Citation: 2012 TCC 420
Date: 20121130
Docket: 2010-1901(IT)G
BETWEEN:
NRT TECHNOLOGY CORP.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
C. Miller J.
[1]
NRT Technology Corp.
("NRT") appeals the Minister of National Revenue’s (the
"Minister") assessment of its taxation year ended September 30, 2007,
in which the Minister denied the non-capital losses brought forward as losses
of Telepanel Systems Inc. ("Telepanel"), a company taken over by NRT
in January 2006. NRT argues that the losses of $4,609,026 are fully
deductible against NRT’s other income as it is in compliance with subsection
111(5) of the Income Tax Act (the "Act") in that :
a)
in the 2007 taxation year it
carried on Telepanel’s business for profit or with a reasonable expectation of
profit throughout the year; and
b)
the income against which it
deducted the losses was derived from the sale of similar properties as
Telepanel’s property, being the Electronic Shelf Label ("ESL")
system.
Facts
[2]
I heard evidence from
Mr. Chris Skillen, formerly the moving force behind Telepanel, Mr. McArthur, a
former employee of Telepanel subsequently employed by NRT (now as Director of
Sales), Mr. Mazza, an officer of Wincor Nixdorf, a distributor of a rival
company in the ESL industry, Mr. Grundy, the CFO of NRT, Mr. Dominelli,
the President and moving force of NRT and an expert, Mr. Perrier, who
explained the technology behind Telepanel’s ESL system.
[3]
I will start by
describing the product which constituted Telepanel’s business, the ESL system.
As the name implies ESL is a relatively small plastic covered module affixed to
a grocery store shelf: it has a small LCD screen used to display products’
prices, with the ability, through the use of a central computer, to change the
price display automatically. The expert went through a much more detailed
explanation of the many components of the ESL technology from the price display
module, to store antenna, to a base station transmitter/receiver through
wireless access points to the actual computer and software application and onto
a main computer. Mr. Perrier pointed out some unique elements of the
Telepanel ESL technology: the high quality plastic container, the durable
mounting mechanism, a process to ensure a long battery life and, most importantly,
a two-way radio function, so that not only does the module receive the price
information, it communicates back to the central computer that it has been
received.
[4]
Telepanel started in
1983, peaked in the mid-1990s and went steadily downhill from there until its
eventual purchase by NRT in 2006. At its peak, in the mid‑1990s, Mr.
Skillen described it as having sales in the millions and the market leader with
more stores (approximately 150) using the product than anyone else. At that
time it also had 50 employees. It had an arrangement with IBM to serve as a
distributor of its product, an arrangement that continued until 2002.
[5]
Mr. Skillen left the
helm of Telepanel in 2000 after having helped with raising $5,000,000 for the
company through a prospectus for the purpose, as he put it, of allowing the
company to continue the business. Notwithstanding the injection of funds, the
Telepanel business started to decline in 2000 as a result of competition, the
introduction of self-scanners which sucked capital investment from ESL systems
and the general malaise hitting the technology industry. Indeed, in PricewaterhouseCoopers
notes to the financial statements of Telepanel for the years ended January 2000
and 2001, PricewaterhouseCoopers noted:
The
accompanying consolidated financial statements have been prepared using
Canadian generally accepted accounting principles applicable to a going
concern. The use of such principles may not be appropriate because, as of
January 31, 2001, there was substantial doubt that the company would be able to
continue as a going concern. If the going concern basis was not appropriate for
these consolidated financial statements, then significant adjustments would be
necessary to the carrying value of the assets and liabilities, the reported
revenue and expenses and the balance sheet classifications used.
[6]
After 2002, it became
even more difficult to finance the business, orders were declining and by 2003
Telepanel had to start laying off employees. It went from 20 to 30 employees in
2003 to 12 in 2004 and just a handful after that. The few left were hired as
independent contractors and were only working a few hours per week: there were
no employees as such.
[7]
The number of stores
with Telepanel’s ESL system peaked in 1995 at 150 and went to 134 in 2000, 100
in 2004 and 60 in 2005, though Mr. Dominelli, upon agreeing to purchase the
Telepanel business believed there were far less stores than Telepanel suggested.
[8]
Mr. Skillen testified
that Telepanel had never, throughout its existence, made a profit. Telepanel’s
revenue came from the sale of the modules, interfaces, transceivers and
antenna, the sale of software along with refurbishments and licence fees. By
the end of 2004, even having put more of his own money into the business, Mr. Skillen
realized that the company needed to find a buyer. In late 2004, he contacted
potential purchasers, Symbol Technologies, Pricer and Retail Store Systems (an
affiliate of IBM), indicating he expected the bidding to start at $2,500,000.
There were no bidders.
[9]
Through his lawyers,
Mr. Skillen was put in touch with NRT, which he described as having some ideal
characteristics:
- retail experience;
- an understanding of the scanning
environment;
-
a United States sales
force;
-
an understanding of ESL
technology; and
-
a manufacturing
facility in Toronto which would be a great location to use Telepanel’s
resources.
[10]
Mr. Skillen first met
with Mr. Dominelli of NRT in April 2005 at Telepanel’s premises. Mr. Dominelli
realized there was not much there physically. He did however see a technology
that was of interest, a technology that could complement the Scanvue (NRT’s
retail scanner) and be a fit with its customers such as Canadian Tire and
Petrocan. He also could envision different uses for the technology in the
gaming industry, which was the most significant element of NRT’s business.
Mr. Dominelli recalled that Mr. Skillen was seeking several million
dollars for the business which he felt was too high.
