Date: 20000114
Docket: 96-4709-IT-G
BETWEEN:
WILLIAMS GOLD REFINING CO. OF CANADA LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowie J.T.C.C.
[1] In filing its income tax returns for the 1992 and 1993
taxation years the Appellant (Williams) claimed to be entitled to
deductions of $560,529 and $67,619 respectively as bad debts owed
to it by a related company, W.G.R. Hollowforms Ltd.
(Hollowforms). These amounts remained unpaid at the end of the
years in question, and were considered by the Appellant to be
uncollectible. It claims to deduct the amounts in computing its
income for the 1992 and 1993 taxation years, either as bad debts,
pursuant to paragraph 20(1)(p) of the Income Tax
Act (the Act), or as outlays or expenses incurred for
the purpose of producing income. The Minister of National Revenue
(the Minister) allowed the deduction to the extent of $19,815 for
1992, and not at all for 1993. The subject of these appeals,
therefore, is the Appellant's claim to deduct the balance of
$540,714 for the 1992 taxation year, and the full amount of
$67,619 for the 1993 taxation year.
[2] In 1989 Richard Dimberio acquired all the shares of
842700 Ontario Ltd., which carries on business as W.G.R. Holdings
(WGR). It, in turn, holds all the shares of Williams. WGR also
owns the three buildings, and appurtenant land, on Courtwright
Street in Fort Erie, Ontario, where Williams carries on its
operations. During the relevant time period, the business of
Williams consisted of formulating alloys of gold, silver and
platinum for use by dentists and dental laboratories, and
precious metal alloys for use in the jewellery business. It also
refined scrap precious metals, separating them into their various
elements for reuse.
[3] In 1989, Mr. Dimberio hired a Mr. Nicholson as his sales
manager. Soon after, he and Mr. Nicholson looked into the
possibility of entering the business of producing hollow form
jewellery. After some investigation, they obtained the rights to
the use of a German process for producing hollow jewellery. This
process involved plating wax forms, which were then melted, to
leave a hollow jewellery item. Hollowforms was created to carry
on this business. Initially, WGR and Mr. Nicholson each owned 50%
of the shares.[1]
Hollowforms obtained the specialized equipment which the process
required by way of lease. A Mr. Fortin was hired as a
jewellery designer, and a Mr. Lewicki was hired as a technician
to manufacture it. Both of them were employees of Williams,
although their work was entirely related to the production of
jewellery for Hollowforms. The jewellery manufacturing operations
began in September 1990.
[4] According to the evidence of Richard Dimberio, which I
have no reason to doubt, his objectives in creating Hollowforms
and entering into the jewellery business were two-fold. One was
to improve the profitability of Williams by devoting some of the
space in the three buildings it occupied, and some of the time of
its employees, to the new business. With surplus space, and
employees who were not fully occupied, Williams had unnecessarily
high overheads. It was Mr. Dimberio's intention to
redeploy some of that overhead to the work of the Hollowforms
company. His other objective was to create an additional precious
metals market for Williams, and it did in fact supply the
precious metals and alloys which Hollowforms used in its
manufacturing business. Hollowforms itself had no employees, and
Mr. Fortin and Mr. Lewicki were added to the payroll of Williams.
The existing Williams staff handled all the necessary
administrative, financial and secretarial work for
Hollowforms.
[5] On March 1, 1991 WGR entered into two leases in respect of
the Courtwright street property where Williams carried on its
business. The first of these was with Williams, and it covered
all the property except the upper floor. The lease was for one
year, at a rent of $3,000 per month. The second lease covered the
upper floor, which was leased to Hollowforms, also for one year,
at a monthly rent of $2,375. During the years under appeal, the
Appellant paid the rent under both leases, and then invoiced
Hollowforms for the amount of the rent paid on its behalf under
its lease.
[6] Williams remitted invoices to Hollowforms for the raw
materials at prices equal to the current value of the metal, plus
overhead, but with no profit factor. Similarly, the time of
employees devoted to the work of Hollowforms was invoiced by
Williams to Hollowforms, at cost, including the cost of related
employee benefits. To the extent that Hollowforms required raw
materials and supplies that were not produced by Williams, these
were purchased for it by Williams, paid for by Williams, and
invoiced to Hollowforms at cost. The proportion of employees'
time invoiced by Williams to Hollowforms appears to have been
arrived at by an estimate made by Mr. Dimberio, or perhaps
by his son David Dimberio, who was the vice-president and general
manager of Williams.
