was the co-founder of L.D.G. (formerly
Ébénisterie Cardinal), but had not held shares
in that company for two and a half years. During the years at
issue, he was responsible for new production models and managed
the employees. He explained that André Cardinal and
he handled the day-to-day decision making while the other
decisions were made by all the shareholders. The meetings often
took place over dinner and the provision on the exercise of
powers in article 19 of the agreement was followed. Mr. Lamarche
testified that, when André Cardinal left L.D.G., he
was not interested in purchasing the latter's shares.
Concerning the addendum, he said he had a rough recollection of
it, but thought he had signed it on the date indicated, namely
May 28, 1992.
[26] On cross-examination, Mr. Lamarche
acknowledged that he had had a telephone conversation with the
respondent's counsel in the week before the trial and had
told her that, in his opinion, the agreement had been signed by
the parties while they were in an area north of Montreal, but he
did not remember where the addendum had been signed. The lawyer,
he said, had faxed him a copy of the addendum that same day and,
when she called him back to discuss it, he had not spoken to her,
on the pretext that he was talking to a government representative
on another line.
[27] The date of signature of the addendum
was seriously questioned by the
respondent. Marc Gaudreau testified and explained what
he had done to have the document analysed in order to determine
whether or not it had been signed in 1992. Thus, one of his
employees took a sample of the ink used in each of the three
signatures on the addendum. In his affidavit, produced in
evidence by the appellant as Exhibit A-12, he reported
that the expert had concluded that André Cardinal's
signature could not have been written in 1992 because the ink
used in his signature was not available commercially until
1995.
[28] The expert in question, Gérald
Laporte, testified as an expert in the analysis of documents,
which included the chemical and physical analysis of various
types of ink and paper. He explained the process the samples
underwent and the analysis he performed on them. Through such an
analysis, using a database of more than 7,600 samples of ink from
all over the world, he can identify the manufacturer of ink and
thus ascertain when it was available on the market. On the basis
of his analysis, he was able to conclude that the ink from the
Bic pen used for André Cardinal's signature was
not available commercially until January 1995 and that its
production only began in June 1995. He testified that the
samples received were carefully sealed and kept in separate
containers. Although the database was not exhaustive, it was
regularly updated and he was satisfied that it contained all the
ink samples.
[29] In 1996,
Jean-François Normand was a business auditor with the
Department of National Revenue's tax services and he
conducted an audit of the appellant for the years at issue. He
was in contact primarily with Jacques Gagnon and he
attended at the place of business of Bermex and L.D.G. According
to Mr. Normand, the appellant was affiliated with SPEQ,
Chez Soi, Bermex Construction, Bermex and Gestion. He
reached this conclusion on the basis that Gestion was the
corporation that controlled de facto all the others, and he
maintained that his conclusion was in accordance with the concept
of control in subsection 256(1) of the Act. The
factors that he took into consideration in reaching his
conclusion were those that are enumerated in Interpretation
Bulletin 64R3 and that allow one to determine, by examining
the facts, whether there was indeed de facto control.
[30] Mr. Normand accordingly took into
consideration the ownership of L.D.G.'s shares having regard
to article 19 of the agreement (Exhibit A-3) and noted that
the proportion of votes required for the adoption of a
shareholders' resolution was 66%, and that this was so
despite the corporation's by-laws. Since Gestion held 50% of
the shares, it could block any decision by itself.
[31] Mr. Normand also took article 20
of the agreement into account, noting that the shareholders
undertook therein to exercise their voting rights in such a way
that Denys Laberge and Richard Darveau would be
appointed directors. These two people, through their companies,
Promotions and 2765791, were Gestion's majority shareholders.
Mr. Normand added that the appellant's board of
directors consisted of five directors. According to
Exhibit I-2, Tab 11, the directors were
Richard Darveau, Denys Laberge, Jacques Gagnon,
Stéphane Lamarche and André Cardinal.
Each director was entitled to one vote and all matters submitted
to the board were to be decided by a simple majority (see Exhibit
I-2, Tab 14, paragraph 9.09). Gestion's three
shareholders, through their respective corporations, thus
controlled the decisions of the appellant's board of
directors and also controlled Gestion.
