Balz Estate v. MNR, 92 DTC 1472, [1992] 1 CTC 2332 (TCC)

Sarchuk, T.C.C.J.:—This is an appeal by Simone Rita Balz, Executrix of the Estate of Frank Bernhard Balz from a reassessment of income tax with respect to the 1987 taxation year.

Frank Balz died January 22, 1987. At the time of death, he was the sole shareholder of Palmela Holdings Inc. (Palmela), a Canadian controlled private corporation, holding 20 shares. These shares passed to his wife, Simone Balz (16 shares) and to his children, Susan (2 shares) and Gary (2 shares). It is the disposition of the latter four shares that is in issue.

By notice of reassessment dated January 4, 1990 an additional taxable capital gain in the amount of $90,6220 realized on the disposition of the four shares in Palmela was taken into account in computing income pursuant to the provisions of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). As a further result the appellant was allowed an additional capital gains exemption in the amount of $27,418.

In reassessing tax as aforesaid, the respondent acted on the basis that:

Palmela was at all material times engaged in the holding of investments and not in active business;

Immediately before and at the time of Frank Balz’ death not all or substantially all of the assets of Palmela were used in an active business carried on in Canada by it or by a company related to it; nor were all or substantially all of the assets of Palmela shares of the capital stock of one or more small business corporations that were at that time connected with the particular corporation or a bond, debenture, bill, note, mortgage, hypothec or similar obligation issued by such a connected corporation; nor were all or substantially all of its assets, assets as herein before described;

Palmela was not a small business corporation within the meaning of the Income Tax Act in that at all material times, not all or substantially all of its assets were used in an active business carried on in Canada by it or by a company related to it;

Corporate assets utilized to produce inactive income exceeded ten per cent of the total assets of Palmela.

The appellant's position is that on January 21, 1987 Palmela was a small business corporation and that all or substantially all of its assets were used at that time in an active business as that term is defined by subsection 248(1) of the Act. Counsel for the appellant quite correctly pointed out that although the assessment relates to the eligibility of shares in Palmela to be transferred to the children of Frank Balz pursuant to the provisions of subsection 70(9.4) of the Act, that of itself relates to the right of Palmela to be considered a Canadian business eligible for the small business deduction. Taking it a step further, this leads to the issue before the Court which is whether all or substantially all of the assets of Palmela were engaged in an active business at the time of Frank Balz's death.

The position of the respondent is that he was correct in assessing on the basis that Palmela was not a small business corporation within the meaning of subsections 70(11) and 248(1) of the Act and accordingly subsection 70(9.4) does not apply to permit a rollover of the gain realized on a disposition of the four shares transferred to Frank Balz's children.

Evidence:

For a number of years Aristocrat Tile Ltd., [1] a wholly owned subsidiary of Palmela, carried on a tile and floor covering business. In 1986 Frank Balz learned he was terminally ill. In August he arranged the sale of the assets of 200139 Ontario Ltd. (200139) to Gaidaco, a company to be incorporated by an employee, Mr. Steve Gaida. The purchase price was to be paid as follows: $25,000 in cash and a promissory note for $787,867 in favour of 200139. The first $200,000 was to be interest free while the balance bore interest at the prime rate plus one per cent (Agreement—Exhibit A-1, Note & Guarantee Exhibit A-2). The agreement required Gaidaco to make an annual payment equivalent to its net profit, such payments to continue until the amount owing was paid. These payments were personally guaranteed by Mr. Gaida and his wife. Another facet of this agreement was that it constituted an employment contract for Simone Balz as bookkeeper for Gaidaco. According to her, this was a mechanism by which she could monitor the ongoing affairs of Gaidaco to ensure that the asset, i.e., the promissory note, was secure and not at risk.

As a result of the foregoing the financial statement of 200139 as of January 31, 1987 (Exhibit R-1, Tab 2) disclosed the following assets:

On the sale of its business operations the company provided financing as follows: While not expressly stated it appears that there was no change in the financial status of 200139 after January 21, 1987, the date of Frank Balz’ death.