[11]
At a second meeting,
Mr. Skillen and Mr. Dominelli discussed the technology and the number of
stores. Mr. Dominelli was made aware of Telepanel’s losses though the number
kept changing, as Mr. Dominelli put it, as the years dropped off. Telepanel,
primarily through Mr. McArthur, made a presentation to Mr. Dominelli who was
impressed with Mr. McArthur’s handle on the business. Mr. Dominelli realized he
would be acquiring a bankrupt company though felt he knew how to get it going
again. He put an offer of $1,000,000 on the table which Mr. Skillen accepted.
Mr. Dominelli acknowledged he probably would have paid more. His intention was
to acquire the technology and felt the tax losses were a bonus. The amount of
losses was not determined as Telepanel had not filed returns for a number of
years. The acquisition was delayed until returns were prepared and filed.
Telepanel’s creditors also had to be dealt with through a Proposal to
Creditors. Telepanel, in the fall of 2005, had over $22,000,000 of liabilities
and only $225,000 of assets.
[12]
Prior to making an
offer in November of 2005, Mr. Dominelli had agreed to let the remnants of the
Telepanel business move into its premises, as Telepanel was having problems
with its landlord. Mr. Dominelli indicated he saw a business in stress and it
was in his nature to help out. He also feared he might lose the technology if
he did not help out. NRT therefore provided three cubicles plus space for
inventory and workspace to Telepanel. NRT also hired Mr. McArthur, as,
according to Mr. Dominelli, he felt he had the technological and customer
background he needed. He also hired Mr. Cheung primarily to fix modules, which
he did starting in the fall of 2005 notwithstanding the sale did not complete
until early 2006.
[13]
NRT made its offer to
acquire Telepanel on November 4, 2005. The following are some of the terms of
note:
NRT
Technology Corporation ("NRT") hereby offers, on the terms and
subject to the conditions set out herein, to subscribe or cause its designated
subsidiary or affiliate to subscribe for all the new common shares to be issues
in the capital stock of Telepanel Systems Inc. ("TSI"), as described
in the attached Schedule "A" (the "New Common Shares"), for
the sum of CAN$1,000,000.00 (the "Consideration"). The Consideration
will be paid upon the successful completion of this Agreement to Mintz & Partners
Limited (the "Trustee"), the trustee with whom TSI will forthwith
after execution of this Agreement lodge a proposal under Part III, Division I
of the Bankruptcy and Insolvency Act (Canada) the ("BIA"), for
the benefit of the creditors of TSI.
…
1.
The Proposal
1.1
TSI will at its own expense:
(a) file,
seek creditor approval of and Ontario Superior Court of Justice, in Bankruptcy
and Insolvency (the "Court"), approval of (including the required
order of the Court as authorized under section 191 of the Canada Business
Corporations Act (the "CBCA"), and
…
1.3 Upon implementation of the Proposal and completion of this
Agreement:
(a) except
as expressly agreed in writing by NRT, TSI will have no liabilities of any
nature, kind or priority whatsoever, including any liabilities to which TSI may
become subject on or after the filing of the Proposal (collectively,
"Liabilities"), and shall own the following property and assets:
(i)
the property and assets (including books and
records) described in the attached Schedule "C"; and
(ii)
the full benefit of and entitlement to the use
without restriction of non-capital loss carryforwards for income tax purposes
in the amount of at least $15 million measured as if TSI had a year-end for tax
purposes immediately prior to the completion of the Transaction and after such
tax loss carryforwards have been reduced or otherwise adjusted by any debt
forgiveness or other matters arising from the Transaction including the
Proposal (collectively, all such tax loss carryforwards being the "Tax
Losses");
…
7.2 The Consideration shall be used solely and exclusively for
the purposes of:
(a) payment of TSI’s legal, consulting and Trustee’s fees and
disbursements in connection with this Agreement, the Proposal, the BIA proceedings
and the Transaction, not to exceed $200,000; and
(b) payment by the Trustee of the distributions to creditors
of TSI required under the Proposal.
…
8.1 … On completion, TSI shall deliver to NRT on terms
satisfactory to NRT:
(d) an undertaking of Christopher Skillen to assist and
co-operate with NRT as NRT may request to support and facilitate NRT’s full
benefit and entitlement to the use without restriction of the Tax Losses,
including, without limitation, by providing NRT with access, and consents to
access, to all documents, books, records, information and facts relevant to the
Tax Losses or the amounts thereof not included with the Assets.
[14]
Mr. Skillen received a
$90,000 fee from the sale of Telepanel.
[15]
Shortly after the sale,
Mr. McArthur drafted a news release announcement for NRT’s website:
It
is NRT Technology Corp.’s intent to continue to manufacture, support and
develop the Telepanel product line. Former Telepanel Systems Inc. customers
have the opportunity to be supported and serviced by NRT Technology Corp.
Mr. McArthur acknowledged that at that time he was of
the view that when it was appropriate the modules would start to be
manufactured.
[16]
By the time of the
acquisition by NRT of Telepanel in January 2006, NRT had two former employees
of Telepanel on staff, Mr. McArthur and Mr. Cheung. Mr. McArthur had been let
go by Telepanel in 2004 and was, as he testified, excited to see it restart
with NRT and hopefully it would happen again. At Telepanel he had done
everything from design technologist to customer support and project management,
and as the operations diminished he constituted the entire sales team.
