Cornwall Gravel Co. Ltd. v. The Queen, 94 DTC 1709, [1994] 2 CTC 2175 (TCC)

Bonner J.T.C.C.:—The appellant appeals from assessments under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for its 1985, 1986 and 1987 taxation years. It contends that the interest earned by it on certain short-term interest bearing deposits is not, as found by the Minister of National Revenue (“Minister”), income from an “active business” within the meaning of subsection 125(7) of the Act but rather is “Canadian investment income” for purposes of section 129 of the Act. That term is defined in subparagraph 129(4)(a)(ii) to include ”. . . income for the year from a source in Canada that is property . . . .” The definition of the latter term is of significance in the circumstances of this case. It is found in subsection 129(4.1) of the Act which reads:

129(4.1) “Income” or "loss".— For the purposes of paragraph (4)(a) and subsection (6), "income" or “loss” of a corporation for a year from a source in Canada that is a property includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada but does not include income or loss

(a) from any other business,

(b) from any property that is incident to or pertains to an active business carried on by it, or

(c) from any property used or held principally for the purpose of gaining or producing income from an active business carried on by it.

[Emphasis added.]

One further definition is relevant in the circumstances of this appeal. The term “active business carried on by a corporation" is defined for purposes of section 125 of the Act by paragraph 125(7)(a) of the Act (see subsection 129(8)) to mean:

.. . 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;

The appellant was at all relevant times in the aggregate business. It owned and operated gravel pits and asphalt plants and entered into contracts for the construction of roads, highways, sewers, water lines and other like works. Its clients included municipalities and the Ontario Ministry of Transportation and Communications ("MTC"). From the time of the appellant’s formation in 1949 until the early 1960s it was not financially sound. Thereafter it prospered and, with conservative and intelligent management, it became a stable, profitable company with an abundance of liquid assets. During the years in issue, the appellant earned substantial amounts of interest income from treasury bills, banker's acceptances, term deposits and similar short-term interest earning investments.

The appellant had two bank accounts. One was a payroll account used for that purpose only. The other was a current account. Funds from the ordinary construction and gravel related operations of the appellant’s business were deposited in the current account and the costs of operating the business were paid from that account. The short-term investments giving rise to the interest income in issue were made using funds from the current account. When the investments matured or were redeemed the proceeds were returned to the current account. The appellant's bank paid, from time to time, interest on the balance outstanding in the current account. Such interest together with interest earned by the appellant on receivables from its customers was treated by the appellant as active business income for income tax purposes. However the interest earned by the appellant on the short-term investments previously described was treated by it as investment income for income tax purposes and it is the Minister's rejection of that treatment which gave rise to this appeal.

The Minister in making the assessments of tax now in dispute took the position that the appellant's active business income included not only the interest earned by the appellant on receivables from customers and on its current bank account but also, for 1985, all of the interest earned on the short-term investments and, for 1986 and 1987, a portion of such interest. The theory on which the Minister acted was that it was necessary to look at the minimum level of short-term investments held during each year. If, as happened for about one month in 1985 the level fell to zero, then in the Minister's view, all of the money held by the appellant in shortterm investments at any time during that year had to be regarded as having been used or employed in the business. If, at all times, during a year the appellant held at least some snort-term investments then that minimum level of such investments might be regarded as having been surplus to the needs of the business but the amount exceeding that minimum must be regarded as having been used or employed in the business during the year. It was on this basis that the Minister concluded that in the years 1986 and 1987 the interest earned on the first $299,762 and $840,932 respectively of short-term investments was Canadian investment income and that the remainder of the short-term investment interest was income from an active business. The Minister found or assumed that the short-term investments formed part of the appellant's working capital base. He further assumed that without the liquid assets represented by those investments, the appellant would not have been able to demonstrate the financial strength necessary to enable it to bid on MTC contracts and to secure performance bonds and, consequently, it would not have been able to carry on business effectively. [1]

The appellant argued that the investment income from the short-term investments did not flow from a source that was incident to or pertained an active business. It contended that the current account was used for convenience in the process of investing and reinvesting surplus funds and that none of the short-term investments was employed or risked in the business. The removal of the short-term investments would not, it argued, have destabilized the company.

At the hearing of the appeals evidence was given by Lionel Grant. During the years in question he owned, directly or indirectly, three operating companies eing the appellant, R.J. Bender Construction Ltd. ("Bender") and Grant Ready Mix Ltd. ("Ready Mix"). He described the mechanisms used to ensure that construction contracts will be completed in accordance with their terms. In most cases the contractor secures from a bonding company a performance bond guaranteeing that the contractor will complete the contract which it enters into. The bonding company must of course satisfy itself as to the ability, financial and otherwise, of the contractor to carry out the contract. The appellant’s bonding company required indemnities from Mr. Grant and from the appellant, Bender and Ready Mix. In the case of the MTC that body itself evaluates the financial status and other aspects of the ability of the contractor to fulfill its undertakings and on that basis places a limit on the amount of work which it will award to that contractor.