Interest bearing note, interest at prime rate less a fixed discount	$587,867
$16,666 for two years
Non-interest bearing loan, to be repaid in full before reduction of in-	172,288
terest bearing note
	760,155

The financial statement of Palmela as at January 31, 1987 (Exhibit R-1, Tab 6) discloses:

Current Assets	1987	1986
Cash in bank	$2,082	$48,125
Short term deposits	171,500	93,385
Corporation income taxes recoverable	14,586	—
Mortgage receivable (note 4)	29,789	—
Due from 200139 Ontario Ltd. (note 3)	390,289	513,652
Due from F. Balz	—	562
	608,246	655,724
Investments (notes 1 and 2)	175,400	175,400
	$783,646	$831,124

Note 2 to the financial statement describes the investments as 4,000 common shares in 200139 valued at cost—$400 and 1,850 common shares in 591523 Ontario Inc. (591523) (representing 18/2 per cent ownership) valued at cost— $175,000. Note 3 states that the receivable from the 200139 has no definite repayment terms nor is interest charged. This financial statement accurately reflects the financial position of Palmela as at January 21, 1987 subject to one exception; the cash in bank and the short term deposits totalled $10,000 less than what is shown on January 31, 1987.

Finally, reference should be made to 591523 in which Palmela had an investment amounting to 1,850 common shares. This numbered company was involved in the development of a project known as St. George's Point, a subdivision in St. Catharines. The Minister accepts that 591523 carried on an active business.

Mrs. Simone Balz gave some evidence regarding the activities of Palmela and 200139 at the relevant times. While she had not been involved in the affairs of Palmela until shortly prior to her husband's death, she was somewhat more knowledgeable about the floor covering business. From her testimony I gather the following. Gaidaco was the only purchaser available. While not describing it as a fire sale she indicated that given his state of health her husband was anxious to put his affairs in order, and this led to the acceptance of the offer and the unusual terms of payment. She said the terms were so generous that 200139 had an interest in seeing Gaidaco succeed. That was the primary reason why they insisted on her employment.

With reference to Ralmela's cash reserves Simone Balz said they were kept at the level shown for a number of reasons, one of which was that it loaned funds as a matter of regular practice to 200139 for use in the floor covering business. She asserted that Palmela continued financing Gaidaco after it acquired that business but conceded that this amounted only to Gaidaco's acceptance of liability for an existing loan of $37,000 and an advance of $27,712 made to it shortly after the sale. [2]

The second reason for the increase in Palmela’s reserves was to provide funds to 200139 to upgrade the showroom. Plans had been made to do so in 1986 but as a result of her husband's illness did not come to fruition. Her recollection was that the estimated budget for this project was between $80,000 and $100,000.

She further asserted that the reserves were also required because Palmela faced substantial contingent liabilities arising out of its involvement in 591523 and the St. George's Point project. Reference was made to Exhibit A-3, the St. George's agreement, and particularly to paragraphs 5 and 21(4) thereof to demonstrate the nature of that financial vulnerability.

In this context several other facts must be noted. At no time was Palmela called upon to contribute any funds beyond the initial subscription to the St. George's project nor to 591523. Secondly, from all appearances neither its reserves nor those of 200139 were ever used after 1986 to finance Gaidaco. Finally, although Simone Balz insisted that the "investment in Gaidaco was extremely risky, it is a fact that the net profit of 200139 (essentially from the floor covering business) as of January 31, 1986 amounted to $143,217. There is nothing in the financial statement as at January 31,1987 to suggest that this business had not performed as well to August 14, 1986 when it was sold. (Exhibit R-1, Tab 2) Finally the net profits of Gaidaco after it acquired the floor covering business were sufficient to enable it to repay the totality of the note by February 1990.

Submissions:

Counsel for the appellant contends that Palmela’s assets were in fact used in an active business. This argument is predicated in part on his analysis of the nature and value of its shares in 200139, in 591523 and on its intended use of its reserves of $173,500.

The assets of 200139 consisted of current assets, investments and fixed assets to a total value of $828,600. There is no dispute, as counsel noted, that the principal asset of 200139, by far outweighing everything else, was the promissory note for $760,155. He submitted, however, that it is to be considered "an active business asset" for two reasons:

Mr: Crossingham: First of all, the company clearly filed in that fashion and the Department has not objected. As you pointed out, though, you are the person I have to convince of that; so, to that end, I'll move to phase 2 of the discussion, which is that this was not an investment that one would make save and except for the active nature of the business.