[17]
Mr. McArthur explained
that Telepanel installed ESL in Europe, the United States and Canada, though, due to stringent requirements in Connecticut grocery stores that State was the major
consumer, and it was saturated by 2000. Before reviewing what Mr. McArthur and
Mr. Dominelli did after the acquisition in January 2006 of the ESL business by
NRT, it is important to set out what made up NRT’s business.
[18]
Mr. Dominelli, after
many years with Eaton’s, laterally working in Point of Sale systems, moved to
PIP Retail Systems, working in Point of Sale technology, which ultimately led
to the establishment of NRT in 1993. Mr. Dominelli is its sole
shareholder. The executive summary of NRT’s 2007 business and marketing plan
describes the business as follows:
NRT
Technology Corp. is a leading provider and integrator of automated transaction
based systems. NRT specializes in innovative solutions for the Gaming and Retail
industry. NRT is currently positioned to achieve dramatic sales growth
highlighted below over the next three years. This growth will be achieved in
the Gaming Industry, where NRT has achieved recognition as the industry leader
in Attendant and Patron Self-Service transaction processing.
[19]
The primary Point of
Sale products that NRT developed over the years, up to the time of the
acquisition of the Telepanel technology, were from two departments: gaming and
retail. Those products are described as follows:
(a) QuickJack.
This is a form of ATM used originally in casinos, though now expanded to
racetracks, radio game terminals in bars and betting stations, which would
allow individuals, within a very short period of time to cash in their winnings
or vouchers through QuickJack. This product requires NRT to obtain gaming
licensing approval in the many jurisdictions worldwide where it sells the
product. It has been hugely successful and clearly makes up the vast majority
of NRT’s revenues.
(b) Cary Keyboards. These are specialized keyboards sold into the retail and gas station
market. NRT acquired assets of Cary Peripherals Inc. in 1999, by buying out the
bank’s position. Mr. Dominelli testified it was the keyboard programmability
that made it special.
(c) Scanvue.
This is a price verifying scanner that Mr. Dominelli took years to perfect. It
was being marketed primarily to Canadian Tire.
[20]
In 2007, NRT was also
in the throes of several new product developments, one among them being QuickChip,
described in the 2007 Business Plan as follows:
The
QuickChip extends the redemption function of the QuickJack product to the table
gaming environment. Chip’s would be accepted, validated, and valued by the
system and then stored in a secure safe. Both RFID Chips and conventional chips
could be used.
Table
gaming chips would be presented to the QuickChip machine and the chips would be
validated and the value of accepted chips displayed for the patron. …
[21]
I was left with the
clear impression that NRT’s main thrust was on the gaming side, and this was
where the company’s fortunes lay. This view was confirmed by an article the
Appellant presented at trial from a gaming industry magazine produced in 2008.
It suggested that 95% of NRT’s business was in gaming.
[22]
I turn now to the circumstances
surrounding Telepanel’s ESL business after NRT took over, that is from January
2006 forward. Clearly, the most significant time period for purposes of this
Appeal is the year in question, from October 1, 2006 to September 30, 2007, but
it is useful to review activities prior to that to put the later activities in
perspective.
[23]
As indicated, Mr.
Dominelli hired two former Telepanel employees even before the takeover, Mr.
McArthur and Mr. Cheung. It is those three, Mr. Dominelli, Mr. McArthur
and Mr. Cheung who remained involved in what remained of Telepanel’s business.
Mr. Dominelli believed that ESL would be a good fit with Scanvue particularly
and with its customers, Canadian Tire and Petrocan. He also saw a possibility
of using ESL technology in the gaming industry, for example putting an ESL tag
in a slot machine to take electronic readings or developing a casino chip with
RFID (Radio Frequency Identification). Mr. Dominelli acknowledged that, after
the takeover, every time he spoke to Mr. McArthur it was clear they were
losing more ESL customers, customers he had hoped to preserve.
[24]
Mr. Dominelli
approached both Canadian Tire and Petrocan. I find that he would have done so
prior to September 30, 2006. Canadian Tire had no budget for the ESL system. As
Mr. Dominelli said, interest was declining, customers were not buying. He said
that efforts were made to go out and sell but provided no extensive description
of such efforts other than his contact with Canadian Tire and Petrocan and Mr.
McArthur approaching grocery stores. Mr. McArthur likewise went into little
detail of the extent of such pursuit of customers and I find that after a few
months, and certainly before September 30, 2006, Mr. Dominelli realized that
the market was virtually dead for ESL and his plan was to simply wait and see.
He was not about to put good money immediately into ESL; according to him the
timing was simply not right. He believed that NRT could deliver quickly if the
market did come back. Mr. McArthur, the Telepanel expert however, in December
2007 (after the year in question) advised Mr. Dominelli in an email as follows:
If
we were to fully "relaunch" the Telepanel line I estimate it would
take a commitment of a minimum of $500,000 to continue with the current product
(programmers, support, electrical engineers, install team, etc. + manufacturing
ramp-up) and $1 – 2,000,000 to develop the product to go to a next generation
product. I would think it would take 5-9 Months to be fully ready for market
for the existing product and 12-18 Months for a pilot of a next gen product.
[25]
Mr. Dominelli also
testified that the obligation to pay Canada Revenue Agency ("CRA")
the amounts owed due to the reassessments caused him pause, however, this was
well after the 2006 and 2007 taxation years.
[26]
It was really Mr.
