The Queen v. Royal Trust Corp. of Canada, 83 DTC 5172, [1983] CTC 159 (FCA)

Urie, J:—It is common ground that the sole issue in this appeal from the Trial Division is whether the sum of $175,500 which the United Trust Company (“United Trust”) paid to Pitfield, MacKay, Ross & Company Limited (“Pitfield”) in 1972 was an “eligible capital expenditure” within the meaning of paragraph 14(5)(b) of the Income Tax Act, RSC 1952, c 148 as amended (“the Act”) and, therefore, in part deductible pursuant to paragraph 20(1 )(b) of the Act.

United Trust was a company incorporated under the provisions of The Loan and Trust Corporations Act of Ontario in 1964. Following a change of its name, the amalgamation, in 1976, of United Trust with the Royal Trust Corporation of Canada was effected, as a result of which the Respondent herein was formed. Prior thereto, in September 1972, after lengthy negotiations, United Trust had entered into an underwriting agreement with Pitfield, a well-known securities underwriter, the ultimate object of which, it is fair to say, was to cause the sale of 325,000 common shares of the capital stock of the company to the public. According to the prospectus filed by United Trust with the Ontario Securities Commission on September 7, 1972 for the purpose of carrying out the terms of the agreement and effecting the share distribution to the public and the listing of its shares on the Toronto and Montreal Stock Exchanges, the net proceeds of sale were to be “initially invested by the Company [to] enable it to continue the expansion of its operating facilities. The increase in shareholders’ equity will enable the Company to increase the amount that may be accepted as deposits.” It is clear that the prospectus constituted an offer by Pitfield to sell the shares of United Trust to members of the public at a price of $8.00 per share and disclosed that United Trust was to pay an underwriting commission of $0.54 per share to Pitfield.

The underwriting agreement was dated September 7, 1972. In it United Trust agreed to sell to Pitfield 325,000 of its shares at the price of $8 per share and to pay to Pitfield “a commission of $0.54 per share in consideration of our subscribing for the said 325,000 shares.” 300,000 of the shares were to be delivered and were, in fact, delivered and paid for, in accordance with the terms of the agreement, on September 25, 1972. The balance of 25,000 shares were delivered and paid for, as required by the agreement, on October 10, 1972. On each of the respective closing dates the shares, which by those dates had been sold, were distributed to the purchasers thereof by Pitfield. On the same dates, and in compliance with the terms of the agreement, United Trust, by certified cheques, paid to Pitfield the respective sums of $162,000 and $13,500 as its commission. Receipts were issued by Pitfield to United Trust for each payment, in the same form, the first of which reads as follows:

Pitfield, Mackay, Ross & Company Limited hereby acknowledges receipt from you of the sum of $162,000 being the commission payable to us with respect to the sale by us of 300,000 shares of United Trust Company (the “Company”) as set forth in the prospectus of the Company dated September 7, 1972.

DATED this 25th day of September, 1972.

PITFIELD, MACKAY, ROSS & COMPANY

by

A supplementary letter dated September 8, 1972 from Pitfield to United Trust, apparently written at the request of the latter, is of some importance in that it illustrates that it was the desire of United Trust that Pitfield use its best efforts to ensure a broad share distribution to the public. That letter reads as follows:

With respect to the public offering of 325,000 shares of United Trust Company, we hereby confirm to you that we shall endeavour to achieve a broad public distribution of the shares by asking our Banking Group members to limit sales to approximately 500 shares per purchaser on a best effort basis. We also wish to confirm to you that it would be our intention to limit institutional placements to approximately 30% including the sale of 50,000 shares to Cemp Investments Limited. The foregoing, of course, will be subject to our judgment of market conditions as they develop during the course of the offering.

For income tax purposes, United Trust treated the payment of $175,000 to Pitfield as an “eligible capital expenditure” within the meaning of paragraph 14(5)(b) of the Act. In accordance with subparagraph 14(5)(a)(i) of the Act, as it read at that time, United Trust added one half of that amount, namely the sum of $87,750, to its “cumulative eligible capital” in each of its 1972, 1973, 1974 and 1975 taxation years in computing its taxable income for those years. The respective deductions were:

All of the deductions were disallowed by the Minister by notices of reassessment posted March 22, 1978 which disallowances were subsequently confirmed by him after consideration of the Respondent’s notices of objection.

