Muir Cap & Regalia Limited v. Minister of National Revenue, 91 DTC 533, [1991] 1 CTC 2342 (TCC)

Mogan, T.C.J.:—The issue in this appeal is whether certain interest derived from term deposits during the appellant's 1983 and 1984 taxation years was income from an active business as claimed by the appellant or income from property as claimed by the respondent.

The appellant corporation was for many years in the business of manufacturing badges, emblems and regalia for lodges and clubs; ribbons for horse shows and fairs; and police caps. Prior to 1973, one of the appellants competitors was a corporation known as Dominion Regalia. At that time, the appellant was managed by Mr. David Hill and the principals in Dominion Regalia were Messrs. Edward Armstrong and Robert Hosier. In 1973, Dominion Regalia purchased all of the issued shares of the appellant. In 1976, four individuals purchased 76 per cent of the appellants shares from Dominion Regalia and thereafter the appellants common shares were held as follows:

In 1976, Mr. Hill became president of the appellant and continued as general manager; Mr. Armstrong continued as president of Dominion Regalia and became vice-president of the appellant; and Mr. Hosier became secretary- treasurer of the appellant and Dominion Regalia. Mr. Hill managed the appellants "Muir Cap" business while Messrs. Armstrong and Hosier managed the “Dominion Regalia" business. Mr. Hill was left in complete control of the appellant and would meet with Messrs. Armstrong and Hosier only a few times each year. The annual sales of the appellant increased significantly in the period 1973-1984 as shown in the table below:

From 1973 to 1975, the appellant was located on O'Connor Drive in the City of Toronto. In 1976, the appellant moved its business premises to 777 Warden Avenue where it remained until 1987 when the shares of the appellant's corporation were sold in an arm's length transaction. Both O'Connor Drive and Warden Avenue are in the eastern part of Toronto. The working conditions on Warden Avenue were very crowded when the business was expanding from 1977 to 1984 and, around 1980, the appellant began to look for new premises. There were certain restrictions on moving because most of the employees were women who came to work by bus or streetcar. Also, there was a retail component of the appellant's business and it had to be convenient for "walk- in" customers.

The location at 777 Warden Avenue was leased and it was the appellant's intention to own its new place of business without having to borrow too much money. In 1979-1980, the appellant started to accumulate significant amounts of cash and term deposits which were set aside to provide a fund for the purchase of new premises. The principals of the appellant were reluctant to borrow because some of their products were regarded as luxury items and a downturn in the economy could produce a significant drop in sales. The cash and term deposits held by the appellant during the relevant years were as follows:

It is the interest earned on the term deposits in 1983 and 1984 which is the subject of this appeal.

In 1982, all of the issued shares of the appellant were transferred to 531875 Ontario Inc. (the ” numbered company") and all of the former shareholders of the appellant took shares in the numbered company in the same proportion as their former shareholdings in the appellant. The appellant paid a dividend of $300,000 in 1982 to the numbered company which loaned back to the appellant the amount of $299,800 without interest and with no specific terms for repayment. The chartered accountant who prepared the financial statements for the appellant testified and stated that the numbered company acquired the shares of the appellant and received the dividend of $300,000 paid in 1982 to avoid the so-called distribution tax" under Part II of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") which was in effect only from 1982 until 1986. There was no adequate explanation given as to why the amount of $299,800 was immediately loaned back to the appellant by the numbered company.

It is admitted in the pleadings that the search for new premises had begun in earnest by 1980 but the respondent has denied that the funds retained in term deposits during 1983 and 1984 were intended for the appellants plant relocation. When making the assessments under appeal, the respondent assumed that, prior to 1983, the appellant had abandoned any intention of purchasing new business premises. Mr. Armstrong (manager of Dominion Regalia) stated that the appellant was looking to buy at least 6,000 square feet when most buildings on the market were in the range of 20,000 to 40,000 square feet. Mr. Hill (manager of the appellant) stated that he did not want to move but, without moving, the appellant was at a standstill for expansion purposes. I did not see any correspondence or other documents indicating that specific instructions had been given to a responsible real estate agent to locate suitable premises.

The appellant never made an offer on even one building and the only specific property mentioned in evidence was in Markham, several miles north of 777 Warden Avenue and too far away from the public transportation needs of the appellant's female employees. If the search for new business premises had begun in earnest by 1980, the appellant had very little to show for that search. This is particularly true when one considers that there was an economic recession in 1981-1982 with a lower demand for the purchase of real estate. The call from a real estate agent about the Markham property is one indication that the appellant had not issued specific instructions as to its needs and limitations concerning public transportation and walk-in retail trade.

