Date:
20020509
Docket:
1999-4643-IT-G
BETWEEN:
BIG COMFY
CORP.,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Reasons
for Judgment
Rip,
J.
[1]
Big Comfy Corp. appeals the income tax assessment for its 1996
taxation year in which the Minister of National Revenue ("Minister") denied its claim for
a Canadian film tax credit provided for in section 125.4 of
the Income Tax Act ("Act").
[2]
In the Minister's view the appellant Big Comfy Corp.
("Big Comfy") is not entitled to the tax credit since
three other taxpayers who advanced funds for a video production
undertaken by the appellant had interests in the production that
permitted each of them, respectively, to deduct an amount in
respect of the production in computing their incomes for the
year: subsection 125.4(4). Respondent's
counsel advised that the intent of subsection 125.4(4) of the
Act is to ensure that incentives and favourable tax
treatment are focused on producers of film and video productions
(and production companies) rather than on those persons who
invest in the productions.
[3]
Big Comfy produces a children's television series called
"The Big Comfy Couch". The fourth season of the series,
which is relevant to this appeal, contained thirteen episodes
("Series IV"). Principal photography of these episodes
began on July 4, 1995 and ended on August 5, 1995. The
series is distributed throughout the world and the appellant
receives income from the broadcast and syndication of the
episodes.
[4]
Funding for the production of the episodes was derived from
several sources:
(a)
participants
("Participants"):
(i)
Canadian Film Development
Corporation ("Telefilm") ($385,000);
(ii)
Shaw Communications Inc. (doing
business as "Shaw Children's Programming
Initiative" and referred to as "Shaw")
($95,000);
(iii)
YTV Canada, Inc.
("YTV") ($40,000);
(b)
licencing and other
fees:
(i)
YTV
($265,042);
(ii)
Cable Production Fund
($176,694);
(c)
three private persons (the
"Investors"):
(i)
Everything But The Kitchen, Inc.
("EBTK") ($10,000);
(ii)
William John Murtagh
($10,000);
(iii)
Lillyann Goldstein
($95,000);
(d)
producer amounts
("Producers"):
(i)
Radical Sheep Productions Inc.
("Radical Sheep") ($361.33);
(ii)
Owl Television Inc.
("Owl") ($180.67); and
(e)
distribution advances from
Hollywood Ventures ($308,000).
[5]
A Canadian film or video production tax credit may, by virtue of
subsection 125.4(3), be claimed by a "qualified
corporation" in respect of a Canadian film or video
production and is equal to 25 per cent of the corporation's
"qualified labour expenditure" for the year in respect
of the production.
[6]
However, according to subsection 125.4(4), a Canadian film or
video product tax credit is not available:
|
... where an
investor, or a partnership in which an investor has an
interest, directly or indirectly, may deduct an amount in
respect of the production in computing its income for any
taxation year.
|
... à la production
cinématographique ou magnétoscopique
canadienne à l'égard de laquelle un
investisseur, ou une société de personnes
dans laquelle un investisseur a une participation directe
ou indirecte, peut déduire un montant relativement
à la production dans le calcul de son revenu pour
une année d'imposition.
|
[7]
The parties agree that Big Comfy is a qualified corporation that
incurred a qualified labour expenditure and filed with its 1996
tax return a video production certificate in respect of its video
production and other information on prescribed forms required by
subsection 125.4(3).
[8]
The issue before me is whether EBTK, Mr. Murtagh and
Ms. Goldstein, the Investors, have a degree of ownership in
Series IV so that they may deduct an amount - for example,
capital cost allowance ("CCA") - in respect of the
production of Series IV in computing income. If so, the appellant
is precluded from claiming the tax credit.
[9]
The appellant states that at no material time did any of the
Investors own any copyright or distribution rights in Series IV
and therefore the Investors had no right of ownership in the film
or video production and could not deduct any amount in respect of
Series IV.