Mr. Balz or the company would not have made that investment were it not for the particular circumstances they found themselves in with Mr. Balz' rapidly deteriorating health. The question is, is this an investment business that they're conducting or is it—is it an account receivable by the corporation for the moneys that are owed to it as a result of the sale. And I suggest to your Honour that the character of that investment is such that it is more of the second than it is of the first

Later counsel submitted:

The point, very simply and directly, is that if we are to say, well, this is an investment business, we should look at the investments it is making to see whether or not those are what one would normally expect to see in an investment business, and the answer is, no, it is not. And that, coupled with the ongoing support that Mrs. Balz, or more particularly Palmela, gave to the new business and her continued involvement

and,

The question is, therefore, whether or not that constituted an investment business or an active business and because of the continued involvement of Palmela and the support that it gave to the new Aristocrat [3] [emphasis added]

His Honour: Are you saying that, by osmosis, it took on the character of the business it was supporting which was now Mr. Gaida's?

Mr. Crossingham: That's correct.

Counsel relied on this analysis to argue that had the principal purpose of 200139 been an investment business one would logically expect to see an investment of a substantially different character than the one which gave rise to the promissory note. Because of the very nature of this unusual and " risky" endeavour he urges the Court to conclude that 200139 was not carrying on an investment business. From that, by the process of elimination, he submits it had to be an active business as that term is defined in subsection 248(1) of the Act.

The only other asset considered was the short term deposit of $171,000 shown in Palmela’s financial statements. Counsel contended this asset was held by Palmela specifically in the context of its ongoing active business for the following reasons:

(a) the need to maintain cash reserves in order to be able to continue to finance the floor and the business on the same basis that Palmela had financed the old Aristocrat prior to the disposition of its assets;

(b) the provision of reserves to guard against the requirement by 591523 for a further contribution of capital with respect to the St. George's project; and

(c) the fact that the reserve had also been built up prior to Frank Balz' death to enable Palmela to provide funds by way of loan to enable the construction of a new showroom.

Counsel relied on Canadian Marconi Company v. The Queen, [1986] 2 C.T.C. 465, 86 D.T.C. 6525, at page 466 (D.T.C. 6526) as to the presumption in favour of a corporation that when it carries on an activity income earned therefrom is income from a business, and upon certain other observations by the Court with respect to matters to be considered when characterization of income is in issue.

Counsel further urged the Court to consider and apply Sanilit Ltd. v. M.N.R., [1987] 2 C.T.C. 2078, 87 D.T.C. 451. That case dealt with the provisions of subsections 129(1) and 129(4) relating to specified investment businesses and to an exclusion of income from any property that is incident to or pertains to an active business or a non-qualifying business carried on by it. In my view Sanilit is of limited assistance.

Respondent's Position:

Counsel submitted that the use to which the assets of Palmela were put is best characterized as that made by a specified investment business or, stated another way, that their use was more akin to the type of investment made by a corporation carrying on a specified investment business. Secondly, counsel argued that the two major assets in issue, being the promissory note held by 200139 and the short term deposits and cash held by Palmela, were not part of a substantive or actual active business. In each instance counsel contended that the purpose of the asset was to derive income from property. Since the two formed the major portion of the assets to be considered in the context of this appeal it was argued that the appellant has not established that all or substantially all of the assets were being used in an active business.

Conclusions:

For the purposes of this appeal the following sections of the Act are relevant. In taxation year 1987 an elective rollover was available for shares of a small business corporation transferred to a child of a deceased on his death. This rollover was permitted by subsection 70(9.4) of the Act.

In taxation year 1987 a small business corporation was defined by subsection 248(1) of the Act as:

"small business corporation" at any particular time means a particular corporation that is a Canadian-controlled private corporation all or substantially all of the assets of which were at that time

(a) used in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,

(b) shares of the capital stock of one or more small business corporation that were at that time connected with the particular corporation (within the meaning of subsection 186(4) on the assumption that such small business corporation was at that time a "payer corporation" within the meaning of that subsection) or a bond, debenture, bill, note, mortgage, hypothec or similar obligation issued by such a connected corporation, or

(c) assets described in paragraphs (a) and (b),

and, for the purposes of paragraph 39(1)(c), includes a corporation that was at any time in the 12 months preceding that time a small business corporation;" (emphasis added)

The term "active business" was defined by subsection 248(1) as:

"Active business”, in relation to any business carried on by a taxpayer resident in