McArthur who, now employed by NRT, was the go-to person for ESL business. It
was Mr. McArthur who took control over everything brought over from Telepanel,
organizing and educating NRT staff and consolidating with NRT business, while
also attempting to understand NRT’s way of doing business. It was Mr. McArthur
who understood the grocery retail market, who understood the ESL technology,
who knew existing Telepanel’s customers and who clearly believed in the ESL
technology. He was "hopeful it would happen again". Even today, Mr.
McArthur testified he has not given up and still has hope NRT can restart the
product, as it was simply not right in the last few years but believes there is
fertile ground in the future. Indeed, Mr. McArthur just recently discovered a
competitor was installing ESL systems in Canada. Mr. Mazza, a representative of
Wincor Nixdorf, testified that they had distributed in 15 stores and expected
30-plus stores in 2013 in Canada though had 5000 stores worldwide with ESL systems
in place.
[27]
Mr. McArthur
recommended NRT hire Paul Cheung in October 2005 specifically to provide
support for the repair and refurbishment of ESL modules. The evidence was vague
as to how much of this work, if any, took place in the year ended September 30,
2007.
[28]
Mr. McArthur testified
that sales efforts continued in 2006 to 2008 with contacts with existing
customers as well as NRT’s two major retail customers, Canadian Tire and
Petrocan. Mr. McArthur went so far as to suggest he was still spending 40% of
his time on ESL in the 2007 fiscal year. I can only presume this time was spent
on reviewing the possibility of ESL technology being manipulated for use in the
gaming industry, and was not spent on pursuing the sale of ESL modules.
I have concluded that within a few months of the takeover, Mr. Dominelli
had determined that marketing ESL was not viable. It would make little sense,
with this direction, that Mr. McArthur was expending any efforts at all in that
regard. Indeed, subsequent correspondence (December 2007 email) confirms that
the ESL business was dormant.
[29]
What concrete evidence
was presented at trial of ongoing conduct of ESL business by Mr. McArthur after
the takeover? As I have indicated, there are two time periods: the 2006 fiscal
year and the 2007 fiscal year. First, the concrete evidence as to activity in the
2006 taxation:
(a) February 2006. Mr.
McArthur responded by email to an inquiry about distributing ESL in Venezuela,
Colombia and the Caribbean, indicating that NRT was pursuing distribution
agreements at this time, concentrating on the domestic market.
(b) February 2006. Mr.
McArthur sent out the announcement letters mentioned earlier.
(c)
March 2006. Mr.
McArthur sent an internal email as follows:
Before
we start marketing and selling Telepanel, John D. feels we must be ready to
produce and support the product. In order to better plan to do so, I have
created a collection of Telepanel documentation on the NRT NAS server. A
project is underway to provide some of this in a web format in the next week or
two.
Please
review this information. I would like to meet with you at your convenience so
we can plan how best to move forward with the product.
(d)
March 2006. Mr.
McArthur provides Mr. Dominelli with a spreadsheet that was done several years
earlier projecting 500 stores per year.
(e)
April 2006. There is
the following correspondence between NRT staff (Middlestadt to Orr – April 10,
2006):
Terry,
The initial work plan for Telepanel Services was to repair/refurbish modules
sent in from customers. Only a small fraction of the total repaired modules
have been sent back and billed. We continued to refurbish the modules that were
returned from customers. The completed work was not shipped and billed as a PO was unavailable from the customers. Eventually it was revealed that the remaining
customers were no longer using the product and subsequently the repaired goods
have become the property of NRT.
At
this point it appears that further repair work on Telepanel modules will be a
waste of resources. The tech hired for this work, Paul, is currently doing an
inventory. He has completed a count of parts in his area, and the next step is
to pull the pallets down one by one and continue counting.
Mr. Dominelli asked Mr. McArthur about this and Mr.
McArthur responds in part:
…
A&P has thus decided to replace the Telepanel systems with brand new NCR
systems. This replacement is now underway with expected completion by the
summer. A&P indicated we could keep the modules we have. These could be
used to fill future orders for spares in this existing client base.
…
It would seem that they are basically giving the modules away now, likely
having written down there book value. This will make it very difficult to sell
new modules until NCR either exhausts there stock in module or prices there
product to make a profit.
[30]
In the 2007 fiscal
year, I have the following evidence:
(a) February 2007. The
Stop & Shop Supermarket pays $9,625 to NRT for software support as an
annual fee, though Mr. McArthur acknowledges this was the only licence renewal
over a six year period.
(b) February 2007 to April
2007. Mr. McArthur is contacted by a customer, Mr. Butler with Island Park Duty
Free, having difficulties with ESL batteries. Mr. McArthur attempts to find
replacements at a decent price.
(c) May 2007. Mr.
McArthur provides information to Mr. Butler so he can program the system with
replaced batteries, apologizing for the delay in responding.
[31]
At the time of the
acquisition in January 2006, Telepanel had losses available for carryforward of
$12,520,548. Initially, NRT used some of those losses to offset 2006 income,
but was subsequently assessed allowing considerable management bonuses which
meant NRT no longer needed Telepanel’s losses in the 2006 year. It did,
however, have taxable income of $4,609,026 in the 2007 taxation year, primarily
from the QuickJack side of the business, which NRT sought to apply against the
Telepanel losses. The Minister denied the use of those losses.
Issue
[32]
Can NRT carryforward
non-capital losses of $4,609,026 incurred by Telepanel and acquired by NRT to
NRT’s September 30, 2007 taxation year to offset NRT’s taxable income of an
equal amount? This issue has two elements:
(a) Did NRT carry on
Telepanel’s business for profit or with a reasonable expectation of profit
throughout the year ended September 30, 2007?