[32] Article 9 of the agreement deals
with the remuneration of Messrs. Lamarche and Cardinal, including
salary increases, vacation, and repayment of leave from work.
According to Mr. Normand, these were conditions normally
found in a contract of employment rather than in a shareholder
agreement. Accordingly, this demonstrates control, that is, it
indicates who was really directing the appellant. He also took
into account the contributions to the capital stock shown in Tab
5 of Exhibit I-1, which showed that Gestion held 50%
of the issued and paid up shares. He further noted that Bermex
had agreed to advance funds to the appellant. That agreement
seemed obvious to him since Gestion controlled Bermex. With
respect to the long-term debts listed in Exhibits A-10 and
I-2, Mr. Normand claimed that there should have appeared in
Exhibit A-10 a debt of $507,643,90 owed to Bermex in
1993, as shown on page 2 of Exhibit I-2. He maintained
that an adjusting entry could have had an impact in this regard,
but asserted that there was no adjusting entry. He also noted
that the second page of Exhibit I-2, namely the one
numbered 103, was dated January 24, 1995, and was therefore
subsequent to the financial statements at Tab 5 of Exhibit
I-1, which were dated October 20, 1994.
[33] Mr. Normand maintained that the
conditions enunciated in clauses 4.1 and 4.2 of the
shareholder agreement had not been met because the loans from
Bermex were non-interest bearing and clause 4.2 could not be
complied with since the loan was not made in accordance with
clause 4.1 of the agreement, which reads as follows:
[Translation]
Any investment that may become necessary for the proper
administration of the Corporation shall be invested by the
Shareholders in proportion to their holdings of common shares, at
no interest. Should circumstances require that one of them make
an advance greater than the required proportion, the portion of
the advance that exceeds that proportion shall bear interest at
the rate of 10% per annum.
There was no written contract governing the terms and
conditions of L.D.G.'s debts with respect to the advances
from Bermex. Mr. Normand noted that L.D.G. was economically
dependent on Bermex and that its sales figure rose from $309,000
in 1990 to over $3,000,000 in 1995 by virtue of the fact
that it did business with Bermex and because Gestion held 50% of
the shares of L.D.G. Mr. Normand also questioned the year-end
adjustment whereby a supplementary invoice was prepared to
increase the appellant's sales or create an operating
expenditure in order to ensure a profit for the appellant (Tabs
17 and 18). This was not a common practice in the case of
independent corporations.
[34] Mr. Normand also took into account
the fact that insurance policies had been grouped together so
that the insured, Bermex, was defined as including the appellant
and other corporations, although he acknowledged that this in
itself was not a decisive factor. He added, however, that a
lawyer's bill dated January 21, 1992, in respect of the
appellant, L.D.G., had been sent to the address of Bermex (see
Tab 21 of Exhibit I-1). An invoice for a business plan for
the appellant had been sent for the attention of Jacques Gagnon
at the address of Bermex (Tab 22, Exhibit I-1). A
purchase order that can be found at Tab 23 of
Exhibit I-1 was signed by Richard Darveau instead
of André Cardinal, who was the president and handled
the day-to-day management of the appellant.
[35] Another fact that Mr. Normand took
into consideration was the agreement between the appellant and
Bermex Construction to provide labour to L.D.G. for the
renovation of one of its buildings. He found that the terms of
the agreement were not the customary ones and did not provide for
any consideration (see Tab 28 of Exhibit I-1). The
cost of the services provided was recorded (see Tab 29 of
Exhibit I-1), and payment of that amount by the appellant
to Bermex Construction was made following advances of funds
by Bermex to the appellant.
[36] Mr. Normand said he never saw the
addendum (Exhibit A-4) during his audit although he had
asked to see all the documentation. Such requests are standard
practice when an audit is conducted.
[37] With regard to the expenses relating to
the roof, Mr. Normand considered four criteria in order to
determine whether they were operating or capital expenses. The
work done provided a lasting benefit as well as a very
appreciable improvement of the property in that the slope of the
roof was altered and insulation and more durable materials were
used. The relative value of the repairs by comparison to the
purchase price, without the land, was 23%, and the repairs were
made shortly after the date of purchase, that is, about two
months later, which indicates that the appellant was aware of the
state of the roof at the time of the purchase.