[10] Each of
the Investors entered into a separate Investment Agreement, dated
July 11, 1995, with the appellant and Nestor Productions
Inc., under which the
Investor contributed or loaned funds to the appellant to be used
by the appellant to produce Series IV episodes
("Agreement"). The Investors were entitled to recover
(recoup) their contribution from the net revenues, as that term
is defined in the Investment Agreements, of the production out of
what is called the "first-tier recoupment". The
Producers and Participants were also entitled to receive a
partial return of their contributions, approximately 10.46 per
cent of their contribution. Once the Investors were fully
reimbursed and the Participants and Producers recouped a portion
of their contributions, the Participants and Producers were
entitled to further payments out of net revenues. Thereafter each
Investor, Participant and Producer was entitled to receive on a
pro-rata, pari-passu basis or share in
50 per cent of the net revenues. The remaining
50 per cent belonged to Big Comfy.
[11] As at
December 31, 2001, the Investors received a return equal to
100 per cent of their investments.
[12] In each
Investment Agreement, the Investor appointed the appellant as its
exclusive agent for the "purposes of exploiting the interest
acquired" by the Investor.
[13] The
Investment Agreements between the Investors and Big Comfy
differed from the agreements the appellant had with each of
Telefilm and Shaw. In the latter agreements, the appellant
granted Telefilm and Shaw undivided copyright ownership interests
in all versions of the production and in all subsidiary rights
and works owned or controlled by the appellant. In the agreement
with YTV, the appellant granted YTV the first right to exhibit
the episodes but the appellant retained ownership. There is no
apparent transfer of ownership rights in the Investment
Agreements between the appellant and each Investor. Each of these
agreements state the contributor "agrees to advance to the
producer, as an investment in Series IV, . . ." the amount
of their respective investments.
[14] Big Comfy
received financial assistance from the Ontario Film Development
Corporation ("OFDC"), an agency of the Ontario
government. The purpose of the OFDC is to contribute to
Ontario's culture by developing policies and providing
programs, among other things, to stimulate the independent film
and television industry in Ontario. One of the programs is the
Ontario Film Investment Program ("OFIP") which provides
cash rebates to eligible investors for Canadian-content film and
television production independently produced in Ontario and
distributed domestically by Ontario based theatrical distributors
or broadcast in Ontario.
[15] Each of
the Investors and Big Comfy was an eligible investor in the
production within the meaning of that term in the OFDC
Guidelines, dated April 1, 1995, respecting the
OFIP.
[16] According
to paragraph C.a) of page 10 of the Guidelines of the OFIP,
effective April 1, 1995 an OFIP rebate is calculated as a
percentage of the 'Eligible Investment Amount', as
defined:
For the purposes of
these Guidelines, the Eligible Investment Amount means the amount
invested by any investor (including the producer and production
entity) to purchase an ownership interest in an Eligible
Production or in its copyright . . .
The OFDC determined that
$678,584 was the Eligible Investment Amount with respect to the
episodes produced by the appellant.
[17] In 1996,
each of the Investors and Big Comfy received a rebate from the
OFDC with respect to their investment in the production, as
follows:
EBTK
$1,800
W.J.
Murtagh
$1,800
L.
Goldstein
$17,100
Big
Comfy
$101,445
[18] Mr. John
Leitch, President of Radical Sheep, which has a
50 per cent interest in the appellant, testified that
the OFDC "gave up its position" requiring an investor
"to purchase an ownership interest" in a production due
to "backlash" from producers. The OFDC's position
at the time the Investors invested in the Series IV
episodes, Mr. Leitch stated, was that investors "had to
have money at risk".
[19] Each of
the Investors is an investor, within the meaning of
subsection 125.4(1) of the Act, since each was a
person, other than a prescribed person, who is not actively
engaged on a regular, continuous and substantial basis in a
business carried on through a permanent establishment in Canada
that is a Canadian film or video production business.
[20] The
Canadian Audio-Visual Certification Office ("CAVCO") of
the Government of Canada issued a Canadian film or video
certificate within the meaning of subsection 125.4(1) of the
Act to Big Comfy on April 11, 1997 estimating the amount
for determining its qualified labour expenditure for 1996 in
respect of the production as $ NIL.
[21] Mr. David
Weisdorf is a chartered accountant who prepared Big Comfy's
tax returns since 1993. The appellant's balance sheet as at
March 31, 1996 reflects as a liability, advances of $155,542
representing the contributions from the three Investors as well
as YTV (of $40,000), Radical Sheep (of $362) and Owl ($180). (The
appellant originally recorded the amount of $155,542 as income
but was adjusted to a liability).