(b) If so, was NRT’s
income against which it deducted the $4,609,026 loss derived from the sale of
similar properties as the ESL?
Analysis
[33]
The applicable
legislation in paragraph 111(5)(a) of the Act reads:
111(5)(a) Where,
at any time, control of a corporation has been acquired by a person or group of
persons, no amount in respect of its non‑capital loss or farm loss for a
taxation year ending before that time is deductible by the corporation for a
taxation year ending after that time and no amount in respect of its
non-capital loss or farm loss for a taxation year ending after that time is
deductible by the corporation for a taxation year ending before that time
except that
(a) such
portion of the corporation’s non-capital loss or farm loss, as the case may be,
for a taxation year ending before that time as may reasonably be regarded as
its loss from carrying on a business and, where a business was carried on by
the corporation in that year, such portion of the non-capital loss as may
reasonably be regarded as being in respect of an amount deductible under
paragraph 110(1)(k)
in computing its taxable income for the year is deductible by the corporation for
a particular taxation year ending after that time
(i)
only if
that business was carried on by the corporation for profit or with a reasonable
expectation of profit throughout the particular year, and
(ii)
only to
the extent of the total of the corporation’s income for the particular year
from that business and, where properties were sold, leased, rented or developed
or services rendered in the course of carrying on that business before that
time, from any other business substantially all the income of which was derived
from the sale, leasing, rental or development, as the case may be, of similar
properties or the rendering of similar services; and
a) Carrying on of
Telepanel’s business for profit or with reasonable expectation of profit
[34]
Clearly, the legislation
contemplates not just the carrying on of the business, in this case Telepanel’s
ESL business, but doing so with a reasonable expectation of profit throughout
the year: in effect, two hurdles for NRT to get over.
i) Carrying on business in 2007
[35]
First, was NRT carrying
on Telepanel’s ESL business in the 2007 taxation year? Telepanel’s business to
be clear was the sale of the ESL systems: that was the business in which the
loss arose. Naturally this entailed the development, manufacturing, marketing
and ongoing maintenance of the ESL product.
[36]
So in what activity did
NRT engage in the 2007 taxation year that constituted carrying on that
business? Very little. But enough says the Appellant that it operated that
business as a "going concern". The Appellant relies on a comment from
the Federal Court of Appeal in the one-page judgment of Garage Montplaisir
Ltée v. Canada 2000
to support the argument that "going concern" is the appropriate test
to be met for the application of paragraph 111(5)(a) of the Act.
The Federal Court of Appeal stated:
[3] On the other hand, in her reasons the trial judge cited
with approval a passage from the Tax Court of Canada decision in the case at
bar to the effect that the purpose of s.111(5) "is not the carryover of
losses as such but the strengthening or survival of a declining business".
[4] We do not feel that the wording of s.111(5) supports such
a statement. All that can be said is that the business of a company subject
to a takeover must still be a "going concern" after the takeover
if the company resulting from the merger is to be entitled to the accumulated
losses.
[Emphasis Added]
[37]
Mr. Chodikoff argued
that to be a going concern requires very little activity, citing Black’s Law
dictionary, 9th edition definition as "a commercial
enterprise actively engaging in business with the expectation of indefinite
continuance". He also goes on to rely on the definition of "going
concern" taken from the Canadian Institute of Chartered Accountants
Handbook:
An
assumption underlying the preparation of financial statements in accordance
with generally accepted accounting principles is that the enterprise will be
able to realize assets and discharge liabilities in the normal course of
business for the foreseeable future. This is commonly referred to as the going
concern assumption.
The Appellant contends that as long as the assets of
the business are not about to be disposed of, it is a going concern. That may be
an appropriate accounting principle but it is not the law. With respect, in the
case of Duha Printers (Western) Ltd. v. R., the
Supreme Court of Canada simply defined subsection 111(5) of the Act requirement
as follows:
However,
this is subject to at least one important qualification: under section 111(5)
where "control" of a corporation has been acquired by another person
(the "Purchaser"), that corporation’s non-capital losses from the
carrying on of a business are only deductible by the Purchaser in a subsequent
taxation year if, throughout that year and after that time, the business in
question was carried on by the corporation with a reasonable expectation of
profit – that is, as a going concern.
That is the test. I do not accept the proposition the
Appellant put forward that "going concern" has some other meaning,
one that effectuates a less onerous requirement for the carrying on of a
business for purposes of paragraph 111(5)(a) of the Act. The
words of this section cannot be displaced by "going concern": that
expression, according to the Supreme Court of Canada, simply is a shorthand way
of encapsulating the subparagraph 111(5)(a)(i) of the Act requirement.
It matters little what name tag is put on the requirement. What matters is the
determination of whether NRT was in fact carrying on Telepanel’s ESL business
in the 2007 taxation year.
[38]
The Appellant argues
that NRT continued to search for potential revenue sources either (i) through
sales of ESL systems or (ii) through potential application of ESL technology in
the gaming industry. The latter, however, was not the business of Telepanel in
which the losses arose. The fact that Mr. Dominelli, perhaps a visionary in the
application of technology to the gaming industry, could see a potential use for
ESL-like technology, does not somehow make that pursuit retroactively the business
of Telepanel. That may have relevance to the issue surrounding subparagraph
111(5)(a)(ii) of the Act but it is irrelevant to my deliberations
under subparagraph 111(5)(a)(i) of the Act. So, was NRT searching
for new sales of ESL systems to retailers in the 2007 taxation year? I find NRT
was not.
