Brunette Investments Ltd. v. The Queen, 81 DTC 5367, [1981] CTC 486 (FCTD)

Marceau, J:—These actions have been joined together to be heard at the same time on common evidence. They both attack the same decision of the Tax Review Board whereby the notices of reassessment issued against the plaintiffs on May 15, 1975, in respect of their 1968 taxation year were upheld. The same facts raise the same issue in both cases, even though the amounts in question differ, there being $90,570.18 in the case of the plaintiff Lake City Industrial Corporation Ltd and $10,063.35 in the case of the plaintiff Brunette Investments Ltd. Indeed the reassessments were based on the ground that an outlay made in that year by each of the two companies in the Same circumstances was not a business expense properly deductible in computing their respective taxable incomes for that year. It was obviously proper that the two actions be considered together.

The facts relevant to the issue are not complicated. They can be summarized as follows.

In 1965, the plaintiffs were, with several other similar real estate business companies, wholly owned subsidiaries of Webb & Knapp (Canada) Ltd, a corporation with huge interests spread all across Canada. Webb & Knapp (Canada) Ltd had been for some years in serious financial trouble; it had been involved in some very heavy estate deals and the cost of its most recent realization, Place Ville-Marie in Montreal, had turned out to be much higher than previously estimated. Place Ville-Marie had already been sold to English interests and many of the eastern assets had been disposed of in an effort to generate cash but the situation was still precarious. Among the most important and most worried creditors of Webb & Knapp Canada Ltd were three individuals of British Columbia, the Riley Associates, who were insisting on being somehow satisfied. A solution was sought and finally an agreement was worked out whereby, through a company to be incorporated, the three individuals would take over the management of the remaining subsidiaries of the corporation. The associates were of course confident that, under their administration and control, the assets of the corporation would enhance in value or at least be realized in a manner and at a time more appropriate to the safeguard of their interests. Western Pacific Projects Ltd (“Western Pacific”) was therefore incorporated for the purpose of managing the various companies and the agreement was put into effect.

Among the companies so placed under the management of Western Pacific, some, like the two plaintiffs herein, had valuable assets, but others, like North Bay Shopping Centre Ltd (“the North Bay company”), a business venture that had so far been unsuccessful, were not in good financial health. A decision had to be made about what to do with the North Bay shopping centre. The new administration decided to act on the assumption that if the company were kept alive and its facilities somewhat improved, a good purchaser could eventually be attracted and a profitable deal could be worked out. So Western Pacific started advancing moneys to the North Bay company to sustain its operation and provide the funds needed to add improvements to its buildings: in 1965, Western Pacific lent $55,710.97 to the North Bay company; in 1966, $28,519.87; in 1967, $15,455.32; and in 1968, $947.37. In 1968, however, it became clear that the efforts to revitalize the centre and attract a buyer were to be fruitless: the managing company gave in and the buildings were simply turned over to the second mortgagees. Western Pacific was left with a loss of $100,633.53, the total of the moneys it had advanced to the North Bay company since 1965.

In its administrative costs for the year ended December 31, 1968, Western Pacific included an expense of $106,442.99 “for bad debts”, covering in fact the advances it had made to the North Bay company since 1965 plus some $5,809.46 for unpaid management fees. These administrative costs, amounting to some $298,360.92, were then proportionately distributed to the companies being actively managed and in good financial position, namely the two plaintiffs herein, on the basis of the relative value of their respective assets and the importance of the services rendered to each of them: Lake City Industrial Corporation Ltd was charged 90% of the total of the adminis- trative costs, Brunette Investments Ltd, 10%. Western Pacific was thus simply passing off to the plaintiffs the loss of $100,633.53 it had sustained with respect to the North Bay project in the form of management fees that the two companies could deduct from their revenues in computing their respective taxable incomes for the 1968 taxation year.

The issue, of course, is whether the plaintiffs were entitled, in view of the provisions of the Income Tax Act as it then was and especially in view of section 12 thereof, to treat as a deductible expense the portion of the bad debt included in the administration fees charged to each of them. The Minister has ruled, as indicated above, that the payment by the plaintiffs of that portion of the administrative fees covering the bad debt was not an expense properly deductible because it had not been made or incurred for the purpose of gaining or producing income from property or business of the plaintiffs, as required by paragraph 12(1 )(a) of the Income Tax Act as it then was, or in the alternative that it represented and outlay loss or replacement of capital, or a payment on account of capital within the meaning of paragraph 12(1 )(b) of the Act.* [1] The plaintiffs dispute the ruling. They contend that the expense was deductible as having been made by the companies for the purpose of gaining income from their properties or businesses and they advance three arguments in support of their contention. Are these arguments persuasive? This is what must be examined.