The Tax Review Board dismissed the Respondent’s appeal from the reassessments. The Trial Division allowed the Respondent’s appeal from that decision finding that the sum of $175,500 paid by the United Trust to Pitfield was an “eligible capital expenditure” one half of which became part of United Trust’s “cumulative eligible capital” and deductible in accordance with subsection 20(1 )(b) of the Act. It is from that judgment that this appeal is brought.

The relevant portions of the relevant subsections of the Act are as follows:

14(5)(a) “cumulative eligible capital” of a taxpayer at any time in respect of a business means

(i) /2 of the aggregate of the eligible capital expenditures in respect of the business made or incurred by the taxpayer before that time, minus . ..

14(5)(b) “eligible capital expenditure” of a taxpayer in respect of a business means the portion of any outlay or expense made or incurred by him, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business — other than any such outlay or expense

(i) in respect of which an amount is or would be, but for any provision of this Act limiting the quantum of any deduction, deductible (otherwise than under paragraph 20(1 )(b)) in computing his income from the business, or in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1 )(b), not deductible in computing such income . . .

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:

(b) such amount as the taxpayer may claim in respect of any business, not exceeding 10% of his cumulative eligible capital in respect of the business at the end of the year;

(e) an expense incurred in the year,

(i) in the course of issuing or selling shares of the capital stock of the taxpayer, or,

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt),

(iii) a commission or bonus paid or payable to a person to whom the shares were issued or sold or from whom the money was borrowed or for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course or issuing or selling the shares or borrowing the money, or

(iv) an amount paid or payable as or on account of the principal amount of the indebtedness incurred in the course of borrowing the money, or as or on account of interest;

Counsel for the appellant attacked the impugned Judgment on three grounds:

(1) the 54¢ per share paid by United Trust to Pitfield was not an outlay or expense but was, rather, a discount or rebate from the purchase price paid for the shares and, thus, was not an eligible capital expenditure under paragraph 14(5)(b) deductible in the manner prescribed by paragraph 20(1 )(b) of the Act.

(2) in the alternative, since subparagraph 14(5)(b)(i) excludes generally any outlay or expense . in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1 )(b), not deductible in computing such income” the specific prohibition against deduction provided by subparagraph 20(1 )(e)(iii) must prevail with the result that the “commission” paid by United Trust to Pitfield is excluded from the purview of subparagraph 14(5)(b)(i). [It should be noted that counsel for the appellant on the hearing of the appeal did not argue, as he had done in his Memorandum of Fact and Law, that subparagraph 20(1 )(e)(iii) is a provision that limits the quantum of deduction in respect of the expense of issuing shares within the meaning of the first portion of subparagraph 14(5)(b)(i)]; and

(3) in any event, even if otherwise it would have been an outlay or expense, it is not deductible in the circumstances of this case under paragraph 14(5)(b) because it was not incurred for the purpose of gaining or producing income.

I will deal with each of the submissions in the order in which they were raised although, as will become apparent, each tends to blend in with the other.

1. The ascertainment of whether or not a given outlay or expense is an “eligible capital expenditure” made “on account of capital for the purpose of gaining or producing income from the business”, is one of fact. Whether or not such an outlay or expense is prohibited or permitted by any other provision in the Act is one of mixed law and fact. The first submission, therefore, would appear to relate essentially to findings of fact by the learned trial judge.

Three witnesses were called by the respondent and some twenty-two documents were adduced in evidence. No oral evidence was called by the appellant. The trial judge reviewed the oral and documentary evidence in some detail and, inter alia, made the following findings:

The evidence discloses that in 1972, United Trust carried on negotiations with more than one broker but, ultimately, negotiated an agreement with Pitfield to underwrite an issue of 325,000 shares at a price of $8.00 each, with a commission of .54¢ per share. Both the share price and the commission were arrived at after extensive negotiations between the parties. The purpose of the transaction was, beyond any question, to achieve a distribution of the shares to the public and there is some evidence that the Plaintiff had requested, even insisted on as broad as possible a distribution, particularly to financial institutions with the intents of increasing its potential clientele. In response to this request, Pitfield wrote on September 8, 1972, to United Trust in the following terms.

With respect to the public offering of 325,000 shares of United Trust Company, we hereby confirm to you that we shall endeavour to achieve a broad public distribution of the shares by asking our Banking Group members to limit sales to approximately 500 shares per purchaser on a best efforts basis. We also wish to confirm to you that it would be our intention to limit institutional placements to approximately 30% including the sale of 50,000 shares to Cemp Investments Limited. The foregoing, of course, will be subject to our judgment of market conditions as they develop during the course of the offering.

