Temax Investments Inc. and Mayon Investments Inc. v. Minister of National Revenue, 91 DTC 364, [1991] 1 CTC 2245 (TCC)

Brulé, T.C.J.:—These appeals were heard on common evidence and concern the taxation years 1984, 1985 and 1987 for Mayon Investments Inc. (Mayon") and 1984 and 1985 for Temax Investments Inc. CTemax"). Both companies were reassessed by Revenue Canada treating sums of income as investment income rather than active business income and by disallowing the small business deduction in computing taxable income in each company.

At the outset the Minister requested that the Court quash the purported appeal for 1986 in Mayon and the 1986 and 1987 purported appeals in Temax as in all three instances no notices of objection had been filed as. required by section 169 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Counsel for the appellants did not object to this, thus giving rise to the appeals only for the years set out in the first paragraph above.

Facts

The appellants were incorporated under the laws of Ontario for the object of carrying on the business of mortgage brokers. At all material times the appellants' principal activity was operating as mortgage brokers. The business of each consisted of providing mortgage financing on the security of second, third and fourth mortgages. The major portion of their income was interest income on these mortgages. Thomas E. Bick is the president and sole shareholder of Temax, while being manager of Mayon. This latter corporation is owned by Mr. Bick's wife, Clementine. Both companies have business premises and employed from time to time various people (about eleven in 1984 on a part-time basis). The only full-time employees are Mr. and Mrs. Bick, while Mr. Nodel, a professional accountant, worked approximately one to two days a week for each company.

Mr. Bick's evidence was to the effect that the activities of the business were akin to those of a bank. The high level of risk involved with the mortgages required investigations and appraisals. Setting the terms of each mortgage involved some negotiation with the tailoring of these carried out with the help of Mr. Nodel.

Appellants’ Position

Briefly stated the appellants submit that they carried on an active business within the meaning of paragraph 125(7)(a) of the Act and that their income was derived therefrom. The appellants maintained that their businesses were not specified businesses within the meaning of paragraph 125(7)(e). They submit therefore that the small business deduction provided for in subsection 125(1) of the Act is allowable in computing income for the years under appeal.

Minister's Position

Conversely the respondent says that the appellants each carried on a specified investment business. The small business deduction specifically excludes in its definition of "active business" the income of a "specified investment business”. The appellants cannot thus take advantage of the said deduction.

Analysis of Previous Cases

While the issue in these appeals is one which has been presented to this Court many times the present appeals concern sections of the Income Tax Act which have been amended in 1979 and 1985. Since these amendments became law this Court has not had to make any decisions involving these amendments.

During the taxation year 1984 the relevant sections of the Act were as follows:

Section 125(6)(d)

(d) “Active business"—'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, a non-qualifying business or a personal services business;

Section 125(6)(e)

(e) ” Income of the corporation for the year from an active business"—" 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);

Section 126(6)(h)

(h) “Specified investment business"—" Specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), 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;

In taxation year 1985 and during the remaining period of these appeals the Act provided as follows:

Section 125(7) (a)

(a) “Active business"—"active business carried on by a corporation" means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade;

Section 125(7)(e)

(e) "Specified investment business"—"specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), unless

(i) the corporation employs in the business throughout the year more than five full-time employees, or

(ii) in the course of carrying on an active business, any other corporation associated with it provides managerial, administrative, financial, maintenance or other similar services to the corporation in the year and the corporation could reasonably be expected to require more than five full-time employees if those services had not been provided;

It is interesting to follow the principles of law developed by the courts in the interpretation of these relevant sections of the Act prior to the 1979 amendment. At that time there resulted in a fundamental change in the proper interpretation of the small business deduction.

All cases cited by the appellants’ counsel involved taxation years prior to 1979 with the exception of those involved in the case of Canadian Marconi Co. v. The Queen, [1986] 2 C.T.C. 465; 86 D.T.C. 6526 and that case while not similar in fact to the appeals now before this Court did make the point that interest income is not synonymous with property. At page 470 (D.T.C. 6529) Wilson, J. of the Supreme Court of Canada said referring to Marconi as CMC:

Thus, CMC had a specific "investment business” object and the traditional rebuttable presumption, in my view, applies in favour of its investment income being characterized as income from a business. Indeed, even if CMC’s investment objects were not expressed, I believe that a broader form of the presumption should apply. In a general sense CMC was incorporated to earn income by doing business. There is no reason why any income earned by it should not be considered as prima facie income from a business so long as it is recognized that the presumption is a rebuttable one.