[38] On cross-examination, Mr. Normand
acknowledged that he had seen mutual insurance in the case of
companies that were at arm's length and that it is possible
for a manufacturer to supply all of its production to a single
customer.
[39] Irène Lalonde is a large
business auditor with Revenue Canada and was the appeals officer
in the appellant's case. Concerning the matter of de facto
control, she testified that she had read Mr. Normand's
conclusions on this issue and was in agreement with him. In
addition, she examined the shareholder agreement and concluded
that there was also de jure control. As an example, she explained
that article 13.2 provided for the redemption of the shares
of a shareholder who resigned by the remaining shareholders in
proportion to the number of shares in the capital stock of the
corporation held by each of those remaining shareholders. In
other words, if Stéphane Lamarche or
André Cardinal left, Gestion would find itself with
66% of the shares, whereas if Gestion left, Messrs. Lamarche and
Cardinal would each have 50% of the appellant's shares.
According to Ms. Lalonde, by virtue of subsection 251(2) of
the Act, the effect of such a clause is that a person who
has the right, whether immediate or future, conditional or not,
to purchase shares of a corporation is deemed to be in the same
position in terms of the control of the corporation as if that
person owned the shares at that time.
[40] She continued her testimony by
explaining the steps she had taken and, specifically, by relating
a conversation she had had with Jacques Gagnon in which
he told her that she would be receiving a certain document early
in September 1998. Subsequently, she contacted a secretary, on
September 23, 1998, to inquire about the availability of the
document in question and was informed by the secretary that it
was ready but not signed. The following day, she received the
documents found in Tab 37 of Exhibit I-1, that
is, the shareholder agreement and the addendum.
[41] Ms. Lalonde subsequently met with
another representative of the appellant, namely
Me Marcoux, and discussed with him
clause 8.3 of the agreement, which in her view triggered the
application of subsection 251(2) of the Act, since
clause 8.3 conferred the right to purchase shares, which put
the holder of that right in a controlling position regarding the
corporation. As for the expenses relating to the roof, she agreed
with Mr. Normand's conclusion.
Analysis
[42] A "Canadian-controlled private
corporation" that carries on an active business in Canada
throughout a taxation year is eligible for a reduced rate of tax
on the first $200,000 of its income from that business
(subsections 125(1) and (2) of the Act). This tax
reduction is limited, however, to corporations that were not
associated during the taxation year with one or more other
Canadian-controlled private corporations. Where such a
relationship exists, the business limit of the corporation for
the taxation year is nil (subsection 125(2) of the
Act). These statutory provisions prevent corporations that
are associated or that belong to the same group of associated
corporations from taking advantage of the above-mentioned
reduction. However, subsection 125(3) of the Act
allows a group of associated corporations to file an agreement
whereby they allocate an amount to one or more of them for the
taxation year so that the amount so allocated or the total of the
amounts so allocated is $200,000, and in that case the business
limit for the year of each of the corporations is the amount so
allocated to it. In the case at bar, for each of the years at
issue, Gestion, Bermex, Chez Soi, SPEQ Régionale
and Bermex Construction filed with the Minister of National
Revenue such an agreement whereby they allocated the total
business limit to Bermex for the purposes of the small business
deduction. The appellant did not participate in that
agreement.
[43] The first issue is, therefore, whether
Gestion exercised de jure control, de facto control, or both de
jure and de facto control, over the appellant such that the
appellant may be considered to have been associated with Bermex
for the three taxation years in question. Paragraph 256(1) of the
Act defines the expression "associated
corporations" as follows:
256: Associated
corporations.
(1) For the purposes of this Act, one corporation is
associated with another in a taxation year if, at any time in the
year,
(a) one of the corporations controlled, directly or
indirectly in any manner whatever, the other;
(b) both of the corporations were controlled, directly
or indirectly in any manner whatever, by the same person or group
of persons;
(c) each of the corporations was controlled, directly
or indirectly in any manner whatever, by a person and the person
who so controlled one of the corporations was related to the
person who so controlled the other, and either of those persons
owned, in respect of each corporation, not less than 25% of the
issued shares of any class, other than a specified class, of the
capital stock thereof . . . .