In 1984, Messrs Hill and Hozier were 60 years of age and Mr. Armstrong was about 70. These three men managed the two businesses, Dominion Regalia and Muir Cap, and there was no evidence that they had a team of younger management who might have fuelled a corporate ambition to expand. Mr. Hill’s health problem in 1984 and the arm's length sale of the appellant corporation in 1987 indicate that there was no internal heir apparent for the appellant's business. In summary, there was little concrete evidence concerning the appellant's search for new business premises; and I am inclined to the view that the appellant has failed to rebut the respondent's assumption that any such search had been abandoned prior to 1983. A finding to this effect would end the matter but I shall briefly consider the legal argument concerning a possible link between the term deposits and the appellant's active business. The relevant provisions of the Income Tax Act are set out below:

125. (1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation (other than a corporation that carried on a nonqualifying business in Canada in the year) that was, throughout the year, a Canadian-controlled private corporation, an amount equal to 21% of the least of

(a) the amount, if any, by which the aggregate of

(i) the aggregate of all amounts each of which is the income of the corporation

for the year from an active business carried on in Canada . . .

125. (6)(e) “income of the corporation for the year from an active business” means the income of the corporation for the year from an active business carried on by it, including any income pertaining to or incident to that business and amounts deemed by subsection 129(6) to be income from an active business, but does not include income for the year from a source in Canada that is a property (within the meaning assigned by subsection 129(4.1) );

129. (4.1) 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) . . .

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

(c) . . .

There is no doubt that the appellant in 1983 and 1984 carried on an active business in Canada. The question is whether the income from the term deposits was income " pertaining to or incident to" that business within the meaning of paragraph 125(7)(c) of the Act, or whether the term deposits were property “that is incident to or pertains to” the appellant's active business within the meaning of paragraph 129(4.1)(b) of the Act. Counsel for the appellant relied on the decision of the Supreme Court of Canada in Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522; [1986] 2 C.T.C. 465; 86 D.T.C. 6526. In that case, Madame Justice Wilson confirmed at 470 (D.T.C. 6529) that the question of whether particular income is income from business or property remains a question of fact; and she referred to the" large scale investment activity” of Marconi because its fund of $18,000,000 was invested in short term securities requiring a frequent turnover.

The judgment 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 was delivered the same day as judgment in Marconi, supra. In both cases, the unanimous decision of the Court was given by Madame Justice Wilson and the issue was whether income in the form of interest from a particular fund was income from property or income from an active business. In each case, the Court held that the income in question was from an active business. In Marconi, the Court relied on a stated corporate object in the company's charter plus the facts but, in Ensite, the Court ignored the corporate charter and adopted a test based on whether the fund was employed and risked in the business. Wilson, J. stated at page 463 (D.T.C. 6524): "However, the wording of the test employed by Le Dain, J. seems more specific and therefore preferable because it emphasizes that the holding or using of the property must be linked to some definite obligation or liability of the business.”

In Ensite, the fund was used indirectly to capitalize a foreign business. In this appeal, the term deposits appear to be redundant to the appellant's business. At December 31, 1983 and 1984, the following amounts from the appellant's balance sheets are relevant:

In 1983, the loan from the parent company (without interest) almost matches the amount held in term deposits; and in 1984, the appellant was able to repay $60,000 to the parent company while increasing its term deposits by $8,300. The ratio of current assets (including term deposits) to current liabilities in 1983 and 1984 is even more significant:

On the above facts, I cannot conclude that the appellants fund of term deposits, was“ employed and risked in the business” in the words of Le Dain, J. which were adopted by the Supreme Court of Canada in Ensite. Referring to section 129, Wilson, J. stated at page 464 (D.T.C. 6525):

It would seem to follow that the legislative intention underlying the amendment was to catch income from property that is employed or risked in the taxpayer's business to such an extent that the income from it could be characterized as active business income. The use of words such as "employed" and "risked" appropriately implement Parliament's intention.

. . . But" risked” means more than a remote risk. A business purpose for the use of 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": March Shipping Ltd. v. M.N.R., supra, at 2531 (D.T.C. 374). This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset in the long term . . . from an investment made in order to fulfill a mandatory condition precedent to trade . . . .

Even if all of the evidence in this appeal were to support the appellant's claims, the accumulation of a fund for the future purchase of business premises is only a collateral purpose like“ the replacement of a capital asset” and the withdrawal of the fund would not have "a decidedly destabilizing effect” on the appellant's operations. The appellant fails the test adopted by the Supreme Court of Canada in Ensite.

In conclusion, I cannot resist the inference that the fund in question (derived primarily from the parent company's non-interest bearing loan) was held in term deposits in the hope that the interest thereby earned would qualify for the low federal tax rate on "manufacturing and processing profits" and would also enjoy the Ontario tax" holiday” in 1983 and 1984 for such profits when earned by a Canadian-controlled private corporation. The appeal is dismissed.

Appeal dismissed.