The cases, mentioned above, referred to by the appellants’ counsel were:

Lois Hollingers M.N.R., [1972] C.T.C. 592; 73 D.T.C. 5003;

L & F Holdings Ltd. v. M.N.R., [1975] C.T.C. 2192; 75 D.T.C. 150;

Parico Limitée v. M.N.R., [1975] C.T.C. 2234; 75 D.T.C. 173;

MRT Investments Ltd., ESG Holdings Ltd. and Rockmore Investments Ltd. v. The Queen, [1975] C.T.C. 354; 75 D.T.C. 5224;

The Queen v. Rockmore Investments Ltd., [1976] C.T.C. 291; 76 D.T.C. 6156;

The Queen v. Cadboro Bay Holdings Ltd., [1977] C.T.C. 186; 77 D.T.C. 5115;

Charwood Investments Ltd. v. M.N.R., [1978] C.T.C. 2545; 78 D.T.C. 1411.

In The Queen v. Rockmore Investments Ltd., supra, the Federal Court of Appeal said in order to conclude that a business could take advantage of the small business deduction, the first step was to decide whether there was a business within the meaning of that word as defined by section 248 of the Act and the second question to be answered was whether the business that was carried on was an“ "active business” within the intent of section 125 of the Act.

The Marconi case, supra, referred to Cragg v. M.N.R., [1951] C.T.C. 322; 52 D.T.C. 1004 saying whether particular income is income from business or income from property is a question of fact to be determined by an examination of the taxpayer's whole course of conduct. One must examine the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments.

Noël, A.C.J. said in the Hollinger case, supra, beginning at page 600 (D.T.C. 5008) the following:

If income from property has any meaning at all, it can only mean the production of revenue from the use of such property which produces income without the active and extensive business-like intervention of its owner or someone on his behalf. I have in mind, for instance, property such as bonds or debentures or shares or real property which do not require the exertion of much activity or energy in order to produce the revenue.

The Cadboro Bay Holdings case, supra, stood for the proposition that once income was defined as being from business any quantum of activity was deemed sufficient to categorize it as "income from an active business".

As to specific money-lending operations such as in the present appeals the Courts have generally concluded their income was from "active business” when there was a certain degree of activity and organization. Illustrative of this is the MRT Investment case, supra, where the three companies involved were engaged in lending money on mortgages on a comparatively small scale. None of the companies had full-time employees. The three companies were operated by two individuals, G and R, who also owned and managed a number of other companies. All of the companies operated out of the same office premises and used the same office staff and equipment. None of the companies dealt with conventional mortgages at conventional rates of interest. Because of the high risk involved in these loans, careful investigations and appraisal were necessary often involving considerable negotiation as to its terms. Post-dated cheques obtained from borrowers were turned over to the bank as collateral for the companies' line of credit.

The Court held that in determining the extent of a company's business activity, its course of conduct over an extended period of time was relevant. Section 125 does not specify the degree of activity which must be determined by the Courts. Each case must be dealt with according to its own facts and a distinction must be made between business activities carried on by an individual and a corporation formed for that purpose since a presumption is created concerning a corporation that the profits emanating from its activities are profits from the business. The Court held that had Parliament intended that the section should not apply to companies such as the plaintiffs’, it would have said so by defining "active business” or by specifically excluding companies whose entire active business consists of investments. There was nothing in the section which justified a conclusion that a corporation whose entire income comes from investments cannot be considered as carrying on an "active business” when the making of investments was the very purpose for which it had been incorporated and constituted the very business it was carrying on. This obiter is of importance since one could interpret the purpose of the 1979 amendment as being done in that light.

Reference was made to the cases Admiral Investments Ltd. v. M.N.R., [1967] C.T.C. 165; 67 D.T.C. 5114 and M.N.R. v. Spencer, [1961] C.T.C. 109; 61 D.T.C. 1079, both cases dealing with corporations with similar businesses and where it was held that the income derived was income from business and in the latter case, it was said that the purchase of mortgages involving substantially greater risk was more indicative of a speculative scheme for profits than a policy of investments for the purpose of securing a fair return on the money invested.