[7] The business of Hollowforms did not go well. Sales figures
did not meet expectations, and significant losses resulted. In
September, 1991, WGR purchased Mr. Nicholson's 50%
shareholding, thus becoming the sole owner of Hollowforms. By
September, 1992 it was apparent that the business of Hollowforms
was a failure. Mr. Fortin's employment with the Appellant was
terminated in October 1992; Mr. Nicholson was let go in December.
Mr. Lewicki remained on the Appellant's payroll until
August 1993, only because he was Mr. Dimberio's
son-in-law.
[8] As a result of its poor sales performance, by the end of
1991 Hollowforms owed Williams $407,000. By August 31, 1992,
which was the 1992 year-end, this debt had risen to $626,686.
During its 1993 fiscal year, Williams forgave debts of
Hollowforms totalling $694,305. Nevertheless, at August 31, 1993,
there remained $68,012 payable by Hollowforms to Williams.
Hollowforms was clearly insolvent at that time, having assets
substantially less than its liabilities. In 1994, Hollowforms
underwent a change of name and became known as Canada Ventures
Dental Supplies Limited. It took up a new line of business,
selling dental products purchased from a U.S. manufacturer. It
continued to incur operating losses in this new business each
year until 1997, when it became dormant.
[9] The amounts which comprise the indebtedness on the books
between Hollowforms and Williams, and which are claimed by
Williams as a bad debt expense, may be divided into three
categories. The first relates to the supply by Williams to
Hollowforms of materials to be formed into jewellery. This amount
was $19,815, and was allowed by the Minister in assessing the
Appellant, as it was a debt which came into existence as the
result of sales of product by Williams to Hollowforms. The second
consists of amounts which were billed by Williams to Hollowforms
as Hollowforms' share of the salaries and benefits of
employees, and as its share of other expenses which were incurred
by the Appellant on behalf of both companies. The third is
comprised of the rent payable by Hollowforms to WGR under its
lease, and other amounts for materials, supplies and services
obtained by the Appellant for Hollowforms, all of which were
initially paid by the Appellant, and then invoiced to
Hollowforms. The second and third categories are the subject
matter of these appeals. Particulars of the items making up the
second and third categories are set out in an appendix to the
Reply filed by the Respondent. There is no dispute as to the
accuracy of that document, and it is included as Appendix
"A" to these Reasons for Judgment.
[10] The Appellant claims to be entitled to deduct the amounts
in issue on either of two independent bases. The first is that
they are bad debts whose deduction from income is specifically
permitted by paragraph 20(1)(p) of the Act. The
second is that they are outlays or expenses incurred by the
Appellant for the purpose of gaining or producing income from its
business, and are therefore proper deductions in the computation
of profit from that business.
[11] The relevant parts of the provisions of the Act
invoked are:
9(1) Subject to this Part, a taxpayer's income for a
taxation year from a business or property is his profit therefrom
for the year.
...
18(1) In computing the income of a taxpayer from a business or
property no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it
was made or incurred by the taxpayer for the purpose of gaining
or producing income from the business or property;
(b) an outlay, loss or replacement of capital, a
payment on account of capital or an allowance in respect of
depreciation, obsolescence or depletion except as expressly
permitted by this Part;
20(1) Notwithstanding paragraphs 18(1)(a), (b)
and (h), in computing a taxpayer's income for a
taxation year from a business or property, there may be deducted
such of the following amounts as are wholly applicable to that
source or such part of the following amounts as may reasonably be
regarded as applicable thereto:
...
(p) the aggregate of
(i) all debts owing to the taxpayer that are established by
him to have become bad debts in the year and that have been
included in computing his income for the year or a preceding
taxation year, and
...
[12] I shall deal first with the claim that these amounts fall
within paragraph 20(1)(p) of the Act. The
evidence establishes to my satisfaction that the amounts here in
question had become bad debts by the time they were so treated by
the Appellant. The more difficult question is whether they had
been included by the taxpayer in the computation of its income
for the year, or for a preceding year. The Respondent takes the
position that they had not, and that this is definitively
established by the undisputed fact that the Appellant recorded
the amounts in question in its accounts as reductions to its
expenses, and not as sales. Counsel for the Appellant responds
that the amounts could as well have been treated as sales for
accounting purposes, and that, in any event, the effect on the
computation of profit from the business would be exactly the same
whether they were treated as revenues, or as reductions to
expenses.