Mr. Grant testified that the appellant had excellent relations with its banker. During the years in question it had a line of credit with the bank of one million dollars. It did not need to draw on that line. The appellant's only liabilities to the bank were for tender loans. When bidding on a contract the appellant was normally required to send with the tender a certified cheque in the amount of ten per cent of the bid. Those cheques were returned if the tender was not accepted. Such cheques were funded by the Bank. The appellant's bonding company never refused to issue any bond sought by the appellant. The MTC invariably set the maximum limit for contracts between itself and the appellant at levels far in excess of anything required by the appellant.

Mr. Grant stated that the short-term investments in question were not crucial to the survival of the appellant’s business. He said that Brian Tardiff, comptroller of the appellant, was responsible for them and spent little time on them. The appellant's bank assisted in finding the investment required by the appellant. Mr. Grant spoke of the investments collectively as what was “left over". He said that no one had ever told him that the monies represented by the short-term investments had to be left in the coffers of the appellant. Mr. Grant was in my view an intelligent and truthful witness and I accept, without hesitation, his evidence as to observable facts.

Evidence was given by William Pritchard, a retired official of the appellant's bank. Mr. Pritchard was at the relevant time area manager of the bank and had overall responsibility for the connection between the appellant and the bank. He confirmed the evidence given by Mr. Grant with respect to the relationship between the appellant and the bank. Mr. Pritchard was asked about the impact of the short-term investments on the bank’s evaluation of the appellant's credit worthiness. He responded that the short-term investments formed a part of the assets of the company and, not surprisingly, that at the bank consideration was given to both assets and liabilities in deciding the amount of credit which would

e extended. More significantly, he added that he would have been happy to see money drawn out of the appellant because, if that had happened, the bank could have loaned the appellant some money. He pointed out that had advances been made against the line of credit the appellant’s indebtedness to the bank would have been amply secured by its accounts receivable. The line of credit was not dependent on the presence of the short-term investments. Finally, Mr. Pritchard indicated that each year the bank furnished to the appellant’s bonding company an update on the appellant's financial position. All such reports were favourable to the appellant. Mr. Pritchard impressed me as an intelligent and credible witness and I accept his evidence without hesitation.

Evidence was given as well by Ronald Mulligan, a chartered accountant in public practice in Cornwall. Mr. Mulligan has for years done the accounting for the corporations in the group owned by Mr. Grant and he prepared the appellant's financial statements for the years in question.

Mr. Mulligan made a number of calculations of working capital both of the appellant alone and of the appellant, Ready Mix and Bender on a consolidated basis. As well he prepared similar calculations of working capital, using figures modified to exclude assets and liabilities of various types. In my view the exercise did not serve to demonstrate that the Minister erred in making any of the findings or assumptions on which the assessments rested. It is not at all clear that the underlying premises on which Mr. Mulligan’s calculations were based were realistic. It was evident that Mr. Mulligan was far from disinterested and that his testimony was affected by his views as to the proper outcome of the appeals. More reliable were Mr. Mulligan’s recalculations of the MTC ratings on the basis of the appellant's financial condition exclusive of the short-term investments. That exercise demonstrated that the appellant, even without the short-term investments, could have qualified for MTC contracts in excess of those held by it during the years in issue.

The assessor apparently placed some reliance on a letter dated October 11, 1988 from an underwriter at the appellant’s bonding company. That letter stated in part:

We require the company to have a positive liquidity position in addition to a positive working capital position to support the bonding undertaken in any given year.

Mr. Mulligan produced a letter dated April 9, 1990 sent to him by another official of the same bonding company stating:

As to your specific questions as to the effect of removal of the term deposits/treasury bills from Cornwall Gravel, we confirm that the company, from 1984 to present, would not have been affected adversely from a bonding standpoint. No bonds issued would have been denied or additional security required.

In my view neither letter is of much assistance. The authors were not called and thus were not available for cross-examination. Furthermore Mr. Mulligan admitted on cross-examination that the letter of April 9, 1990 was written following a discussion between himself and the letter’s author of the dispute with Revenue. Mr. Mulligan furnished the author with a draft of the letter which he desired. I must observe that it would be surprising if a bonding company was prepared to issue performance bonds in respect of a construction company experiencing working capital or liquidity problems. I cannot find on the evidence that the appellant would not have experienced such problems from time to time during the years in issue had the short-term investments been withdrawn.

A list of the details of short-term investments purchased and sold during the period was entered in evidence. In 1985 20 such investments were acquired and 23 were redeemed. The amounts ranged from $125,000 to $1.19 million. In 1986 there were 38 purchases and 33 redemptions. The amounts ranged from about $100,000 to more that $800,000. In 1987 there were 30 purchases and 35 redemptions. The amounts ranged from $150,000 to $850,000. The average daily balances for the years 1985, 1986 and 1987 were $840,887, $1,216,129 and $1,702,104 respectively.