The Tax Review Board has also heard a number of cases dealing with the same issue and regarding similar businesses. In Cosmopolitan Investments Co. v. M.N.R., [1974] C.T.C. 2335; 74 D.T.C. 1252, the Board held that a company engaged in lending money on mortgages who had no offices or telephone listing and who had in the material years only two mortgages, was entitled to the small business deduction. Although the business had receded into a state of non-activity, the Act did not indicate the measure of activity needed to qualify for the deduction. The business of a corporation could be defined as a more or less permanent organization or arrangement of production factors as a potential source of income. Such an organization could be kept alive in name only awaiting future reactivation.

In Parico Limitée v. M.N.R., supra, the appellant had three shareholders, no separate letterhead or telephone listing and did not advertise its address. It granted mortgages to local clients from its own capital. Nine loans were made in 1972. The president and the other shareholders were active in processing loan applications and loans were repaid by post-dated cheques. The Board held that the appellant was not an investment company but a money-lending operation. The appellant's business activity was reasonable for its size and could be called an active business within the meaning of subsection 125(1).

In Marlee Investments Ltd. v. M.N.R., [1975] C.T.C. 2189; 75 D.T.C. 153 and L & F Holdings Ltd., supra, it was held that upon reading the relevant sections of the Act, 125 and 129, three types of income are present: income from property, income from business and income from active business. In both these cases the fact that the taxpayers had no organization and the absence of a certain degree of activities led the Board to conclude that they were not in an active money-lending business.

In Lazare Investments Corp. v. M.N.R., [1975] C.T.C. 2036; 75 D.T.C. 26 the appellant's company was engaged in interim financing, the discounting of balance of sale documents and the lending of money on second mortgages. The Court held it was an active business.

In Transregent Holdings Ltd. v. M.N.R., [1980] C.T.C. 2221; 80 D.T.C. 1212 the taxpayer owned business property but had only one tenant who made repairs and paid for them. The taxpayer exercised only infrequent supervision. The Board decided that, assuming the taxpayer's income as business income, it nevertheless could not be characterized as income from an active business. The nature, extent and frequency of the taxpayer's business activities did not allow the business to be characterized as "active". This differs from SBI Properties Ltd. v. M.N.R., [1981] C.T.C. 2288; 81 D.T.C. 263, where the activity, though minimal, was sufficient to characterize the appellant's property management as active business.

The Court in Porter Land Ltd. v. M.N.R., [1986] 1 C.T.C. 2481; 86 D.T.C. 1348 was dealing with appeals involving the 1981 and 1982 years. The appellant was engaged in three businesses, the largest of which was the leasing of land to tenant farmers, the others were farming itself. The Minister disallowed the small business deduction on the basis that the principal purpose of the taxpayer's business was to derive income from property, a specified investment business”. The taxpayer's appeal was allowed in respect of its contract and farm management businesses but was dismissed otherwise. As the evidence showed that the agreements entered into by the appellant were leases and that the agreement was not in substance a joint venture or a partnership, the appellant's income was not derived from farming activities but from property. The primary purpose was to derive income from property.

Analysis of Present Case

The appellants’ arguments are centred around the interpretation given by the courts. The principles enunciated by the case law were described above and one can conclude that much support for the appellants is found therein. The appellants submit that the corporations at issue are not specified investment businesses because their “ principal purpose” is to derive income from business. Interest income can be either income from business or income from property. The working of paragraph 125(6)(h) does not change that basic proposition. The principle that interest income can be either income from business or income from property is dependent upon the level of activity associated with acquiring it. This principle is illustrated in Marconi, supra. The phrase" income from property”, the appellants submit, contemplates a distinction from income from business based on the level of activity of the taxpayer in addition to the presumption of business. The evidence indicates intensive business-like intervention. The appellants then conclude that the income earned by the companies was income from business.

The respondent's argument is centred around a complete departure from past jurisprudence. The new provision was enacted to disqualify from the small business deduction corporations which would otherwise qualify under the criteria of section 125. The principal purpose of the corporations at issue was to derive income from interest, meeting thereby the criteria set out in paragraph 125(6)(h). The respondent submits that the level of activity is irrelevant, what is important is the nature of the income. Since over 96 per cent of the income generated by the said corporations is interest income from mortgages, one must conclude that they are from a "specified investment business”.