[39]
In the 2006 taxation
year, Mr. Dominelli did inquire of Canadian Tire and Petrocan if they were
interested in ESL. They were not. The evidence is overwhelming that within a
few months of the acquisition, the complete lack of potential sales resulted in
what I will call a wait and see attitude. The timing was simply not right.
There was no evidence of any concerted marketing plan to sell ESL in the 2007
taxation year. The 2007 business plan talked of potential, but there was no
plan as such for realizing that potential. No, in the 2007 taxation year NRT
was not searching for ESL sales.
[40]
The Appellant argues
that it hired multiple Telepanel employees who continued to work at NRT
throughout 2006 and 2007. There were in fact two, Mr. McArthur and Mr.
Cheung. The latter was employed initially to handle the refurbishment of ESL
modules. In the 2007 taxation year that had diminished to next to nothing. Mr.
McArthur was a bright light in Mr. Dominelli’s eyes who was well integrated
into NRT’s business by the 2007 taxation year. Mr. McArthur’s suggestion of
still spending 40% of his time on Telepanel business in the 2007 taxation year
I find questionable. There simply was not that amount of activity with respect
to the ESL product. Only if one considers the shift of technology into the
gaming industry, which as I have indicated I do not consider the business in
which the losses arose, could Mr. McArthur’s estimate of 40% of his time
possibly be explained.
[41]
The Appellant
maintained an inventory of ESL modules. This is equally consistent with
carrying on business as it is with putting the business on hold until some
future date.
[42]
NRT argues that it had
suppliers available in the event demand increased. This is more consistent with
a future hope than the ongoing carrying on of business.
[43]
The Appellant argues
NRT continued to provide technical support for existing Telepanel customers
throughout 2006 and 2007. I find there was, understandably, more of that
activity in 2006 than in 2007. In 2007 the only activity in that regard was the
problem with Island Park Duty Free, which took Mr. McArthur some time to
sort out. I do not doubt the contention that NRT was ready to help a Telepanel
customer should the need arise. The need simply did not arise.
[44]
The Appellant suggests
that Mr. Dominelli was ready to commit capital as needed if the timing was
right, suggesting he was monitoring the market carefully. This does not accord
with the fact that as recently as this year, Mr. McArthur stumbled across the
fact a competitor was installing ESL in Ontario, and indeed had systems in 5000
stores worldwide. This did not leave me with the impression that five years
after the year in question the market was being closely monitored by NRT. Further,
the notion that NRT was ready to commit capital is just that, a notion. The
evidence was that ESL could be re-launched with as little as a half‑million
dollar investment. NRT was financially sound and such a commitment would not
have been onerous. It never made that commitment.
[45]
This all leads me to
the conclusion that Mr. Dominelli decided, with the good commercial sense that
he had, that it was not timely to continue the ESL business. At some point
shortly after NRT’s acquisition of Telepanel, a bankrupt business, as Mr.
Dominelli put it, efforts ceased to sell ESL. That business effectively ended.
[46]
Mr. Chodikoff directed
me to a 1964 Tax Review Board decision which appears to emphasize how little
activity is required to carry on a business. In Carland (Niagara) Ltd. v.
Minister of National Revenue
the Tax Review Board indicated:
…In
other words, a business of some extent that was a reduced, but the same,
business was carried on. It is not necessary that there be sustained activity
before it can be maintained that a business is carried on; there may be and
often are periods of quiescence in almost any business enterprise. Cases cited
in Hannan and Farnsworth’s The Principles of Income Taxation, at p. 162 and on,
show that such happenings have not been viewed as inconsistent with carrying on
a business. An instance is The Commissioners of Inland Revenue v. The South
Behar Railway Co., Ltd., (1925) 12 T.C. 657, at p. 712, where Sumner, L. J.,
remarked:
…as
long as her trade bets remain undischarged, there would seem to be a
presumption that a company continues to carry on business as long as it is
engaged in collecting debts periodically falling due to it in the course of its
former business. Business is not confined to being busy; in many businesses long
intervals of inactivity occur.
I
do not suggest that the company now under consideration did no more than this,
but the South Behar railway case indicates how little need, be done to
constitute a carrying on of business. I find, as a fact, that some measure of
business, be it greater or lesser, never ceased to be conducted at any material
time. Always, the premises were open to any customer who might call there. In
this regard, it may be noted that throughout the period described, the business
started originally by Mr. Macklem was at the same location, in the same
building, with the identical showroom, parts department and mechanical garage.
In no quarter that has come to my attention was there any physical change.
[47]
Also in the Tax Court
of Canada decision of Garage Montplaisir Ltée
Justice Lamarre-Proulx stated:
29. Counsel for the appellant properly suggested that the
following principles emerge from the case law: it is the business which
generated losses which must be continued, not necessarily the corporate entity;
a reduction of activities, inventory and assets is not sufficient to show that
the business was terminated; a minimum of activity may suffice to lead to the
conclusion that there was continuity in the business; a business may have two
separate operations and it is essentially a question of fact and of weighing
the evidence, as to whether the business continued or not.
[48]
Finally, in Canadian
Dredge and Dock Co. v. MNR
the Tax Review Board stated:
The
courts are consistent in holding the company will not be entitled to deduct
losses incurred in previous years if there has been a change of control in the
company and if it has clearly interrupted, ceased and altered the business in
which the losses were sustained. Both these conditions are question of fact.
[49]
I do not disagree with
the principles set forth in these cases, but it is a matter of degree of
activity and nature of activity that must be considered. I have concluded that
there was such little activity in the 2007 taxation year (one receipt and one
maintenance call) that the business was not carried on throughout the year.
