Miramar Shoe Imports Limited v. Minister of National Revenue, 91 DTC 317, [1991] 1 CTC 2124 (TCC)

Lamarre Proulx, T.C.J.:—The appellant is appealing the respondent's reassessments for its 1979, 1980 and 1983 taxation years.

The question in issue is whether the appellant may deduct as an operating cost that part of the purchase price of shares of a corporation, which relates to the value of that corporation's entitlement to a quota for importing footwear.

The appellant is a corporation that imports shoes. At the end of the year 1976, the federal government announced its decision to establish a global quota for the importation of shoes. The quota entitlement was based on 80 per cent of the importer's performance record as established between September 1, 1976 and August 31, 1977. (Exhibit A-2). That freeze on the importation of shoes was to last three years starting from December1, 1977. On July 17, 1980, a governmental news release informed the importers that the global quota on footwear would be extended for a period of not more than a year beyond its then current expiry date of November 30, 1980. (Exhibit A-11). [1]

Mr. Leonard Tucker, the appellant's president who testified on its behalf, explained that during the base period, for various reasons, the appellant's performance record was much lower than usual. Mr. Tucker realized that unless he could obtain a greater quota allotment, the appellant could not be maintained in a competitive situation. The quota allotment was to be calculated on each importer's performance record and an importer could not purchase someone else's performance record and add it to its own record. (Exhibit A-2). Mr. Tucker offered the shareholders of T.K.T. Corporation Ltd. (T.K.T.), which had imported a large amount of shoes for the said period, nearly triple the amount of the appellant for the same period to purchase their shares. The witness testified to the effect that T.K.T.'s shareholders wanted to discontinue T.K.T.'s operations and were ready to sell it to the appellant, because they were not satisfied with its return. T.K.T.'s financial statement for the year 1978 shows a net loss of $49,259 and in 1977 a net income of $1,083.

The appellant received from the Export and Import Permit Division of the Department of Industry, Trade and Commerce the following letter dated May 1, 1978. (Exhibit A-10).

Re: T.K.T. Corporation Ltd.

Dear Mr. Klein:

Thank you for your recent letter in which you outlined the details of the proposed acquisition of "TKT" by Miramar Shoe Imports Ltd.

After reviewing the details, I would like to advise that the proposal as outlined in your letter will not affect the quota allocated to either company.

However, in the event that one company or the other should not continue its corporate existence, that company's allocation would have to be surrendered to the Department.

In conclusion, I would like to confirm that if the firm TKT retains its corporate existence and the only change is that of shareholders, their quota entitlement will remain with that firm.

Therefore the appellant purchased T.K.T.'s shares. The price of the shares was Calculated as follows: there was a balance of 40,000 pairs left on the entitlement for the year 1978 and 160,000 pairs for each of the years 1979 and 1980, for a total of 360,000 pairs. The price was set at 664 a pair which came to a total of $237,600. To this amount was added the value of the accounts receivable, the shareholders' loans, and what had been paid for the issued shares. At the end, the total purchase price of the shares which had been subject to adjustments respecting the value of the accounts receivable was of an amount of $355,882, which was composed of, in addition to the value of the accounts receivable, the amount set for the footwear quota, plus $69,000 for the outstanding shareholders' loans and $6,000 for the capital stock.

The amounts claimed by the appellant were shown as prepaid purchase expense in the financial statements (Exhibit A-1) and were apportioned over a period of three years in accordance with the life of the quota entitlement. For the years 1978, 1979 and 1980 they totalled $308,295 apportioned as follows: $106,514 for the year 1978; $106,515 for the year 1979 and $95,266 for the year 1980. The appellant's 1978 taxation year has not been reassessed as being outside the reassessing prescribed period.

Once the shares were acquired, the appellant used the quotas as if they were its own though the importing permits were issued to T.K.T. The letters of credit were opened by the appellant. The invoices from the foreign factories were made under the name of T.K.T. When the goods came into the appellant's warehouse, they were invoiced to the appellant's customers under the appellant's name. The witness explains the situation as such: "And really T.K.T. was acting on behalf of Miramar as an agent for importing the pairs." [2]

A sign bearing the name of T.K.T. was placed next to the appellant's door to show a semblance of an active company in case of inspection by the government employees. [3] There was also an agreement signed with T.K.T.'s purchasing agent, whereby the agent undertook, for a period of four years, not to exercise his trade in the foreign country where T.K.T. had acquired its footwear. (Exhibit A-8).

