Indema Ltd. v. The Queen, 92 DTC 6244, [1992] 1 CTC 309 (FCTD)

The Associate Chief Justice:—This action by way of an appeal from reassessments of income tax by the Minister of National Revenue (the"Minister") for Indema Ltd.'s 1982 and 1984 taxation years came on for hearing at London, Ontario on March 26 and 27, 1991. The sole issue in this appeal is whether during the 1982 and 1984 taxation years the plaintiff carried on a "nonqualifying business” as defined in paragraph 125(6)(f) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), as amended. For reasons given orally from the bench on March 27,1991 I allowed the plaintiff's appeal with costs and indicated that these written reasons would follow.

Background:

The relevant facts are as follows. The plaintiff was initially incorporated under the Ontario Business Corporations Act, R.S.O. 1970, c. 53 on September 20, 1972 as“ Heizer and Associates Ltd.". The objects of the corporation as set out in the Articles of Incorporation were:

To promote, sell, advertise, distribute or introduce any and all manufactured products, merchandise, personal property and subjects of trade or commerce of every kind and nature or any rights or interest therein and thereto; and to manufacture, handle on commission or otherwise deal in, contract for or otherwise acquire, advertise, promote, introduce, distribute, buy, sell, or otherwise dispose of, for itself or for any other or others, any of the aforesaid.

On November 17, 1976, by resolution of the board of directors, the name of the corporation was changed to Indema Ltd. and the objects of the corporation were extended. [1] By agreements dated January 1,1977 and May 1, 1978, Indema Ltd. agreed to provide to Thermon Canada Ltd. ("TCL") and Thermon Manu- facturing Ltd. ("TML") respectively, “all management and administration services required by [these companies] in the conduct of its business of manufacturing and sales, or other aspects of its current business." [2] At that time both TCL and TML carried on manufacturing and sales businesses through Canada.

In its 1982 and 1984 income tax returns, Indema Ltd. claimed $37,588.95 and $32,322.36 respectively as a small business deduction in accordance with subsection 125(1) of the Act. By notices of reassessment dated June 17, 1987 the Minister of National Revenue (the "Minister") reassessed the plaintiff on its 1982 and 1984 taxation years by reducing the small business deduction claimed by the plaintiff from $37,588.95 to $22,668.23 in 1982 and from $32,322.36 to $12,877.91 in 1984. The reassessments recalculated the small business deduction at the "non-qualifying business" rate of 12 A per cent in accordance with subsection 125(1.1) of the Act.

Pursuant to the order of J.-C. Couture, C.T.C.C.J. dated December 1, 1987 the plaintiff was permitted to file notices of objection dated September 18, 1987 for the 1982 and 1984 taxation years. The plaintiff stated that it was not a "nonqualifying business" in that its principal purpose is to supply direct and indirect labour to TCL and TML as well as to have a labour force for its own use. By notice dated September 28, 1988 the Minister confirmed the reassessments on the basis that the plaintiffs principal purpose was to provide managerial, administrative, financial, maintenance or other similar services to connected businesses and, accordingly, it did not qualify for the higher rate of the small business deduction under subsection 125(1) but only the rate of 12 A per cent pursuant to subsection 125(1.1) of the Act.

Indema Ltd. filed a statement of claim in this Court on December 21, 1988 requesting that the 1982 and 1984 reassessments be vacated and referred back to the Minister for reconsideration and reassessment on the basis that the plaintiff is not a“ non-qualifying business” within the meaning of subparagraph 125(6)(f)(iii) of the Act. A statement of defence was filed by the Minister on February 24, 1989 and on June 27, 1989 a certificate was issued transmitting the relevant documents to this Court.

Issue:

The sole issue before this Court is whether the plaintiff was engaged in a “non-qualifying business” within the meaning of paragraph 125(6)(f) of the Act during the taxation years at issue and, specifically, whether the "principal business" of Indema Ltd. in the 1982 and 1984 taxation years was to provide the services outlined in subparagraph 125(6)(f)(iii).

Relevant statutory provisions:

The statutory provisions relevant to this matter are subsections 125(1) and 125(1.1), subparagraph 125(6)(f)(iii), and paragraphs 125(9)(a) and (c) of the Income Tax Act, as amended by S.C. 1980-81-82-83, c. 48, section 70 and c. 140, section 86:

125 (1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation (other than a corporation that carried on a nonqualifying business in Canada in the year) that was, throughout the year, a Canadian-controlled private corporation, an amount equal to 21% of the least of.