[44] Subsection 256(5.1) explains that,
where control in fact is involved and the expression
"controlled, directly or indirectly in any manner
whatever," is used, a corporation shall be considered to be
so controlled by another corporation, person or group of persons
(in subsection 256(5.1) referred to as the
"controller") at any time where, at that time, the
controller has any direct or indirect influence that, if
exercised, would result in control in fact of the
corporation.
[45] The term "control" is not
defined in the Act. Formerly, that is, before the
provisions of subsection 256(5.1) were enacted, the term
"control" meant that a shareholder held a number of
shares that allowed the shareholder to appoint the members of the
board of directors. Such control was called "de jure
control" and was recognized as such by the courts: see, for
example, the decisions of the Supreme Court of Canada in
M.N.R. v. Dworkin Furs (Pembroke) Ltd. et al.,
67 DTC 5035 and Duha Printers (Western) Ltd. v.
Canada, [1998] 1 S.C.R. 795. The addition of
subsection 256(5.1) to the Act created a new concept
of control called "de facto control", as Iacobucci J.
stated moreover in Duha Printers (supra) at
paragraph 52:
52. Moreover, as Wilson J. correctly observed in her dissent
in Imperial General Properties, supra, taxpayers
rely heavily on whatever certainty and predictability can be
gleaned from the Income Tax Act. As such, a simple test
such as that which has been followed since
Buckerfield's is most desirable. If the distinction
between de jure and de facto control is to be
eliminated at this time, this should be left to Parliament, not
to the courts. In fact, while it is not directly relevant to the
outcome of this appeal, I would observe nonetheless that
Parliament has now recognized the distinction between de
jure and de facto control, adopting the latter as the
new standard for the associated corporation rules by means of s.
256(5.1) of the Income Tax Act, enacted in 1988.
[Emphasis added.]
[46] In Interpretation Bulletin IT-64R3
dated March 9, 1992, the concept of de facto control was
summarized as follows in paragraphs 17, 18 and 19:
17. De facto control consists of all forms, other than
de jure control, by which a person may exercise control
over a corporation. De facto control may even exist
without the ownership of any shares. It can take many forms, e.g.
the ability of a person to change the board of directors or
reverse its decisions, to make alternative decisions concerning
the actions of the corporation in the short, medium or long term,
to directly or indirectly terminate the corporation or its
business, or to appropriate its profits and property. A potential
influence, even if it is not actually exercised, would be
sufficient to result in de facto control.
18. The moment when the influence must exist, for the purposes
of the de facto control test, depends upon the context in
which the notion of control is applied. For example, in the case
of the small business deduction, where the status of
"Canadian-controlled private corporation" (paragraph
125(7)(b)) is critical, the potential control will be examined
for the whole year for which the deduction is claimed. In the
case of the investment tax credit (section 127.1), the reference
period will be the year in which the allowable expenses are
incurred.
19. Whether a person or group of persons can be said to have
de facto control of a corporation, notwithstanding that
they do not legally control more than 50 per cent of its voting
shares, will depend on each factual situation. The following are
some general factors that may be used in determining whether
de facto control exists:
(a) the percentage of ownership of voting shares (when such
ownership is not more than 50 per cent) in relation to the
holdings of other Shareholders;
(b) ownership of a large debt of a corporation which may
become payable on demand (unless exempted by subsection 256(3) or
(6)) or a substantial investment in retractable preferred
shares;
(c) Shareholder agreements including the holding of a casting
vote;
(d) commercial or contractual relationships of the
corporation, for example, economic dependence on a single
supplier or customer;
(e) possession of a unique expertise that is required to
operate the business; and
(f) the influence that a family member, who is a Shareholder,
creditor, supplier, etc., of a corporation, may have over another
family member who is a Shareholder of the corporation.
Although the degree of influence is always a question of fact,
close family ties (between parents and children or between
spouses) especially lend themselves to the development of
significant influences. Generally, these persons must demonstrate
their economic independence and autonomy before escaping
presumptions of fact which apply naturally to related
persons.