This is one aspect of the services rendered in this transaction by the broker Pitfield but, in my opinion, there were many others. These included provision of expertise in the analysis of the price and the market possibilities, as well as the public commitment of Pitfield to the value of the shares at $8,000 each. There can be no doubt that for a junior company involved in its first public share offering, the quality of the broker involved in the underwriting commitment is a significant factor. The broker’s service in bringing about actual sales to the public is also quite considerable and clearly upon the evidence includes the purely mechanical aspect of receiving the shares in one certificate from United Trust and accomplishing the actual distribution to the purchasers, as well as, obviously, the promotional aspect of locating the purchasers and finalizing the sales. It is the usual brokerage practice not to enter into an underwriting agreement unless confident, if not certain, of adequate sales and in this case, the agreement between the parties contained the usual clause that up to the moment of closing, the broker could release itself from the obligation to proceed if, for any reason, it felt that the issue could not be marketed. I accept the evidence of Mr MacKay that recourse to that escape clause almost never happens and indeed a broker’s reputation is based on its skill in placing a value on the shares which will produce the maximum return for the seller and meet the necessary acceptance in the market. Repeated association with transactions in which this process has not been done skillfully would severely damage any broker’s reputation. It is my view that as a result of the rendering of all of these services by Pitfield, an agreement was entered into whereby United Trust shares were sold at $8.00 and that the intention of the parties for immediate re-sale by the broker was an element of the agreement from the beginning and in this case, was fully achieved since the issue was largely pre-sold.

There was, in my opinion, ample evidence to support the findings and the inferences drawn from the evidence by the Trial Judge. Appellant’s counsel argued vigorously that the agreement of September 7, 1972 was simply an agreement to sell the shares in question to Pitfield and the agreement imposed no obligation on that firm to distribute them to the public. He further argued that the “commission” was not paid for services rendered but merely represented a discount from the purchase price. He premised this contention on the basis that no services were performed by Pitfield, according to his interpretation of the agreement, aside from taking the shares. In his submission the principles enunciated in Australian Investment Trust v Strand and Pitt Street Properties, [1932] AC 735 govern underwriting agreements of this kind.

In that case the issue defined in the judgment of Lord Tomlin delivered for the Judicial Committee of the Privy Council was whether an underwriting agreement pursuant to which the shares in question were allotted to the appellants for a commission of one shilling upon each share underwritten was ultra vires the respondent. At 746 of the report Lord Tomlin said:

For the purpose of determining whether such an underwriting agreement is within the powers of the company their Lordships are content to apply the test suggested by Lord Watson in the passages already quoted from his speech in Ooregum Gold Mining Co of India v Roper (1892) AC 125, 136. What are the services rendered by the underwriter in return for the commission over and above his agreement to subscribe for shares? In their Lordships’ opinion the answer must be that there are none, (italics added)

That passage illustrates the factual distinction between two cases. First, the Australian case arose out of the necessity of determining whether or not the sale of shares at a discount was within or beyond the powers granted to a company by statute. Secondly, in that case the Court held that, on the facts before it, no services had been rendered by the purchaser over and above its agreement to purchase shares.

No issue of the statutory powers of a company arises in the case at bar. Moreover, as held by the learned trial judge, the evidence clearly discloses that the payments made were for the services to be performed by Pitfield in the distribution of shares. Some of those services were referred to in the judgment appealed from in the passage earlier cited herein. There was, thus, a basis for concluding that (a) the substance of the transaction was a distribution of United Trust shares to the public, (b) that the sale price for the shares was $8 per share, without any rebate or discount, (c) that the fee of .54C per share was negotiated by the parties as a fee for services to be rendered, and (d) those services were in fact rendered in the share distribution to the public.

All the documentary and oral evidence was considered by the learned trial judge and enabled him to conclude that:

The .54¢ per share commission negotiated between the parties constituted compensation to Pitfield for all such services rendered and was therefore, a cost of the share issue, and as such, an expense to United Trust in 1972, in the amount of $175,500., clearly an eligible capital expenditure within the meaning of section 14(5)(b).

It is trite to say that an Appellate Court ought not to disturb the findings of fact of a trial judge unless it is satisfied that the judge had proceeded on a wrong principle or that he made some “palpable and overriding error which affected his assessment of the facts”.* [1] Having reviewed the evidence I am satisfied that the learned trial judge in this case neither proceeded on a wrong principle nor did he ignore, misapprehend or otherwise make any palpable or overriding error affecting his assessment of the evidence. His finding that the payment here in issue was not a rebate or discount but was compensation for services rendered should not, therefore, be disturbed.