From a volume of sales in the amount of $590,430 in the year 1977, the appellant's volume of sales increased to $1,047,501 in 1978, to $2,566,509 in 1979 and to $3,696,971 in 1980.

Insofar as T.K.T.'s volume of sales was concerned it went as follows: $2,057,714 for the year 1977, $2,025,856 for the year 1978, $9,673 for the year 1979 and nil for the year 1980.

In the financial statements of either corporation no value was given to the quotas entitlement.

Mr. Tucker explains the purpose of the purchase and the reasons [for] the accounting treatment of the purchase costs as follows:

Q. Were you interested in acquiring the business of T.K.T. as a going concern?

A. Not at all. We were only interested in one thing. As far as we were concerned, we wanted their quota. I didn't need their business. We were achieving what we wanted to achieve on our own, until the quota slapped us down. I didn't want any inventory. We never bought any inventory. I didn't want their structure. I didn't need their office staff. We never even leased their premises. They had a beautiful warehouse and offices. We didn't lease their warehouse. [4]

A. So we didn't buy the inventory from them. We didn't take over their premises. Their two (2) major salesmen were Bernard Tardif, who sold probably the majority volume of the company, we didn't hire him.

Mr. Herb Tapley, who was selling for them in Western Canada, we didn't hire him for sales purposes, because we had our own, and more but most important thing is their customer base, their customer base was completely different from ours. We were strictly volume accounts. We sold only the chain stores, where the risk was very low. We didn't have the type of financing to carry us through, to carry the small accounts.

Their customer base were smaller accounts, independent accounts where they obviously took a higher profit, but there was a much higher risk, and we didn't bother taking that over.

We were only interested in the quotas, and that's all we were interested in. [5]

Q. Did Miramar enter into an agreement with Mr. Tapley, at or about the closing with reference to future services?

A. We had entered, we were planning to enter into an agreement with Mr. Tapley for his services as a purchasing agent, but let me explain that, because it's very— it’s a little more complicated than that.

As I explained earlier, when you're doing business in South America, especially as a Canadian, the people you're working with don't know the companies; they know the people. In other words, they knew Mr. Tapley. He was representing T.K.T. so he worked with the factories in South America. They knew me, because, at the time I was representing Miramar, and prior to that I was representing Danmor.

So there was some kind of a personal goodwill in terms of sources of supply, and as a businessman he said to me that he had some sources, that perhaps, I could use. I didn't—I wasn't sure, I never wanted to overlook any possibilities if 1 could find a good source of supply.

So we discussed the fact that maybe we would entertain him working for us, sourcing for us in South America and perhaps, purchasing for us in South America. And I put a—the only thing that I was concerned about was that I—wasn't sure if I could use his services, but I wanted to look him over, but I also wanted—I felt that if he came into my company, he would then begin to know my sources of supply, and my trade secrets, and I wanted to protect that.

So I put in a limited non-compete contract, stating that if it didn't work out he couldn't import footwear from South America. [6]

A. In fact, we never even hired him. He had made contentions that he had some sources that we could use, in particular, a factory called "Centenario", which had a reasonably good reputation. He couldn't deliver the factory to me, and we never even hired him. It just never worked out. [7]

A. Basically, as far as I’m concerned, we only bought the quota. There was no need for me to buy that company. We were a very low-cost type of a company. I didn't need an extra overhead. I didn't want any inventory. I just wanted the quota to be able to continue the continuity of my own company, Miramar Shoe.

And if you look at it from a business point of view, as far as I’m concerned, it was like a pre-payment on a commission for the use of three hundred and sixty thousand (360,000) pairs over a short period. In fact, that was the problem. It was a short period of time, because when they announced it it was two and a half years.