[47] There is no doubt that the concept of
de facto control and the direct or indirect influence that the
existence of such control may entail can have consequences when
applied to subsection 256(5.1) of the Act. Since a
question of fact is involved, the facts must be analysed with
care. In the case at bar, a number of factors must be taken into
consideration in determining that question.
[48] It was admitted in the evidence that
Gestion, Bermex, Chez Soi, SPEQ Régionale and
Bermex Construction filed with the Minister an agreement in
accordance with the provisions of subsection 125(3) of the
Act, whereby they allocated to Bermex the entire business
limit for the purposes of the small business deduction. It is
also clear that Gestion, which held all of the shares in Bermex,
was looking for a furniture manufacturer. Having previously done
business with the appellant, it decided to purchase half of its
capital stock. The division of responsibilities after the
purchase leaves no doubt about the new orientation the appellant
was to have. It became a major supplier of unfinished furniture,
which it sold almost exclusively to Bermex. The fact that
André Cardinal and Stéphane Lamarche
together held 50% of the shares would not, in my opinion, have
changed the role that Gestion had given to the appellant. It is
true that André Cardinal and
Stéphane Lamarche were responsible for the day-to-day
management of the appellant's operations, but decisions
concerning sales and purchasers were undoubtedly the
responsibility of Gestion. It was Gestion, moreover, that,
through Richard Darveau checked the invoicing of the
appellant's only two customers-with which the appellant was
associated-and ensured that purchases were made at the best price
and that the bills were paid. Denys Laberge's role was
to help Messrs. Cardinal and Lamarche develop products for
manufacturing. Since Bermex bought almost everything, it seems
clear to me that Denys Laberge played an important part.
[49] It is also important to note that,
after the acquisition of the shares by Gestion, the
appellant's sales figure went from $369,000 to over $3
million and the proportion of its sales to Bermex and Chez Soi
rose from 30% to 95% in 1993, 85% in 1994 and 79% in 1995 (see
Exhibit A-11). The appellant's financial
statements contain a note indicating that the appellant's
sales came almost entirely from two affiliated corporations.
[50] It must be remembered as well that
Gestion created Chez Soi at the time of its purchase of the
shares in the appellant for the purpose of also doing the
finishing of products manufactured by the appellant and others.
Chez Soi belongs to Richard Darveau's two brothers.
[51] Because the appellant had only two
customers, had no receivables and was dependent on Bermex for the
sale of nearly all its production, it was impossible for it to
obtain financing. Consequently, Bermex provided it with the
financing necessary for its operations, which financing was
described by Richard Darveau as being advances relating to
Bermex's accounts payable to the appellant. Regardless of how
this financing is described, the appellant's activities were
financially supported by Bermex. In addition, the appellant
guaranteed in part Bermex's $4 million line of credit for the
financing of its activities as a whole. The appellant's sales
to Bermex were grossed up by 15% representing administrative
expenses, and the transactions between it and Bermex were
adjusted at the end of the year to ensure that profit to the
appellant. These adjustments were only possible in the case of
the appellant, because, according to Richard Darveau, the
same could not be done with Bermex's other
subcontractors.
[52] The effect of these financial,
contractual and commercial arrangements was, in my opinion, to
make the appellant economically dependent on Bermex. It also
seems clear to me that the know-how and influence of the
directors of Gestion and Bermex were behind the appellant's
economic revival and its profitability, and this put the
appellant under their control.
[53] Furthermore, the document in Exhibit
A-10 provides details about the appellant's long-term debt.
For the years 1993, 1994 and 1995, that document shows a loan of
$300,000 from
Garage Côté Laroche Inc. with no
repayment terms or interest and, for 1995, a loan of
$75,000 from Servan RDAJ Inc., a corporation 66%
of the shares of which were held by Richard Darveau and 33%
by Denys Laberge's wife. The chart filed as Exhibit
A-10 by the appellant did not match, for 1993, the excerpts from
the corporation's general ledger for that year, which fixed
the appellant's debt to Bermex at $507,643.90 at the end of
the fiscal year. With the exception of the mortgage, the
appellant's financing during the years at issue was provided
largely by Bermex and, in 1995, by Servan RDAJ Inc.