2. For the sake of convenience I repeat the appellant’s second ground of appeal as I understood it:

In the alternative; since subsection 14(5)(b)(i) excludes generally any outlay or expense . . in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1 )(b), not deductible in computing such income” the specific prohibition against deduction provided by subsection 20(1 )(e)(iii) must prevail with the result that the “commission” paid by United Trust to Pitfield is excluded from the purview of subsection 14(5)(b)(i).

section 20 spells out specific deductions permitted in computing income from a business or property. It sets in motion the capital cost system of deductions including some that, prior to the enactment of the section, had not been eligible for such treatment. Paragraph 18(1 )(b) of the Act prohibits deduction of payments on account of capital or allowances in respect of depreciation, inter alia, except as otherwise permitted by the Part. Section 20 comes into play to alleviate some of the outright prohibitions prescribed by section 18. Among them is the change in treatment of such things as goodwill and similar assets previously known as “nothings” due to the fact that they were not deductible either because of their capital nature or because they were not depreciable since no asset existed the cost of which could be amortized over a given period. It is to these kinds of assets that paragraph 14(5)(a) and (b) are directed by employing the concepts of “eligible capital property” and eligible capital expenditures”. Paragraph 20(1 )(b) permits the one-half of a company’s eligible capital property as defined in paragraph 14(5)(a) to be amortized at the rate of 10% per annum on a declining balance basis.

Paragraphs (c) and (d) authorize the deduction of interest payments which would not otherwise be deductible because they would be considered to be payments on account of capital prohibited by paragraph 18(1)(b). They have no application in this case.

Paragraph (e) of subsection 20(1) refers to two kinds of expense deductions — those incurred in the course of issuing or selling capital stock of the taxpayer and those incurred in the course of borrowing money for the purpose of earning income. It is the former type of expense with which we are concerned here. Subparagraph (e)(iii) excludes the deduction in full of commissions paid for services of the kind performed by Pitfield in the case at bar. I can see nothing, however, which would preclude their inclusion in Cumulative eligible capital within the meaning of paragraph 14(5)(a) of the Act, provided they meet all of the tests imposed by subsection 14(5)(b). In my opinion they do for the following reasons:

1. The expenditures were made in respect of a business (that of United Trust),

2. aS a result of a transaction (the issuance of shares and the payment of a commission in connection therewith),

3. which occurred after 1971,

4. on account of capital (those moneys raised from the issuance of shares).

5. which, in turn, was for the purpose of producing income (as described in the prospectus earlier quoted herein) and

6. were outlays or expenses not otherwise deductible by virtue of any provision of the Act, other than subsection 18(1 )(b), in computing income from the business.

The payment of $175,500 by United Trust to Pitfield meets all of the tests imposed by subsection 14(5)(b), in my opinion, and is, therefore, eligible for deduction in accordance with paragraphs 14(5)(a) and 20(1 )(b).

In the recent unreported decision of the Supreme Court of Canada in Nowegijick v The Queen et al (pronounced January 25, 1983), Dickson, J reiterated the view first expressed by de Grandpré, J in Harel v The Deputy Minister of Revenue for the Province of Quebec, [1978] 1 SCR 851; [1977] CTC 441, on reliance on administrative policy as an aid to statutory interpretation in the following way:

Administrative policy and interpretation are not determinative but are entitled to weight and can be an “important factor”in case of doubt about the meaning of legislation: per de Grandpré J Harel v The Deputy Minister of Revenue of the Province of Quebec, [1978] 1 SCR 851 at p 859. During argument in the present appeal the attention of the Court was directed to Revenue Canada Interpretation Bulletin IT-62 dated 18 August 1972, . . .

It is, therefore, not without interest and significance in this case that Interpretation Bulletins IT-143R dated December 29, 1975 and IT-341 R dated April 26, 1982 have each dealt with this question and interpreted it in the manner which I have concluded is the correct one. In paragraph 19 of IT-143R, for example, the following is stated:

A provision such as paragraph 20(1 )(e) that authorizes in qualified terms a deduction from income subject to certain exceptions is not always considered to have the effect of making the exceptions non-deductible for all purposes of the Act. Thus, such commission or bonus, not being non-deductible “by virtue of any provision of this Act other than paragraph 18(1)(b)” (see subparagraph 14(5)(b)(i)), is an eligible capital expenditure if the other requirements of paragraph 14(5) (b) are met.