So who was going to buy an asset or share in a company that in two and a half years is not gonna be worth anything. [8]

For the years 1979 and 1980, the appellant's financial statements show pre-tax profits or net income of $13,774 and $62,251.

To a question from his counsel (who had added together the amounts for the years 1979 and 1980) the witness answered:

Q. Had you not deducted the two hundred thousand dollars ($200,000), which was the allocation of quota and had shown a profit of two hundred and seventy-six thousand dollars ($276,000) that had been left with shares that would have been valueless, would you feel that your profit was two hundred and seventy-six ($276,000), or would you feel that your profit was seventy-six ($76,000)?

A. Seventy-six thousand dollars ($76,000).

Q. Why is that?

A. Because it was the cost of doing it. We put out the money. I mean, it was the cost of doing business. So there is no way that that could not be considered. [9]

The appellant did not dispose of T.K.T.'s shares in the years in question.

Counsel for the appellant submits that this case should be determined by taking into consideration the commercial reality. The appellants volume of sales would not have been such if it had not been for the purchase of T.K.T.'s shares. The appellant purchased these shares not for their resale and not as a capital investment but to obtain the necessary quotas that were temporary in nature, and therefore, their purchase was an operating cost of the appellant. Counsel for the appellant submits that the substance or the purpose of the transaction are the determining criteria and that they lead to a categorization of the expenses being revenue expenses.

Counsel for the appellant refers the Court to several cases but more especially to:

B.P. Australia Ltd. v. Commissioner of Taxation (Australia), [1966] A.C. 224 (P.C.)

Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; [1985] 2 C.T.C. 111; 85 D.T.C. 5373

Longueuil Meat Exporting Co. v. The Queen, [1974] C.T.C. 486; 74 D.T.C. 6421 (F.C.A.); affd [1976] C.T.C. 193; 76 D.T.C. 6145 (S.C.C.)

Paco Corporation v. The Queen, [1980] C.T.C. 409; 80 D.T.C. 6215 (F.C.T.D.)

In B.P. Australia (at pages 226-27) the Privy Council agreed with the finding of the minority judges of the Full High Court of Australia. That minority held (and I quote freely from the headnotes) that sums of money paid in consideration for the undertaking by service station proprietors to deal exclusively with B.P. for a number of three or five years were not for the acquisition of a new market, nor a new framework within which to carry on trade, nor an extension of B.P.'s selling organization to include a regiment of re-sellers, nor such an exclusion of competition to increase the value of goodwill; that it consisted simply of the practical assurance of receiving bundles of orders for motor spirit, the circumstances being such that for the foreseeable future it would be only by getting similar bundles of orders that a trade such as B.P. could be carried on, and that the ultimate question for B.P. was whether, bearing in mind the probable amount of the trade which would result from obtaining an agreement with the operation, it was worth while paying a particular sum as the price of the agreement. The Privy Council decided that on a balance of all the relevant considerations the scales appear to incline in favour of the expenditures being revenue and not capital outgoings (at page 274).

Here are some excerpts of this important and relevant decision in circumstances that are not that different from those of the case at bar:

Where a trader buys out a rival in order to secure his goodwill or to suppress it and so provide or maintain a clear field for his own enterprise over a substantial period, there is a definite prima facie pointer towards a capital payment. But in the present case B.P. was not achieving a monopoly nor buying off competition nor obtaining any substantial area for its own domain. Although one retailer was tied to B.P., the retailer next door could still buy some other brand and the passing motorist could do likewise. (page 262).

Again in W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation a lump sum paid to get rid of an unnecessary director was held to be a revenue payment since •The purpose was transient and, although not itself recurrent, it was connected with the ever-recurring question of personnel" (per Dixon, J.). (page 263).

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so Clearly that it dominates other and vaguer indications in the contrary direction. It is a common sense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer:

depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured employed or exhausted in the process:

per Dixon, J. in Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation. As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.

One may approach the problem by considering the first of the matters mentioned by Dixon, J. above, namely the character of the advantage sought, and in this both its lasting qualities and the fact of recurrence may play their parts. Under this head one might also take account of the nature of the need or occasion which calls for the expenditure: Dixon, J. in Hallstrom's case, (pages 264-65).