[54] Returning to the matter of the
management of the appellant, there is evidence from which it can
be concluded that the administration of the appellant was
directed by Gestion and Bermex. The appellant's insurance
policy (Exhibit I-1, Tab 19) was sent to Bermex
and was in its name; the appellant's correspondence was sent
to Bermex's address (Exhibit I-1, Tab 21); and a
business plan for the appellant was sent to Jacques Gagnon
at Bermex's address. Taken together, these are significant
indications of the role of Bermex in the appellant's
activities.
[55] According to article 20 of the
shareholder agreement, the presence of Denys Laberge and
Richard Darveau on the board of directors was assured.
According to the appellant's registers, the board of
directors consisted of five people-namely, the two specified in
the agreement, as well as Jacques Gagnon,
Stéphane Lamarche and
André Cardinal-during the three years at issue. Each
was entitled to one vote and matters submitted to the board were
decided by a simple majority of the directors who voted. Gestion
therefore controlled the board of directors during the years at
issue. As well, the fact cannot be overlooked that, under
article 19 of the agreement, resolutions by shareholders had
to receive 66% of the votes in order to be passed. It was
accordingly possible for Gestion, which held 50% of the votes, to
block any proposal by the other shareholders.
[56] The sudden existence of the addendum in
1998 and the issue of when it was signed create serious doubt
about the credibility and the testimony of Richard Darveau,
Jacques Gagnon and Stéphane Lamarche. In my
opinion, the addendum was not signed on the date indicated and
those concerned tried to blur the facts surrounding its signing.
The fact that the addendum was not produced before September
1998, the comment by the secretary in Mr. Gagnon's office
and the expert opinion of Gérald Laporte satisfy me
that the document was signed in September 1998 in order to
minimize the impact that the Shareholder agreement could have on
the determination of the existence of de jure control.
[57] Nor can I overlook the fact that
Bermex Construction performed the work of expanding the
appellant's plant at actual cost, without making any profit.
This, in my view, constitutes a privilege comparable to the
privileges encountered among associated or friendly corporations
and is therefore not a normal business transaction. The business
relationship between Bermex and the appellant was very special in
that the appellant could adjust its billings at the end of its
fiscal year so as to ensure that it would receive a profit set at
15% of its sales to Bermex. This, again, is inconsistent with
usual business transactions between two parties dealing with each
other at arm's length.
[58] Taking into account the whole of these
facts, I conclude that Gestion, through Bermex, of which Gestion
had 100% control, exercised control over the appellant so as to
make the two of them associated corporations under
paragraphs 256(1)(a) and (b) of the Act
during the three years at issue.
[59] In view of this conclusion, it is
unnecessary for me to consider the matter of de jure control.
[60] The second point at issue concerns the
expense of $57,304 incurred to repair the roof of the
building in which the appellant's activities were carried on.
The appellant treated this cost as an operating expense whereas
the respondent maintains that it was a capital outlay.
[61] The appellant was the tenant of the
building and its officers were aware of the condition of the roof
when the appellant decided to purchase the building in
August 1992. After taking into consideration the cost of
repairs that would involve redoing the roof, it was decided to
construct a new roof on top of the existing one and thus change
the slope of the roof. A photograph (Exhibit A-7) of the north
side shows the new roof. It must also be remembered that a new
annex was built during the same period, which contributed to
raising the value of the property for property tax purposes (see
Exhibits A-8 and A-9). Exhibit A-9 was prepared before the roof
repairs in question. The new assessment, therefore, did not take
into account the new roof.
[62] Counsel for the parties both submitted
case law setting out a variety of criteria and tests that can be
used in determining this issue. Earl v. Canada, [1993] 1
C.T.C. 2081, a decision of this Court, sets out the various tests
used by the Federal Court of Appeal and the Quebec Court of
Appeal, and the facts in Earl bear some similarity to
those of the case at bar. Without repeating all of the references
cited by Judge Rowe in his decision, I would like to reproduce
some excerpts from what he said about the case law he
considered.