Ordinarily, of course, income from investments of the sort now in question is regarded as income from property. In the case of a corporation the position may be different. In Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, [1986] 2 C.T.C. 465, 86 D.T.C. 6526, the Supreme Court of Canada held that there exists a rebuttable presumption that income derived by a corporation from an activity in which it is specifically permitted by its corporate objects to engage is to be regarded as income from a business. In this case the appellant’s corporate objects [2] were not entered in evidence. However even if those objects do not expressly empower the appellant to engage in activity of the sort which generated the income now in question, the presumption may still be applicable. In Marconi, Wilson J. stated at page 531 (C.T.C. 470, D.T.C. 6259):

Indeed, even if. . . investment objects were not expressed, I believe that a broader form of the presumption should apply. In a general sense . . . 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. 190, 81 D.T.C. 5136 (F.C.T.D.) and Fontaine Watch Co. v. M.N.R. (1960), 25 Tax A.B.C. 146, 60 D.T.C. 535 (T.A.B.).

The evidence in this case does not rebut that presumption. Although the time spent by the appellant's comptroller in making and keeping track of the investments was not great, the revenues generated were not insignificant. The transactions occurred frequently and involved substantial sums of money. They centred on the current bank account used for purposes of the aggregate business. They appear to represent nothing more or less than the method adopted by the appellant to secure the highest possible yield on cash which it did not immediately need for purposes of the aggregate business. The argument that the invested funds were surplus because the appellant could have withdrawn the funds represented by those investments and have carried on the aggregate business using funds borrowed from the bank is of little force. The appellant did not choose to carry on business in that way.

In argument counsel for the appellant placed considerable emphasis on the decision of the Supreme Court of Canada in Ensite Ltd. v. The Queen, [1986] 2 S.C.R. 509, [1986] 2 C.T.C. 459, 86 D.T.C. 6521. In that case the Court considered the question whether interest income on certain U.S. dollar deposits made by the taxpayer with a Philippine Bank was foreign investment income within the meaning or section 129 of the Act. The section 129 definition of such income excluded income from a source that is a property ”. . used or held by the corporation in the year in the course of carrying on a business . . .” The Court adopted the test laid down by LeDain J. in R. v. Marsh & McLennan Ltd., [1983] C.T.C. 231, 83 D.T.C. 5180 (F.C.A.), namely, whether the money invested was employed and risked in the business. [In Ensite, supra] at page 518 (C.T.C. 463, D.T.C. 6524), Wilson J. expressed approval for that test because:

. . . it emphasizes that the holding or using of the property must be linked to some definite obligation or liability of the business . . . .

Wilson J. stated at page 520 (C.T.C. 464, D.T.C. 6525):

A business purpose for the use the property is not enough. The threshold of the test is met when the withdrawal of the property would "have a decidedly destabilizing effect on the corporate operations themselves".. ..

Later on that page she continued:

The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfill a requirement which had to be met in order to do the business. Such property is then truly employed and risked in the business . . . .

In my view the money represented by the short-term investments whether held in a demand deposit in the bank or in the form of the investments was used to fulfill a requirement of the sort contemplated by the Ensite test. The assessor was correct in regarding only the minimum level of short-term investments held throughout a year as those which could not be said to have been used in that year to fulfill the requirements of the aggregate business.

Although counsel for the appellant placed considerable stress during argument on Ensite, supra, it should be noted that the statutory language which was under consideration in that case is not the same as that now incorporated in paragraph 129(4.1)(b). It excludes from income of a corporation from a source that is a property income from any property that is “incident to or pertains to an active business". That language was considered by this Court in Atlas Industries Ltd. v. M.N.R., [1986] 2 C.T.C. 2392, 86 D.T.C. 1756 (T.C.C.). At page 2404 (D.T.C. 1764), Christie, A.C.J. stated:

Giving the words "incident to or pertains to an active business” their grammatical and ordinary sense, and bearing in mind their context, there must I think be a financial relationship of dependence of some substance between the property and the active business before the exclusion in paragraph 129(4.1 )(b) comes into play. The operations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This I regard to be the basic approach to paragraph 129(4.1)(b). Whether income-producing property has crossed the dividing line into the paragraph will depend on the facts of each case.

The assumptions on which the assessments rested included the following: [3]

(c) by includin the term deposits as part of its available current asset base, the appellant had a positive liquidity position and a positive working capital position for the 1985, 1986 and 1987 taxation years;

(d) by excluding the term deposits from its available current asset base, the appellant had a negative liquidity position in 1986 and 1987 and a negative working capital position in 1987;

(e) but for the availability of the term deposits for use in the appellant’s business, the appellant would not have been able to obtain the services of its surety;

Those assumptions have not been rebutted. Where, as here, money is retained by a corporation either in the form of an ordinary current account at a bank or in the form of short-term investments in order to satisfy the liquidity needs of that corporation such money is clearly a “back up asset to be called on in support of” the business operations and the test in Atlas Industries is satisfied. Paragraph 129(4.1)(b) therefore applies to preclude treatment of the interest income in issue as income from a source that is property. The appeals will therefore be dismissed with costs.

Appeals dismissed.