The advantage which B.P. sought was to promote sales and obtain orders for petrol by up-to-date marketing methods, the only methods which could now prevail. Since orders were now and would in future be only obtainable from tied retailers, it must obtain ties with retailers. Its real object, however, was not the tie but the orders which would flow from the tie. (page 265).

A temporary ad hoc solution is none the less of a recurrent nature because it is recognised that when the problem recurs it may have to be met in some other or more permanent fashion. (page 267).

What additional indication is given by the actual length of the agreements? That must be a question of degree. Had the agreements been only for two or three year periods that fact would have pointed to recurrent revenue expenditure. Had they been for 20 years, that fact would have pointed to a non-recurring payment of a capital nature. Length of time, though theoretically not a deciding factor, does in practise shed a light on the nature of the advantage sought. The longer the duration of the agreements, the greater the indication that a structural solution was being sought. In this case the periods varied between three and 15 years, but the average appears to be something just under five years and the predominant number of agreements was for a five-year period. (page 267).

It is of commercial importance that profits should not be inflated for tax purposes by the artificial withdrawal from the profit and loss account of expenditure directly incurred in earning them unless it is of a truly capital nature. (page 270).

In Hallstrom's case, where by a majority the court held that the cost of fighting a patent was a revenue expenditure, Dixon, J. described the difference between capital and income expenditure as lying

between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work; . . . between an enterprise itself and the sustained effort of those engaged in it. (page 271).

The appellant refers me also to the following words of Mr. Justice Jackett in the Longueuil case, supra, (at page 487 (D.T.C. 6422)):

Without holding that in no circumstances can money paid for shares in a company that has no assets other than foods desired by the purchaser as inventory be rewarded as the cost of inventory or otherwise as a payment of a current nature, in the circumstances of this case, where, on the face of the matter, the transaction had for one of its objects and for one of its effects the elimination of a competitor and the acquisition of its goodwill. I am of opinion that the appeal fails on the facts.

[Emphasis added.]

He says that in the present case, the appellant did not purchase the shares to eliminate a competitor or to acquire its goodwill and submits that the Court may consider holding that sums paid for the shares were on revenue account, because they were not expended for the purchase of a business organization but for the carrying on of the appellants business where a temporary ad hoc solution was needed.

When shares are purchased, it has usually been found by the Courts that, unless they had been purchased in view of their resale, it was a capital investment. There are very few cases holding a different view. But there are some. The Paco decision, supra, is one of those. This decision has been studied in the Canadian Tax Journal, Vol. 29 (1981), pages 46-47:

Except in the most unusual circumstances, money invested in the shares of a company or money advanced by a shareholder by way of loan to a corporation will be regarded as an investment on capital account. From time to time, however, the circumstances in which the money is advanced or invested may support an argument that the" investment" was made as part of a business operation or in the course of an adventure in the nature of trade. Perhaps the most striking example of this is found in the 1968 decision of theSupreme Court of Canada in the Freud case [M.N.R. v. H.J. Freud, [1969] S.C.R. 75; [1968] C.T.C. 438; 68 D.T.C. 5279]. There, the taxpayer spent substantial amounts in developing a prototype sports car with the intention of selling the prototype, not of engaging in the business of manufacturing and selling cars.

It was held that the taxpayer's intention throughout was to sell the prototype and accordingly the amounts expended were expenses incurred in the course of carrying on the business, not of making an investment.

. . . His Lordship said that although an investment in shares and advances to a separate corporation was prima facie an investment, there were circumstances in which such a transaction would be on income account.

The conclusions reached by Mr. Justice Dubé in Paco are the following (at page 413 (D.T.C. 6218)):

[Translation]

Although this transaction was not merely a loan, but also involved the purchase of another company's shares, and so was a transaction which prima facie would appear to be an expenditure on capital account, it is important not to be misled by appearances. The court must look at the substance of the transaction, and this is characterized above all by the overriding intent of the taxpayer at the time the money was invested, namely the intent to establish a demonstration project in Europe.