Operations had not only been interrupted and altered they had effectively
ceased. Waiting for a former customer to call for the purpose of repairing a
module does not constitute carrying on a business.
ii) With a reasonable expectation
of profit
[50]
Had I concluded
otherwise, that such minimal sporadic activity meant the business was simply
asleep throughout the year but not deceased, and thus might, under the most
generous of interpretations, be considered to be carrying on business, it must
have done so profitably or with a reasonable expectation of profit throughout
the year.
[51]
First, was the business
carried on for profit in the 2007 taxation year? The Appellant argued, albeit
briefly, that some element of the $9,600 licence fee received in 2007 constituted
profit, and the test was therefore met. Even making the tiniest allocation of
overhead to Telepanel’s business, as well as some of Mr. McArthur’s 40% of
his salary, this figure would quickly be overshadowed. The Appellant did not go
through the exercise to satisfy me that any of the $9,600 was profit. I
conclude the business was not carried on for profit.
[52]
With respect to the
reasonable expectation of profit, this has been a much maligned concept in the
context of determining a source of income, culminating in the Supreme Court of
Canada’s Stewart v. R.
decision which laid to rest the reasonable expectation of profit test for that
purpose. The court stated:
47. To summarize, in recent years
the Moldowan REOP test has become a broad-based
tool used by both the Minister and courts in any manner of situation where the
view is taken that the taxpayer does not have a reasonable expectation of
profiting from the activity in question. From this it is inferred that
the taxpayer has no source of income, and thus no basis from which to deduct
losses and expenses relating to the activity. The REOP test has been
applied independently of provisions of the Act to second-guess bona fide commercial decisions of the
taxpayer and therefore runs afoul of the
principle that courts should avoid judicial rule-making in tax law: see Ludco, supra; Royal Bank of Canada v. Sparrow
Electric Corp., 1997 CanLII 377
(SCC), [1997] 1 S.C.R. 411; Canderel, supra; Shell Canada Ltd. v. Canada, 1999 CanLII 647
(SCC), [1999] 3 S.C.R. 622. As
well, the REOP test is problematic owing to its vagueness and uncertainty of
application; this results in unfair and arbitrary
treatment of taxpayers. As a result, “reasonable expectation of profit”
should not be accepted as the test to determine whether a taxpayer’s activities
constitute a source of income.
[53]
I am not faced with
judicial rule-making, nor am I faced with whether or not there is a source of
income. I am faced with a section of the Act that explicitly adopts the
reasonable expectation of profit test for the determination of when losses can
be used after a change of control. For the determination of a source the
Supreme Court of Canada asks first if it is clearly commercial activity and, if
so, such endeavours "necessarily involve the pursuit of profit". This
cannot be the test where the legislation itself demands the two elements of
carrying on business along with a reasonable expectation of profit. It cannot
be enough to say that if you are carrying on business then it is implicit you
had a reasonable expectation of profit. No, I must consider the reasonable
expectation of profit element of the test. In so doing it is useful to consider
the objective factors set out in the case law. This has been summarized by the Federal
Court of Appeal in Tonn v. R.
65. I am now ready to
decide this case. A variety of factors have been proposed over the years by
which objective reasonability might be demonstrated in given circumstances. In
the original Moldowan decision, these factors were enumerated
as follows:
The following criteria
should be considered: the profit and loss experience in past years, the
taxpayer's training, the taxpayer's intended course of action, the capability
of the venture as capitalized to show a profit after charging capital cost
allowance. The list is not intended to be exhaustive.
66. Another listing of
the factors to be assessed was set out in Sipley
(P.D.) v. Canada:
The objective test includes
an examination of profit and loss experience over past years, also an examination
of the operational plan and the background to the implementation of the
operational plan including a planned course of action. The test further
includes an examination of the time spent in the activity as well as the
background of the taxpayer and the education and experience of the taxpayer.
67. Finally, Landry (C.) v. Canada suggests the following items to
consider:
Apart from the tests set out
by Mr. Justice Dickson, the tests that have been applied in the case law to
date in order to determine whether there was a reasonable expectation of profit
include the following: the time required to make an activity of this nature
profitable, the presence of the necessary ingredients for profits ultimately to
be earned, the profit and loss situation for the years subsequent to the years
in issue, the number of consecutive years during which losses were incurred,
the increase in expenses and decrease in expenses in the course of the relevant
periods, the persistence of the factors causing the losses, the absence of
planning, and failure to adjust. Moreover, it is apparent from these decisions
that the taxpayer's good faith and reputation, the quality of the results
obtained and the time and energy devoted are not in themselves sufficient to
turn the activity carried on into a business.
68. These quotations
suggest that the list of relevant factors is growing and that it may continue
to grow. What this indicates is that a detailed look at the business in the
context of its operations is what is required, and that reasonableness is to be
assessed on the basis of all the relevant factors, both the already listed ones
and any new ones that may be helpful.
[54]
Before addressing some
of these factors, I would like to summarize what I find to be the
situation at NRT vis-a-vis Telepanel’s ESL business and its future prospects.
Mr. Dominelli saw technology at Telepanel that impressed him and he made a
lowball bid to buy it and he got it. I believed he saw some possible future
value in that technology, primarily as it might relate to developments in the
gaming industry, but also with the ESL system itself. Soon after the
acquisition of Telepanel he realized the market was not right for pursuing the
ESL business. No more time, little effort and no money was put into that business.