Counsel for the plaintiffs suggested in his first argument that the expense in issue was only part of management fees that the plaintiffs were required to pay in their entirety: the services were rendered and the amount charged was not excessive in view of the total value of the assets being administered; the Minister was not entitled to enquire as to how that amount was arrived at. The suggestion, however, is not borne out by the facts. It is clear on the evidence that the amounts were included in the fees claimed not as charges for services rendered but as a means of reimbursing Western Pacific for the loss it had sustained. Of course, to verify the deductibility of an outlay, the true nature thereof must be looked at regardless of the label or appellation given to it by the taxpayer. It may be that the plaintiffs had no choice but to take upon themselves the loss sustained by Western Pacific, but it does not follow that they were entitled to treat the outlay as a deductible expense for income tax purposes. If counsel’s suggestion were to be accepted, it would follow that any group of companies could assure a levelling of their profits through a managing company acting as a “conduit pipe’, to borrow the phrase used by the Tax Review Board, a possibility that would clearly defeat the first principle of the Income Tax Act according to which every person, a natural person as well as a corporation, is an entity of assessment, ie, the possessor or recipient of an income which must be separately assessed for tax purposes.

Counsel submitted in his second argument, as I understood it, that the advances to the North Bay company could be seen as having been made by the plaintiffs, through the managing company acting as a mere vehicle, in order to avoid foreclosure and to protect their own inventories. Here again, however, the facts do not support the contention. The advances were never directly or indirectly made by the plaintiffs and the latter have never had anything to do with the centre in North Bay. The plaintiffs were called upon to reimburse Western Pacific when the centre had ceased functioning and when they made their payments, there could be no question of protecting their inventories. But, in any event, even if the facts could be somewhat distorted and the corporate veils disregarded, the advances, or the loss thereof, would still be non-deductible as being on account of capital within the meaning of paragraph 12(1 )(b) of the Act, as it then stood. A reasoning similar to that applied in the cases of Berman & Co Ltd v MNR, [1961] CTC 237; 61 DTC 1150, and Her Majesty the Queen v F H Jones Tobacco Sales Co Ltd, [1973] CTC 784; 73 DTC 5577, on which counsel particularly relied at this point of his argument, would not be possible. North Bay Shopping Centre Ltd has never been the agent of the plaintiffs nor one of their customers. The very vague statement of Mr Loftus (one of the three individuals acting behind Western Pacific who was called as a witness) to the effect that (reading from my notes) “there was a risk that foreclosure of the mortgage on the North Bay centre could have an effect on the other companies of the group” — a statement not otherwise substantiated or explained in reference to what actually happened in 1968 — is obviously insufficient to lead to the conclusion that the advances were in fact expenditures made on behalf of the plaintiffs themselves for their own sake and advantage and for the direct protection of their inventory. Mr Loftus testified clearly that the advances were made with a view to improving the facilities of the centre and attracting a buyer: the project could only benefit Western Pacific, the three individual creditors and ultimately Webb & Knapp (Canada) Ltd, and never the plaintiffs.

Counsel argued in his third and last argument, again as I understood it, that Western Pacific was formed for the sole purpose of managing the companies and that its expenditures and administrative costs had necessarily to be assumed by the companies being managed: when paid by the latter they were, aS a necessary result, regular business expenses. This argument, when analyzed, is to the same effect as the first one and the answer is the same. It is not supported by the evidence and it disregards altogether the fact that the managing company and the companies being managed were distinct legal entities operating separately and apart from each other. Furthermore, as presented here, it is self-defeating: Western Pacific was not in the business of lending money, its loans to North Bay centre were not outlays of an administrative nature, they were outlays of an investment nature which could not, on their becoming unrecoverable, be transformed into administrative costs. The companies being managed were of course entitled to assume proportionately as business expenses the administrative costs incurred by their managing company, they were not entitled to assume on the same basis outlays of an investment nature their managing company saw fit to make.

The conclusion that appears to me unavoidable is that the plaintiffs have failed to show that the ground upon which the reassessments under attack were issued was unfounded. I am of the view that the Minister was right in disallowing as a deductible expense that portion of the loss sustained by Western Pacific with respect to the North Bay Shopping Centre that each of the plaintiffs was called upon to assume in the guise of administrative fees. The payments made by the plaintiffs to reimburse Western Pacific were not outlays made by them for the purpose of gaining income from their properties or businesses.

The actions will therefore be dismissed.