Canada, means any business carried on by the taxpayer other than a specified investment business ora personal services business;" [emphasis added]

While consideration of "personal services business” is not germane to the issue before me, both counsel in their submissions referred to a specified investment business". However an anomaly appears to exist since at the relevant time "specified investment business” was not defined by section 248. A definition is found in paragraph 125(7)(e) of the Act but it is restricted solely to section 125, and is not, as I read the Act, applicable to the issue before me. No other definition of a "specified investment business" is to be found in the Act as it read in taxation year 1987." [4]

Very recently my colleague Christie, A.C.J.T.C. faced a similar problem in Canada Trustco Mortgage Co. v. M.N.R., [1991] 2 C.T.C. 2728, 91 D.T.C. 1312. In that case the issue was whether certain interest on bank deposits and on a portfolio of mortgages constituted income from an active business in which case it could be excluded from the calculation of its foreign accrual property income under paragraph 95(1)(b) of the Act. No definition of "active business” for the purpose of that paragraph existed in the Act and the definition of "active business” in subsection 248(1) was specifically limited to a business carried on by a taxpayer resident in Canada. As a result Christie, A.C.J.T.C. found it necessary to look to the origin of the notion of active business in Canadian income tax legislation and to certain early jurisprudence which dealt with the small business deduction provisions at that time. His thorough review and analysis is most useful and the approach he adopted commends itself to me.

I begin my consideration by first referring to the presumption in favour of the characterization of the income of a corporate taxpayer as income from a business. In Canadian Marconi Company Inc. v. The Queen, supra, at page 470 (D.T.C. 6529), Wilson, J. said:

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. This approach has commended itself to courts even where no express object was contained in the constating documents: see, for example, Supreme Theatres Ltd. v. The Queen, [1981] C.T.C. 170, 81 D.T.C. 5136 (FCTD) and Fontaine Watch Co. v. M.N.R., supra.

As I have indicated, the presumption that income earned by a corporate taxpayer In the exercise of its duly authorized objects is income from a business is rebuttable. For example in Sutton Lumber and Trading Co. v. M.N.R., [1953] 2 S.C.R. 77, [1953] C.T.C. 237, 53 D.T.C. 1158, the appellant successfully rebutted the presumption and in Burri v. The Queen, [1985] 2 C.T.C. 42, 85 D.T.C. 5287 (F.C.T.D.), Strayer J., although questioning the existence of the presumption (pp. 5289-90), held that if such existed it was rebutted on the facts before him. The question whether particular income is income from business or property remains a question of fact in every case. However, the fact that a particular taxpayer is a corporation is a very relevant matter to be considered because of the existence of the presumption and its implications in terms of the evidentiary burden resting on the appellant.

In this context Locke, J., speaking for the Court in Sutton Lumber, said at page 244 (D.T.C. 1161):

The question to be decided is not as to what business or trade the company might have carried on under its memorandum, but rather what was in truth the business it did engage in.

As to whether a business is an active or inactive one, Urie, J., in King George Hotel Ltd. v. The Queen, [1981] C.T.C. 87, 81 D.T.C. 5082 (F.C.A.), stressed that such a conclusion must be dependent on the circumstances of each case. He said at pages 90-91 (D.T.C. 5084):

That being so, it is neither possible nor desirable to lay down any rule or principle applicable in every case. It cannot be said, therefore, in my view, that income from "other than an active business” necessarily means that derived from a business that "is in an absolute state of suspension" or one "devoid of any quantum of business activity” as has been said in earlier decisions in the Trial Division. In any given case, the business may be of that kind but whether or not it is, is not necessarily determinative of the issue, the resolution of which depends on the fact finder’s view of the true nature of the business based on the facts in the particular case. The quantum of activity may well vary from case to case but still it is necessary for the Court to weigh all of the evidence to characterize the quality of the particular business.