The legislative purpose of the small business deduction is to limit the application of a lower rate of corporate tax (designed as an incentive to small business) to income the source of which is an active business, and to prevent it from extending to investment income. It is also aimed to achieve an integration in respect of investment income derived by a corporation and thereby to maintain approximate neutrality in the taxation of investment income, neither penalizing nor benefitting individuals who choose to make their investments through a corporation rather than by direct personal ownership. Prior to the amendment of 1979, the meaning of section 125 was by way of reference to its presumed antonym the "Canadian investment income" in section 129. Investment income generates refundable tax on hand under subsection 129(3). A distinction was made between active business and one that was not; such a distinction was based on the quantum of activity. It would seem that the purpose of the amendment was to distinguish a "specified investment business" from any other business. Any other business would simply be labelled "active" and fall into the residual category in respect of which the lower rate of corporate tax is enjoyed.

In the 1981 Canadian Tax Conference, David C. Nathanson contributed an article entitled "Active Versus Passive Once Again: Active Business Income and Investment Income of Canadian Controlled Private Corporations". At page 913 he says:

Because of the “specified investment business” concept, the fine distinction between property-type income that is from an active business, on the one hand, and property-type income that is not, on the other, for the future has been made largely irrelevant. Most property-type income that, but for the "specified investment business” definition, could pass for business income will now effectively be treated as property-type income unless the five-employee limit is exceeded.

This passage lends support to the respondent's position in the present appeals.

Interpretation Bulletin IT-73R4 illustrates the position of the respondent on the proper definition and analysis of paragraph 125(6)(h), now paragraph 125(7)(e), and more particularly the words "principal purpose”. Paragraphs 11 and 13 of that bulletin read as follows:

11. “Principal purpose” is not a defined term in the Act for the purposes of paragraph 125(7)(e), but it is considered to be the main or chief objective for which the business is carried on.

13. The principal purpose of a corporation's business must be determined annually after all the facts relating to that business carried on by that corporation in that year have been considered and analyzed. Included in this evaluation should be such things as

(a) the purpose for which the business was originally commenced,

(b) the history and evolution of its operations, including changes in its mode of operation and purpose of existence and

(c) the manner in which the business is conducted.

No cases have yet dealt directly with the issue, except for Porter Land Ltd., supra. However, I do not think that this case can assist in any way in the proper interpretation of paragraph 125(6)(h) especially when we are, as in the present case, confronted with a more nebulous situation where income from property and income from business seem to overlap. This case is of no assistance since the Court made a conclusion based on facts which demonstrated income from property, the income from leases, which would meet the general criteria developed by the courts in distinguishing income from business from income from property.

The difficulty with the interpretation of the section at issue is that the legislator has used both the terms "business" and "income from property" which seem at first glance contradictory. The courts have usually concluded on the presence of income from property when there was an absence of business. The proper interpretation must therefore reconcile these two apparently contradictory notions found in paragraph 125(6)(h). In the past, the courts have been very liberal in defining the scope of the small business deduction. It would seem that the amendment was made to restrict this trend. A "specified investment business” as then defined in section 125(6)(h) is, it says it in express terms, a business. The general opposition between income from business as opposed to income from property, as defined for instance in Hollinger, supra, seems to have been circumvented. Furthermore, the presumption of business income from a corporation cannot again be of assistance.

The appellants are deriving income from business. This seems quite apparent from the evidence presented as one can see the presence of, at least, a large enough level of activity to warrant such a conclusion. The case of MRT Investments Ltd., supra, dealt with very similar facts, and had it not been for the amendments enacted in 1979, that case would be directly on point.

The legislator, however, has intervened. Even if there is no presumption that an amendment of law means a change of past interpretation, it seems that such a change has been enacted. The legislator has used the words “ principal purpose". These words have not been interpreted before. I would tend to think that the purpose of defining "specified investment business”, as it was done, was to bring in its scope businesses such as the appellants'. Although there is, in the case of the appellants, sufficient activity to conclude that they are indeed deriving income from business, since the source of revenues is principally interest income, it would seem that this is what is meant by “the principal purpose of which is to derive income from property”. That is when the source of revenue, the nature of the assets held, ana the purpose of the corporation are to derive income from property, such as interest income. The appellants are not generating the major portion of their income from the services that they provide but rather from the interest from mortgages.

The appeals are dismissed.

Appeals dismissed.