(1.1) 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 and that carried on a non-qualifying business in Canada in the year, an amount equal to 12 A% of the lesser of. . . .

(6) In this section and section 129

(f) non-qualifying business" carried on by a corporation in a taxation year means

(i) the professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor,

(ii) a business of providing services if more than 66% of the gross revenue for the year of that business derived from services

(A) is derived from services provided to, or performed for or on behalf of one entity, and

(B) can reasonably be attributed to services performed by persons who are specified shareholders of the corporation or persons related thereto

unless the corporation employs in the business throughout the year more than five full-time employees who are not specified shareholders of the corporation or persons related thereto, or

(iii) a business the principal purpose of which is to provide managerial, administrative, financial, maintenance or other similar services, to lease property (other than real property), or to provide any such services and to lease property (other than real property), to one or more businesses connected at any time in the year with the corporation but does not include a personal services business.

(9) For the purposes of this section,

(a) “business connected" at any time in a taxation year with a corporation means any business carried on by an individual, a partnership or another corporation if at that time more than 20% of the shares of any class of the capital stock of the corporation are owned, directly or indirectly, by

(i) the individual,

(ii) one or more members of the partnership,

(iii) one or more specified shareholders of the other corporation, or

(iv) the other corporation

as the case may be, and for the purposes of this definition . . .

For the taxation years at issue here [3] the Act provided that certain corporations which carried on a managerial, administrative, financial, maintenance or other similar business were deemed to be carrying on a non-qualifying business. Such corporations were not entitled to the then 21 per cent small business deduction under subsection 125(1), but were limited to a 12 /3 per cent deduction on their first $200,000 of active business income each year under subsection 125(1.1).

Submissions:

The plaintiff submits that the Minister has incorrectly calculated the small business deduction available to the plaintiff in accordance with subsection 125(1.1) because the plaintiff did not carry on a “non-qualifying business” pursuant to former paragraph 125(6)(f) of the Act. During the relevant taxation years, the plaintiff was in the business of supplying all the direct and indirect labour requirements to TCL and TML to those companies pursuant to agreements in writing. The plaintiff also provided other services to TCL, TML and to other corporations. During the 1982 taxation years and the 1984 taxation year, approximately 60 per cent to 70 per cent of the charges to TCL and TML by the plaintiff related to the supply of direct and indirect labour and engineering services consumed by TCL and TML in the course of their product manufacturing operations. In addition, Indema Ltd. deals at arm's length with these two companies and the agreements between them are to facilitate the operation of all of the companies through a mutually agreeable arrangement whereby there is one payroll system, one pool of employees, and so on. The plaintiff states, therefore, that its principal purpose is not to supply managerial, administrative, financial, maintenance or similar services to TCL or TML or to any other person, firm or corporation.

The defendant submits that the plaintiff is a non-qualifying business” in accordance with subparagraph 125(6)(f)(iii) of the Act. Pursuant to written agreements between the plaintiff and TCL and TML, the plaintiff supplies management and labour services including direct and indirect labour requirements to these two companies. During the 1982 and 1984 taxation years the plaintiff received 97 per cent and 98 per cent of its gross income respectively from TCL and TML. The defendant notes that at all material times, Frank Heizer owned 100 per cent of the issued shares of the plaintiff, Indema Ltd., and was its sole director. He also owned 24.5 per cent of the issued shares of TCL and 49 per cent of the issued shares of TML. The plaintiff owned 25 per cent of the issued shares of TCL. Therefore, during 1982 and 1984 the principal purpose of the plaintiffs business was to provide managerial, administrative and similar services to TCL and TML both of which were businesses connected with the plaintiff within the meaning of paragraph 125(9)(a) of the Act.

Analysis:

It is agreed that but for subparagraph 125(6)(f)(iii), the plaintiff is eligible for the small business deduction in the taxation years at issue. Subparagraphs 125(6)(f)(i) and (ii) are not at issue here due to the fact that the plaintiff was not engaged in the listed professional practices nor was it providing services to only one entity. It is acknowledged that the plaintiffs business in 1982 and 1984 was related almost entirely to TCL and TML. It is also acknowledged that in the 1982 and 1984 taxation years, Indema Ltd. carried on a business, one of the purposes of which was to provide most of the services referred to in subparagraph 125(6)(f)(iii). Therefore, the only issue before this Court is whether the '^principal business” of Indema Ltd. in the 1982 and 1984 taxation years was to provide the services outlined in subparagraph 125(6)(f)(iii) of the Act.