[13] The question whether an amount has been included in
computing a taxpayer's income is not resolved simply by
whether it has been credited in the books to a revenue account.
What I must look at is the true nature of the transactions giving
rise to the amounts, and not simply the treatment given to them
by the bookkeeper: see L. Berman & Co. Ltd. v.
M.N.R.,[2] and Associated Investors of Canada Ltd. v.
M.N.R.[3]The evidence before me establishes that
the employees were employees of the Appellant company. They had
no contractual relationship with Hollowforms. I am driven to the
conclusion that the Appellant was their employer, and that it
supplied their labour to Hollowforms in return for the debt
represented by the account receivable. This is true of the shared
employees, and it is equally true of Mr. Lewicki and Mr. Fortin,
even though all the work that they did was done for the benefit
of Hollowforms. The amounts due to the Appellant for the services
of these employees is no less revenue because it was recorded, in
my view inappropriately, as a reduction of the Appellant's
wage expense for the year, rather than as revenue from the supply
of services.
[14] The evidence as to the other items in the second category
was sparse. However, I see no reason to treat them differently
than the wages and related costs. I did not understand counsel
for the Respondent to be asserting that there was any reason to
do so. The amounts falling into category two, therefore, should
properly be considered charges for supplies and services
furnished by the Appellant to Hollowforms, and are to be treated
as being on revenue account. The fact that the sales were made at
cost does not affect the appropriate treatment of them: see
Greenfield Industries Ltd. v. M.N.R.[4]The amounts in the
second category therefore qualify as bad debts under paragraph
20(1)(p), and are deductible in the years in which they
were written off.
[15] The third category consists of amounts which were owed to
the Appellant by Hollowforms as the result of transactions
between Hollowforms and third parties, for which payment was made
to those third parties by the Appellant on behalf of Hollowforms.
These amounts are set out in the lower half of
Appendix "A". It is not at all clear from the
evidence whether these liabilities of Hollowforms arose from
contracts entered into on its behalf by the Appellant as its
agent, or by the employees of the Appellant while they were
serving Hollowforms. I doubt that any of the people involved ever
gave a thought to that question. In either event, however, the
debt to the third party supplier is the debt of Hollowforms, and
the discharge of those debts by the Appellant is properly
characterized as a loan from the Appellant to Hollowforms, and
not as a supply of goods or services. The amounts making up this
category cannot therefore be charaterized as revenues, and have
not been included in the computation of the Appellant's
income. They do not qualify for the deduction under paragraph
20(1)(p).
[16] I turn now to the Appellant's subsidiary argument,
which is that the amounts in question may be deducted by the
Appellant in the years in which it recognized them as having
become uncollectible, pursuant to the ordinary principles
governing the computation of profit. Those principles were
recently reconsidered by the Supreme Court of Canada in
Canderel Limited v. Canada.[5] Iacobucci J. summarized them at pages
174-5:
(1) The determination of profit is a question of law.
(2) The profit of a business for a taxation year is to be
determined by setting against the revenues from the business for
that year the expenses incurred in earning said income: M.N.R.
v. Irwin, supra, Associated Investors, supra.
(3) In seeking to ascertain profit, the goal is to obtain an
accurate picture of the taxpayer's profit for the given
year.
(4) In ascertaining profit, the taxpayer is free to adopt any
method which is not inconsistent with
(a) the provisions of the Income Tax Act;
(b) established case law principles or "rules of
law"; and
(c) well-accepted business principles.
(5) Well-accepted business principles, which include but are
not limited to the formal codification found in GAAP, are not
rules of law but interpretive aids. To the extent that they may
influence the calculation of income, they will do so only on a
case-by-case basis, depending on the facts of the taxpayer's
financial situation.
(6) On reassessment, once the taxpayer has shown that he has
provided an accurate picture of income for the year, which is
consistent with the Act, the case law, and well-accepted
business principles, the onus shifts to the Minister to show
either that the figure provided does not represent an accurate
picture, or that another method of computation would provide a
more accurate picture.