It is my opinion that paragraph 20(1 )(e) neither was intended to nor does it in fact limit the deduction of sums which are deductible under other provisions in the Act. It is not a specific provision overriding a general one as argued by the appellant. The two subsections relate to the same kinds of expenditures characterized and treated in different ways. Therefore, I am of the view that the appellant’s second attack fails.

3. The appellant’s third ground of attack must now be considered. It was appellant counsel’s contention, it will be recalled, that, in any event, the expenditure of funds to Pitfield was not made for the purpose of gaining or earning income. I have already expressed the view that it was. I shall now endeavour to show why I have this view. Having reached that conclusion it is unnecessary for me to deal with the respondent’s preliminary objection to the appellant’s attack on the trial judgment on this basis based on the contention that this ground of attack was not pleaded.

Counsel for the appellant submitted that the distinction between expenditures made in providing capital for a business and those for the carrying on of the business from which its earnings are derived is well recognized in the jurisprudence ie, the expenditures incurred in providing capital as in this case are not, in counsel’s submission, considered to be directly related to the earning of income. In support of this proposition counsel cited the decision of the Judicial Committee of the Privy Council in Montreal Coke and Manufacturing Co v MNR, [1944] AC 126; [1944] CTC 94; 2 DTC 535 and of the Supreme Court of Canada in Bennett & White Construction Co Ltd v MNR, [1949] SCR 287; [1949] CTC 1; 4 DTC 514.

I do not believe that either of those cases assist the appellant’s contention. Both cases arose under section 6 of the Income War Tax Act, the predecessor to The Income Tax Act, 1948. That section read as follows:

6(1) In computing the amount of the profits or gains to be assessed, a deduction shall not be allowed in respect of

(a) Expenses not laid out to earn income, — disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income;

(b) Capital outlays or losses, etc — any outlay loss or replacement of capital or any payment on account of capital or any depreciation, depletion or obsolescence, except as otherwise provided in this Act; (italics added)

Paragraphs 6(1 )(a) and (b) were replaced in the Income Tax Act, 1948 by paragraphs 12(1 )(a) and (b) which read as follows:

12. (1) In computing income, 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 property or a business of the taxpayer,

(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.

As will be seen those two subsections are identical to paragraphs 18(1 )(a) and (b) of the present Act, supra. The subsections from the older Acts were the subject of comment by Abbott, J in B C Electric Railway Company Limited v MNR, [1958] SCR 133; [1958] CTC 21; 58 DTC 1022, as follows:

The less stringent provisions of the new section [the 1948 Act] should, I think, be borne in mind in considering judicial opinions based upon the former sections.

His reference to the lesser stringency in the 1948 Act stems from the removal of the words “not wholly, exclusively and necessarily . . from the section as well as the definite article “the” before the word “income”. In the Montreal Coke case Lord MacMillan stated, in reference to subsection 6(1) of the Income War Tax Act, that:

It is important to attend precisely to the language of section 6. If the expenditure sought to be deducted is not for the purpose of earning income, and wholly, exclusively and necessarily for that purpose, then it is disallowed as a deduction. If the expenditure is a payment on account of capital it is also disallowed.

Mr Justice Abbott’s warning is thus apt in considering the applicability of the reasoning in the Montreal Coke and the Bennett & White cases in the case at bar particularly because paragraphs 14(a) and (b) and 20(1)(b) relate to deductions for capital expenses. Deductions for such capital expenses were prohibited in the predecessor Acts. The concept of expenses arising from the raising of capital being deductible if all the statutory criteria are met, including whether or not they were incurred “for the purpose of gaining or earning income”, could not have arisen under the old Acts. The issues facing the Courts under those Acts were, first, to determine whether the expense was one on account of income or of capital and, second, if it was found to be an income expense was it made for the purpose of gaining or producing income? Now, while it is true that both of those questions are Still issues, the fact that the expenditure may have been on capital account does not, per se, prohibit the deduction. Having considered the distinction and found the expenditure to be capital in nature, the next question to be answered is whether it was incurred for the purpose of gaining or earning income — not “the income” (which implies a specific source of income) and not “wholly, exclusively and necessarily . . .” therefrom, but simply “for the purpose of .. .”. It is hard for me to conceive that expenditures incurred in the raising of capital to be used in the operations of the company, as described by the witnesses and in the prospectus, not being characterized as being “for the purpose of earning income”. I am of the opinion, therefore, that none of the cases relied upon by the appellant are binding in the circumstances of this case and the expense of the underwriting in the sum of $175,500 was for the purpose of earning income. Accordingly, the appellant’s third ground of attack must fail.

For all of the foregoing reasons, the appeal should be dismissed with costs.