Collier, J (orally):
1 This is an appeal on behalf of the Minister of National Revenue from a decision of the Tax Review Board. The facts before the Board are the same as those before this Court. They are set out in an agreed statement (Exhibit 1).
2 The defendant is a British Columbia company. One of the objects for which the company was established is as follows:
(b) To provide management services for any Canadian Corporation for the purposes of earning a management fee, provided however the company must be the registered owner of the majority of the issued share capital, having full voting rights under all circumstances, of such Canadian Corporation, and the Company shall not have the power to receive dividends from such Canadian Corporation;
3 In 1965 and 1966 the defendant purchased all but one of the issued common shares of Salmon River Hotel Ltd (“Salmon River”), and all but 1,000 of the preferred shares of that company. Part of the purchase price was deferred. The deferred payments carried interest. Another part of the purchase price was paid with borrowed money. The borrowed funds as well carried interest.
4 The defendant entered into an oral management agreement with Salmon River. It was paid management fees for its services in the years 1967 through 1969. It brought those fees into income for tax purposes. In those same years interest was paid or payable on the deferred purchase price and the borrowed moneys. The amounts are set out in paragraphs 5 and 6 of the agreed statement of facts. The defendant sought to deduct the interest amounts, pursuant to paragraph 11(1)(c) of the Income Tax Act, RSC 1952, c 148 (as amended up to and including 1970) in computing its income for the year in question.
5 The Minister would not permit the deductions on the grounds the interest payments were caught by the qualifications set out in parentheses in subparagraphs (i) and (ii) of paragraph 11(1)(c):
(other than borrowed money used to acquire property the income from which would be exempt ...)
(other than property the income from which would be exempt ...)
6 The Minister relies also on paragraph 12(1)(c) prohibiting the deduction of
(c) an outlay or expense to the extent that it may reasonably be regarded as having been made or incurred for the purpose of gaining or producing exempt income or in connection with property the income from which would be exempt,
7 The Tax Review Board decided in favour of the taxpayer. From that decision this appeal is taken.
8 The Minister's position is that the borrowed moneys were not used for the purpose of earning income from a business, but to acquire property the income from which would be exempt. The property acquired, it is asserted, were the shares of Salmon River and nothing else. The plaintiff contends the borrowed funds were not used for the purpose of earning income, that is, the providing of management services for a fee; the money was used to buy share property; the secondary or ultimate object of gaining the right to provide the services is immaterial; the only income that could flow from the acquisition of the share property was dividends; the dividend income (on the facts of the case) is exempt, or deductible from the defendant's income (see section 28 of the statute); the fact the defendant did not receive income by way of dividend is immaterial, as is the fact its memorandum of association forbade it to receive dividends from Salmon River.
9 The Minister's position, to my mind, ignores the legal substance and the business reality of what occurred between the defendant and Salmon River. In my opinion, the control of Salmon River was purchased or acquired by the defendant in order that it could earn a management fee. Part of its business operations was to provide management services, and from that kind of business to earn income. Its memorandum of association stipulated that before it could provide those services to a company such as Salmon River and earn income from the business services rendered, it must have control of the company. A usual way of securing control is through shares. In this case the purchase of the shares was the technical vehicle to gain the right to provide management services (carry on the defendant's business) and earn income from the source of endeavour.
10 Part of the price of obtaining control to effect that purpose was interest paid on deferred purchase price money or on money borrowed to assist in buying control and the income-earning right sought.
11 The business reality of the situation was that the defendant used the borrowed money for the purpose of gaining, producing, or earning income from a business or property. The only reasonable way, in the circumstances here, and the way described in the memorandum of association, was to acquire share control. The acquisition of share control was a mere method of securing the income earning right.
12 The definition of “property” in paragraph 139(1)(ag) includes “a right of any kind whatsoever”. As I see it, the real property right here was the right to provide services and be paid. But accepting for the moment the plaintiff's contention the property acquired was simply the controlling shares, it does not to my mind follow that those shares were “property the income from which would be exempt” (subparagraphs 11(1)(c)(i) and (ii)). Nor, in my view, can the interest payments be reasonably regarded as having been made or incurred in connection with “property” (shares) the income from which would be exempt (paragraph 12(1)(c)).
13 It is said by the Minister that ownership of the shares of Salmon River carried the right to receive income; income could or would be received in the form of dividends; that that income was exempt.
14 To put the submission another way, the only income receivable (in fact or hypothetically) was necessarily exempt. I am not persuaded that income receivable by virtue of owning the shares would inexorably materialize in the form of dividends. I can foresee other types of income from this “property” which would not be excluded (by reason of some provision in Part I of the statute) in the computation of the owner's income.[FN1: <p>I refer to the definition of “exempt income” in paragraph139(1)(o) of the Act.</p>]
15 In any event one must look at the legal and business reality of the relationship between the defendant and Salmon River. The latter did not pay any dividends. The defendant was prohibited from receiving any. So long as the defendant had share control it is obvious Salmon River would never pay dividends. I think it an unrealistic approach in endeavouring to ascertain whether the interest payments are or are not permissible deductions by virtue of the relevant sections of the statute, to postulate the hypothetical situation that (a) dividends could have been paid by Salmon River, (b) the defendant could have received the dividends or was entitled to them to the exclusion of anyone else, therefore (c) the hypothetical receipt or receivability, is receipt in law, even though in fact it would be ultra vires and, from a company law point of view, illegal.
16 In the particular circumstances in evidence here, no income in the form of dividends, could in law or in fact, be received or be receivable. There could therefore be no so-called exempt income.
17 The decision of the Tax Review Board vacating the assessments for the taxation years 1967 to 1970 inclusive is affirmed. The plaintiff's action is dismissed.
18 The defendant is entitled to its costs. The amount of tax in controversy for each individual year was under $2,500. The aggregate amount for the four years exceeded that figure. Here the appeal from the Board was by the Minister. If the amount of tax in controversy does not exceed $2,500 the Court must order (regardless of result) that the Minister pay all reasonable and proper costs of the taxpayer in connection with the appeal (subsection 178(2) of the so-called new Act). The wording of the subsection is ambiguous and unclear, particularly as applicable to cases where more than one taxation year and therefore more than one assessment of tax is involved in one appeal. While I have some doubts and reservations, I propose to follow the somewhat similar course to that taken by Cattanach, J in The Queen v Clark, [1974] C.T.C. 305, 74 D.T.C. 6242. I consider that, in the circumstances here, the amount of tax in controversy was less than $2,500.
19 The defendant is therefore entitled to all reasonable and proper costs of this appeal. Those costs shall be calculated, however, because the issues in respect of each taxation year were identical, as if only one appeal for one year only had been brought by the Minister.
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