[17] It is well established that a taxpayer may, in the
computation of profit, deduct amounts that it has paid
gratuitously to, or for the benefit of, another, where the
payment has been made for the purpose of increasing the
profitability of the taxpayer's own business, by creating or
preserving a market for its product, for example. This may be
seen in such cases as The Queen v. F. H. Jones Tobacco Sales
Co. Ltd.,[6]
where the taxpayer, Jones, guaranteed certain loans for a
customer in return for the customer's undertaking to continue
buying its raw materials from Jones in the future. The customer
became insolvent, and Jones was required to honour the
guarantees. Noël A.C.J. held that the amount that Jones was
required to pay was not deductible under the predecessor of
paragraph 20(1)(p) of the Act, but that it was
nevertheless deductible as an amount expended by Jones for the
purpose of gaining or producing income from its own business.
The Queen v. Lavigueur[7] and Paco Corporation v. The Queen[8] are other examples of
the application of this principal.
[18] Counsel for the Respondent argued that the deductions in
question should not be allowed because they were capital in
nature, representing the Appellant's investment in the new
business. As capital outlays, their deduction would be precluded
by paragraph 18(1)(b) of the Act. In Stewart
& Morrison Ltd. v. M.N.R.,[9] the Supreme Court of Canada found
that an amount advanced by the taxpayer to its subsidiary as
working capital, and later written off as a bad debt, could not
be deducted as it was a capital outlay, the purpose of which was
to finance the start-up of the subsidiary. A similar result was
reached by Strayer J. in Morflot Freightliners Limited v. The
Queen.[10] In
both these cases the result was driven by the factual finding
that the payments were made for the purpose of bringing a capital
asset into existence for the enduring benefit of the taxpayer,
and not to produce income from the taxpayer's existing
business.
[19] Hollowforms was not a subsidiary of the Appellant, but
during the years under appeal they were both wholly owned by Mr.
Dimberio's holding company, WGR. The question, then, is
whether the purpose of the loans was, as in Stewart &
Morrison and Morflot Freightliners, to capitalize a
new business venture through loans from the existing subsidiary
to the new one. If it was, then the deduction is precluded by
paragraph 18(1)(b) of the Act.
[20] Mr. Dimberio's evidence was to the effect that his
purpose in creating Hollowforms was to improve the profitability
of the Appellant, both by providing an expanded market for its
products, and by reducing its overhead costs. He was not
cross-examined as to this aspect of his evidence, and I accept
it. The conclusion that the loans in question were not simply an
alternate way of capitalizing the Hollowforms business is
reinforced by an examination of the balance sheets of Hollowforms
throughout the period from its year-end on August 31, 1990
to August 31, 1993. During all of that period it had paid up
capital of $100,200.00, consisting of two preferred shares issued
for $50,000.00 each, and 200 common shares issued for $1.00 each.
There were also loans from shareholders in excess of $80,000.00
on the balance sheet throughout the period.
[21] I conclude that deduction of the amounts making up the
third category is consistent with both established case law
principles and well-accepted business principles, and that it is
not inconsistent with paragraph 18(1)(b), or any other
provision of the Act. The appeals are therefore allowed,
with costs.
Signed at Ottawa, Canada, this 14th day of January, 2000.
"E.A. Bowie"
J.T.C.C.
Appendix "A"
Williams Gold Refining Co. of Canada Limited v. Her
Majesty the Queen
The accumulated intercompany Liability for years ended
8/31/90, 91, 92, 93 is as follows:
1.) Expenses incurred by the Appellant and rebilled to
Hollowforms:
|
Wages and Benefits
|
$234,708.08
|
|
Building and Equipment Repairs
|
10,425.85
|
|
Small Tools
|
17,180.31
|
|
Utilities and Telephone
|
22,866.12
|
|
Insurance
|
6,425.40
|
|
Convention Booths and costs
|
1,913.27
|
|
Travel
|
1,771.06
|
|
Office Equipment Rent
|
1,883.44
|
|
|
|
|
Total
|
$297,173.53
|
2.) Costs paid by the Appellant on behalf of Hollowforms:
|
Raw Materials
|
$208,016.66
|
|
Supplies
|
53,331.67
|
|
Advertising and Promotion
|
14,376.23
|
|
Supplier Carrying Costs
|
1,244.37
|
|
Sales Commissions
|
373.28
|
|
Association/Professional Fees
|
4,565.33
|
|
Third Party Rent
|
2,300.00
|
|
Provincial Sales and Federal Excise Tax
|
6,700.81
|
|
Capital Assets
|
22,666.66
|
|
Cash Repayments
|
(2,415.50)
|
|
Total:
|
$311,159.51
|
Total Amounts Included in Bad Debt Expense
$608,333.04
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