In The Queen v. Rockmore Investments Ltd., [1976] C.T.C. 291, 76 D.T.C. 6156 (F.C.A.) the Court had occasion to consider whether the respondent's income for that year was income "from an active business carried on in Canada" for the purposes of subsection 125(1) of the Act. The Chief Justice stated at page 293 (D.T.C. 6157):

In considering whether there is an“ active business” for the purposes of Part I, the first step is to decide whether there is a “business” within the meaning of that word. Section 248 provides that that word, when used in the Income Tax Act, includes "a profession, calling, trade, manufacture or undertaking of any kind whatever” and includes "an adventure or concern in the nature of trade" but does not include "an office or employment". Furthermore, the contrast in section 3(a) of the Act between “business” and "property" as sources of income makes it clear, I think, that a line must be drawn, for the purposes of the Act, between mere investment in property (including mortgages) for the acquisition of income from that property and an activity or activities that constitute "an adventure or concern in the nature of trade, ora "trade" in the sense of those expressions in section 248 (supra). Apart from these provisions, I know of no special considerations to be taken into account from a legal point of view in deciding whether an activity or situation constitutes the carrying on of a business for the purposes of Part I of the Income Tax Act. Subject thereto, as I understand it, each problem that arises as to whether a business is or was being carried on must be solved as a question of fact having regard to the circumstances of the particular case.” [emphasis added]

And finally as to the distinction between income from business and income from property Wilson, J. in Canadian Marconi v. The Queen said at pages 470-71 (D.T.C. 6529):

It is trite law that the characterization of income as income from a business or income from property must be made from an examination of the taxpayer's whole course of conduct viewed in the light of surrounding circumstances: see Cragg v. M.N.R., [1952] Ex. C.R. 40, [1951] C.T.C. 322, per Thorson, P. at 46 (C.T.C. 327). In following this method courts have examined the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments themselves.

With these principles in mind I turn to the evidence before me.

With respect to 200139, prior to the summer of 1986 its sole business activity consisted of a tile and floor covering business. As a result of the ill health of Frank Balz all of the physical assets underlying that business activity were sold. All that remained as of January 21, 1987 was a small amount of cash on hand, short term deposits and accounts receivable, a very small amount of fixed assets and the promissory note. The promissory note in its entirety was derived from the sale of the assets and was not set aside or dedicated for any other business purpose. There was no activity of any import involved with respect to the promissory note, it simply was a property which earned interest at the rate set out in the relevant agreement. The activity of Gaidaco is not relevant to the issues in this case nor is Simone Balz’s employment. My assessment of the evidence leads me to conclude that while not in an absolute state of suspension the business activity of 200139 was extremely minimal.

As to the assets of Palmela I find that the short term deposits and cash in bank can only be characterized as an investment in property. I reject the submission made by counsel for the appellant that the reserves formed an integral and necessary part of its ongoing active business. As to the assertion that a reserve was required to provide for liabilities which might arise from Ralmela's involvement in 591523 I can only say that such an eventuality was extremely remote. The term deposits in issue cannot be logically linked to some definite obligation or liability. Insofar as the receivable from 200139 is concerned it had no definite repayment terms nor did it bear any interest. That leaves only Palmela’s shares in 591523 and they form a small part of the assets in issue.

I derive little assistance from the fact that Palmela is a corporation. The facts presented to me as to the mariner in which Palmela earned income lead me to conclude, notwithstanding the presumption, that it was earning income during the relevant taxation year from property and not from an active business.

To be successful the appellant must establish that all or substantially all of the assets of Palmela were used in an active business. In Wardean Drilling Co. Ltd. v. M.N.R., [1974] C.T.C. 190, 74 D.T.C. 6164 Cattanach, J. had occasion to consider the phrase “all or substantially all of the property” in subsection 83A(3) of the Act. He said at page 198 (D.T.C. 6169):

The words used in subsection 8(a) of section 83A are “ all or substantially all”. Used in this context the words "substantially all” must mean the substantial portion of the whole business.

Both counsel made reference to Interpretation Bulletin IT-486R in which the "Minister's rule”, sometimes referred to as the"90 per cent rule” is discussed. Counsel for the appellant submitted that this rule was arbitrary while counsel for the respondent described it as useful and functional in dealing with a difficult concept. But in reality the phrase “all or substantially all” does not readily lend itself to any form of simple mathematical formula. I concur with my colleague Taylor, J. who, in D. Wood v. M.N.R., [1987] 1 C.T.C. 2408, 87 D.T.C. 312 said that the phrase came much closer to the description accorded it by counsel for the Minister as "small unrelated amounts such as interest, etc.”.

The evidence fails to satisfy me that all or substantially all of Palmela’s assets were used in an active business carried on by it or by a corporation related to it at the time of Frank Balz's death.

Appeal dismissed.