[63] Referring to Gold Bar Developments
Ltd. v. the Queen, 87 DTC 5152, he cited Jerome A.C.J.
of the Federal Court-Trial Division:
I think it is more helpful to emphasize the purpose of the
outlay by the taxpayer. What was in the mind of the taxpayer in
formulating the decision to spend this money at this time? Was it
to improve the capital asset, to make it different, to make it
better? That kind of decision involves a very important elective
component-a choice or option which is not present in the genuine
repair crisis.
[64] Jerome A.C.J. went on to say:
There remain two other considerations that arise from the
jurisprudence. An expenditure which is in the nature of repair
will not be allowed as a deduction from income if it becomes so
substantial as to constitute a replacement of the asset. See
Canada Steamship Lines Limited v. M.N.R, 66 DTC 5205,
[1996] CTC 125; M.N.R. v. Haddon Hall Realty Inc., 62 DTC
1001, [1961] CTC 509; and M.N.R. v. Vancouver Tugboat
Company, Limited, 57 DTC 1126, [1957] CTC 178. Here, however,
while the sum of money is certainly substantial, the undisputed
evidence is that this building's value at the material time
was in the range of $8,000,000 so that the sum in issue
represents less than 3% of the value of the asset. There is no
justification therefore to reclassify the expenditure on that
basis.
Finally, there have been a number of decisions in which
repairs, either alone or in combination with other work, have
rendered the capital asset not simply restored to its original
condition, but greatly improved because of its new-found
resistance to those factors which caused the deterioration.
[65] Judge Rowe also considered the decision
in Le sous-ministre du Revenu du Québec c. Denise
Goyer, [1987] R.D.F.Q. 159, in which the Quebec Court of
Appeal, after examining the relevant case law, ruled as follows,
through Vallerand J.A. on the distinction between capital outlays
and operating expenses:
[TRANSLATION]
. . .
Maintenance and repairs are effected to preserve a capital
asset. As a rule, it is of little importance if a few boards on a
balcony and a few lengths of pipe are replaced each year-the
expenses incurred would unquestionably be considered current
maintenance expenses-or that having neglected to maintain the
property, major and lasting repairs have to be done. As long as a
new capital asset is not created, that the normal value of the
capital asset is not increased and that an asset that had ceased
to exist is not replaced by a new one, the repairs and
maintenance in question are effected to restore the asset to its
normal value.
. . .
[66] The contention of counsel for the
appellant is based on this decision. He maintains that the new
roof in the case at bar is merely a component of capital and its
replacement is equivalent to a simple repair.
[67] In the case at bar, the appellant was
aware of the condition of the roof at the time of purchase and
knew repairs would have to be made. The appellant, through
Richard Darveau, had evaluated two other possibilities:
either repairing the old roof or constructing a new one, with a
different slope, on top of the old roof, which would then serve
as a partition. The choice made by the taxpayer constitutes a
full replacement of the roof, whose new slope seems to have
improved its effectiveness, and, on the whole, the replacement
gave the appellant a more lasting improvement. The value of this
expense in relation to the purchase price, exclusive of the land,
was 23%, according to Mr. Normand. No evidence was led on
the basis of which I might find that the repair increased the
value of the property.
[68] Judge Rowe's conclusion in
Earl (supra) reads as follows:
Basically, the jurisprudence comes down on the side of
treating the expenditure by the appellant as one on account of
capital. In principle, there is no real difference between the
installation of a new roof and the expenditures in Goyer,
when the purpose was to maintain the asset in its normal
revenue-producing condition. However, with the exception of the
decision in Goyer, the line of authority is consistent
that work of the nature undertaken by the appellant will, barring
unusual circumstances, be regarded as capital in nature.
The Minister was correct in treating the expenditure as one on
account of capital.
[69] The treatment by the Minister of the
expenditure relating to the roof was therefore correct. The
appeals are dismissed, with costs.
Signed at Edmundston, New Brunswick, this 11th day of December
2002.
J.T.C.C.
Translation certified true
on this 25th day of April 2003.
Erich Klein, Revisor
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