Counsel have indicated that this is uncharted territory but have suggested that there is some guidance from other jurisprudence. For instance, in Sogemines Development Company Ltd. v. M.N.R., [1972] C.T.C. 284, 72 D.T.C. 6254 (F.C.T.D.), Heald, J. [as he then was] considered whether the "principal business” of the appellant's predecessor corporation (Sogemines Ltd.) was "mining or exploring for minerals" in accordance with paragraph 83A(a) of the Act. He observed [at page 291 (D.T.C. 6259)] that the Shorter Oxford English Dictionary defines "principal" as “the chief, main, or most important thing, part, point or element” and he commented [at page 290 (D.T.C. 6258]) that:

The cases have held that the question of “ principal business” is a question of fact to be determined by an examination and comparison of all the facts concerning each of the various types of business in which the company is engaged. [4]

In Sogemines, the predecessor corporation had as its object and purpose the carrying on of an investment business, it had only one part-time employee and no office or telephone listing, and it owned no mining equipment. Furthermore, out of a total holding of over $10 million in its investment portfolio, only about $247,000. represented the company's participation in mining exploration projects. Heald, J., therefore, concluded at page 291 (D.T.C. 6260) that mining exploration was only a minor part of the predecessor corporation's total operation, that at most it was only a sideline, and that its" principal business” was not that of "mining of exploring for minerals" within the meaning of subsection 83A(8a).

Here, it is clear that Indema Ltd. was brought into existence to fulfil several purposes. In 1972, ten years prior to the taxation years at issue, Heizer and Associates Ltd. was formed to fulfil a genuine business purpose unrelated to the present dispute—to enjoy distributor status for the purpose of bids and to ensure a more competitive sales position in the Canadian market. That purpose was accomplished. In addition, when Heizer and Associates Ltd. was transformed into Indema Ltd., the current taxpayer in this dispute, it continued to enjoy a distributor status and was still providing that service or advantage to TCL and TML during the taxation years at issue. At the hearing, I found Mr. Heizer's explanations as to why that could not have been done by the two other companies to be adequate. As well, I accept the evidence of the controller, Mr. Christiaans, that there are clear advantages from the point of view of efficiency or convenience to operate in this fashion, i.e., unemployment insurance deductions, group insurance, Canada pension plan, advantages that are considerable and unrelated to income tax.

I also find that there was an operational purpose here. In C.R. Management Ltd. v. M.N.R., [1983] C.T.C. 2754, 83 D.T.C. 673 (T.C.C.), the sole issue before Bonner, T.C.J. was also whether the entity, C.R. Management Ltd., carried on a non-qualifying business as defined by subparagraph 125(6)(f)(iii). In that case, a law firm had specifically incorporated the entity in order to retain it to provide administrative services. The situation was clearly one where an attempt had been made to establish a small business which really had no independent identity whatsoever. The law firm was and continued to be the only operating entity which was making income and, therefore, the establishment of a corporation to provide services to it had no independent identity or other purpose. I have no difficulty, therefore, accepting the conclusion reached in that case by Mr. Justice Bonner that C.R. Management Ltd. was clearly one of the entities contemplated by subparagraph 125(6)(f)(iii).

Here, the objective of obtaining efficiency from a financial or accounting point of view, payroll convenience, the distributor status and the advantage of a competitive position in "a highly competitive field”, are all purposes for which Indema Ltd. was brought into existence. Clearly, these purposes were achieved in addition to those services outlined in subparagraph 125(6)(f)(iii).

In the final analysis then, I find that a sound business decision was made several years prior to the taxation years at issue here to take steps to create the plaintiff to fulfil a role as a distributor. That role was independent of taxation purposes and resulted in a competitive market advantage in both taxation years. I also find that while the services outlined in subparagraph 125(6)(f)(iii) were provided by the plaintiff to connected businesses, those services were not its principal purpose in that clearly there were other sound business purposes, some predating and some entirely independent of those described in the subparagraph.

Accordingly, it is my view that Indema Ltd. ought not to have been prevented from claiming the greater small business deduction in 1982 and 1984 and the taxpayer's appeal is allowed.

Conclusion:

For reasons given orally from the bench on March 27, 1991, I therefore signed judgment in this matter allowing the appeal with costs.

Appeal allowed.