Counsel for the respondent submits that the purchase of the shares was capital in nature. It was the acquisition of an ongoing business, the appellant having to maintain the subsidiary as a corporate entity to ensure the allotment of pairs of shoes. Counsel for the respondent refers the Court to the case of Seven-Up of Montreal Ltd. v. M.N.R., [1952] C.T.C. 75; 52 D.T.C. 1078 a case, that is, according to counsel, on all fours with the case at bar. The quotas by themselves could not have been sold. They maintained their existence insofar as the corporation maintained its corporate entity.

It would seem indeed that the decision of Mr. Justice Cameron in the Seven-Up case, supra, is very much of application, where it was found that the acquisition of a business undertaking to ensure a larger sugar quota was of a capital nature (pages 81 and 84 (D.T.C. 1080, 1082).

All that the appellant could do to increase its sugar quota basis was to buy the assets of Rocket as a going concern, satisfy the Sugar Administrator that that had been done, and then make application to the Administrator—not to transfer Rocket's sugar quota authorization to it, but—to increase its own to the extent formerly enjoyed by Rocket.

In my opinion, the mere fact that within a few days the appellant made a resale of most of the assets for the price of one dollar cannot change the nature of the original outlay from one on capital account to one on revenue account.

In the present case, moreover, the acquisition of the business was made through the purchase of shares. Can and should this decision be distinguished?

Counsel for the appellant submits that it should on the basis that it is not a business as a going concern that was purchased by the appellant. The shareholders wanted to wind-up the corporation and the appellant did not take over T.K.T.’s leased premises, employees, sources of supply nor its customers.

The evidence has shown that the amounts claimed as current expenses for the acquisition of the right to the quotas were not amounts expended for the purpose of the acquisition of a business as a going concern, nor for the acquisition of goodwill nor for the elimination of a competitor. However, the appellant needed T.K.T. to retain its corporate entity although on a temporary basis.

I believe however that had it not been for the Paco decision, supra, and some other decisions such as the Johns-Manville, supra, Freud, supra, and the Bronfman cases, (The Queen v. P.B. Bronfman Trust, [1987] 1 C.T.C. 117; 87 D.T.C. 5059) where it would appear that the purpose of an investment is determinative as to the nature of the investment, I would have felt bound by the Seven-Up decision, supra. In the Paco decision, and to a certain extent in the Freud decision, moneys expended for shares that had not been acquired for resale and not as a capital investment were found to be current expenses. The decisive factor in Paco was said to be"the overriding intent of the taxpayer at the time the money was invested".

If I examine the appellants intent in the case at bar, I do not find that it was for their resale that the appellant acquired the shares of the corporation nor was it in the hope of an interest in their value. It was not either to acquire an ongoing business. I find that the appellant acquired the shares because it needed a chose-in-action, the entitlement to the footwear quota, that had a three-year life. That disbursement was made to maintain the appellants volume of sales in a manner not unlike the sums of money paid in B.P. Australia. As in that case it appears to be more an operational solution of a temporary nature to a production problem than the bringing into existence of an asset of an enduring nature such as the acquisition of an ongoing business, the elimination of a competitor or the acquisition of goodwill.

Common sense dictated that these expenditures be made, otherwise the taxpayer's operations would, of necessity, be closed down. These expenditures were not part of a plan for the assembly of assets. Nor did they have any semblance of a once and for all acquisition.

Those words come from the Johns-Manville case, supra (at page 117 (D.T.C. 5376)). There the Supreme Court of Canada found that moneys expended to acquire land may in certain circumstances be on account of revenue though land had not been acquired for a speculative purpose. Before that decision I believe that in a way similar to shares, land was considered to be purchased or for resale or for a capital investment, not for operational purposes.

Not all the sums expended to purchase T.K.T’s shares were claimed as operating expenses. Some activity remained in the Corporation and the value of the shares [was] accordingly apportioned. It is that part of the purchase price of the shares that related to the value given to the quota entitlement that was claimed as being an expense made for the purpose of earning income. I find from the facts of this case that"many aspects of the whole set of circumstances" point in the direction of a disbursement made for a non-capital investment so as to "dominate" "indications in the contrary directions" (B.P. Australia, supra at page 264). I therefore allow the appeal with costs.

Appeal allowed.