It was on hold. I am satisfied that when he acquired Telepanel he, and
therefore NRT, hoped that at some point in the future the sale of ESL modules
might produce a profit. This hope was based almost exclusively on future market
conditions. Can this hope be considered a reasonable expectation of profit? Let
us look at some of the factors.
i) Profit and loss in past years
[55]
The Appellant argues
that this factor should not be determinative, but instead the potential for
future profit should overshadow the track record of ESL and Telepanel. Looking
retrospectively and prospectively must be viewed in balance. Looking backward,
the fact is no profit was ever made from the ESL business. Looking forward, the
fact is that one of the key employees in the past operation of the business,
Mr. McArthur, would be the key employee of the ESL business in the future if it
was ever re-launched. I have not been convinced from the evidence that the
potential market in the future is any different than it was in the past: there always
were and continue to be thousands of grocery stores that would benefit from ESL
technology.
[56]
The same factors
affecting the bottom line faced ESL going forward in 2007 as faced Telepanel in
the past: competition and economic depression. Indeed, when the economy was
thriving, and Mr. Skillen was able to significantly increase revenues, he was
still unable to produce a profit.
[57]
The Appellant argues
that NRT had ready-made customers of some note, Canadian Tire and Petrocan. The
fact is they were approached and they were not interested.
[58]
The only factor that
might diminish Telepanel’s dismal profit and loss history as a factor, in
making the determination of a reasonable expectation of profit, is the
commercial strength of Mr. Dominelli personally. He successfully turned the
Cary Peripherals Inc. business around and has clearly done well in the
gaming industry. Yet, after limited efforts soon after the acquisition, he did
nothing by way of planning or actuating the future of the ESL business: that
does not jive with an expectation, reasonable or otherwise, of potential
profit.
[59]
The potential for
profit, with nothing by way of a game plan as to how to realize on that
potential, other than a wait and see approach, has not convinced me to ignore
Telepanel’s inability to ever make a profit. This factor works against finding
a reasonable expectation of profit.
ii) Training
[60]
Certainly NRT had
well-trained and knowledgeable employees, albeit apart from Mr. McArthur and
Mr. Cheung, not specifically in ESL systems. This factor, though, favours a
view that such a team could have the technical and commercial expertise to make
a profit from the ESL business.
iii) Intended course of
action/planning
[61]
As I have made clear,
in the 2007 taxation year the only intended course of action was to wait and
see. There was no concrete plan as to what NRT would do when the market
revitalized. There was no timeline. There was certainly no injection of funds
into ESL. There was simply an attitude that at some unknown point in the future
by taking some yet to be determined steps to re-launch the ESL product, there
could be the potential for profit. The intended course for the foreseeable
future was inaction.
iv) Capability as capitalized
[62]
The evidence is clear
that the decision was not to capitalize the ESL business either at one or two
million dollars or even at half a million dollars. Again, this is something
that may or may not have happened in the future. This factor is inapplicable.
v)
Time required to
make activity profitable
[63]
The activity was, prior
to acquisition, never profitable after many years of operation. There is no
time after acquisition that the minimal activity carried on by NRT on ESL would
have been sufficient to make a profit, so it is not possible to even predict
what time would be required.
vi) Presence of necessary
ingredients for profit ultimately to be earned
[64]
The necessary
ingredients from what I can derive from Mr. Skillen’s and Mr. McArthur’s
testimony are: greater volume, that is many many more stores, lower cost of
production and effective marketing. Again, without a plan, it is not possible
to say whether NRT would have these necessary ingredients whenever it got
around to marketing ESL.
vii) Persistence of factors causing
loss
[65]
This more aptly than
any other factor hits the nail on the head. In 2007 and into the foreseeable
future there was no evidence to suggest the economic circumstances that
triggered only losses was about to change.
viii) Failure to adjust
[66]
The irony of the
situation facing NRT is that it did adjust. It adjusted by virtually ceasing
the ESL operation and perhaps shifting work into the use of ESL technology in a
casino chip, but as I have indicated, that is not the business in which the
losses arose. There was also not a great deal of detail by Mr. McArthur or Mr.
Dominelli as to what actual work was carried on vis-à-vis ESL technology’s
application to a casino chip.
[67]
In summary, NRT
acquired a bankrupt business, took minimal steps in the short term (not in the
year in question) to determine the viability of the business and determined the
timing was not right. This is not a criticism. Understandably there was no
capital injected, no plans made and, without a crystal ball, no idea when the
timing might be right. In these circumstances, I find any expectation of profit
is wishful thinking, illusory even, but certainly not reasonable.
Reasonableness for the purpose of expecting profit requires some grounding in
economic reality. The economic reality facing NRT would not support a reasonable
expectation of profit. With no definite time projection of a re-launch of the
product it is impossible to know what competitors might be doing, how far
technology might have developed, or what labour and manufacturing costs might
be: in effect, too many unknowns to have any reasonable expectation of profit.
[68]
Having concluded NRT
was not carrying on the ESL business with a reasonable expectation of profit
throughout the 2007 taxation year, it is unnecessary to address the second
element of subsection 111(5) of the Act, being the determination of what
income of NRT the losses could be deducted against. I would have had no
difficulty however concluding that the income from NRT’s Scanvue was
sufficiently similar: similar market and similar pricing mechanism. I could not
however reach the same conclusion with respect to NRT’s QuickJack product:
different market and different function all together.
[69]
The Appeal is dismissed
with costs to the Respondent.
Signed at Ottawa, Canada, this 30th day of November 2012.
"Campbell J. Miller"
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