[22] In any
event, when distributions of net profits were made to the
Investors, the distributions were not treated by the appellant as
repayments or reductions of loans. Mr. Weisdorf was asked by
respondent's counsel whether, in the case of a loan, if a
borrower repays the loan should the principal amount of the loan
not be reduced. Mr. Weisdorf replied: "In certain
cases". When the appellant repaid the principal amount of
the loans from the contributors, counsel suggested, it is an
accurate reflection to reduce the amount of the loan payable. Mr.
Weisdorf acknowledged that that "is one way to record the
transaction". The most accurate way to record the
transaction is to reduce the capital of the loan so there is no
excess above that portion of the amount of the loan that has been
distributed.
[23]
In the view of Big Comfy's
counsel, the sum advanced by the Investors "would be an
amount paid to acquire rights to certain amounts, and that would
be a recoupment of the investment, plus an interest in the
profits". Counsel states that "it may well be property,
but it is intangible property, and falls within no schedule of
the CCA schedules contained in the regulations, and therefore,
the investors would not be able to deduct any CCA with respect to
their investment". Even though the investment may not be a
loan, it is still not an acquisition of ownership of any asset
that is depreciable property.
[24]
The amounts advanced by the
Investors were treated as liabilities on the financial statements
of Big Comfy. If the money had been advanced as consideration for
an interest in, or a portion of, the copyright to the series
(whether a legal or beneficial interest) the amounts would not
have been treated as liabilities, appellant's counsel stated.
The amounts advanced to the appellant by Telefilm and Shaw for
assignment of copyright were not treated as liabilities on the
financial statements. The Telefilm and Shaw agreements also
indicate that GST is chargeable on the transfer of copyright,
while the agreements with the Investors do not contain this
provision. Further, if the amounts advanced by the Investors were
for consideration of a transfer of copyright, whether it was a
legal transfer or an equitable interest, the aggregate amount of
$115,000 that they advanced would have been deducted from the
balance of the undepreciated capital cost of the production and
this was not done, Mr. Weisdorf did not purport to make this
adjustment.
[25] Counsel for
the appellant referred to
the Canadian Customs and Revenue Agency ("CCRA")
Interpretation Bulletin IT-441, Capital Cost Allowance -
Certified feature productions and certified short productions.
The Bulletin states that to qualify for capital cost allowance an
investor must beneficially hold an undivided proprietary
interest, whether alone or jointly with other persons, in all the
components of the film or tape property and not merely an
interest in some elements thereof. The Bulletin lists elements of
a property which the investor must acquire to establish
ownership, one of which is copyright.
[26]
Subsection 13(4) of the
Copyright Act requires that, to be valid, any assignment
of copyright must be in writing and signed by the owner of the
right. Counsel for the appellant noted that while the Investment
Agreements between the Investors and the appellant are in
writing, there is no clear statement in the Agreements to assign
any portion of copyright to the Investors and the Agreements, in
and by themselves, therefore, are not capable of transferring a
copyright interest.
[27]
In Canada Deposit Insurance
Corp. v. Canadian Commercial Bank ("CDIC"), Iacobucci J.
found that if a transaction contains features of both debt and
equity, an effort must be made to determine the true
"substance" of the relationship between the
parties:
As I
see it, the fact that the transaction contains both debt and
equity features does not, in itself, pose an insurmountable
obstacle to characterizing the advance of $255 million. Instead
of trying to pigeonhole the entire agreement between the
Participants and CCB in one of two categories, I see nothing
wrong in recognizing the arrangement for what it is, namely, one
of a hybrid nature, combining elements of both debt and equity
but which, in substance, reflects a debtor-creditor relationship.
Financial and capital markets have been most creative in the
variety of investments and securities that have been fashioned to
meet the needs and interests of those who participate in those
markets. It is not because an agreement has certain equity
features that a court must either ignore these features as if
they did not exist or characterize the transaction on the whole
as an investment. There is an alternative. It is permissible, and
often required, or desirable, for debt and equity to co-exist in
a given financial transaction without altering the substance of
the agreement. Furthermore, it does not follow that each and
every aspect of such an agreement must be given the exact same
weight when addressing a characterization issue. Again, it is not
because there are equity features that it is necessarily an
investment in capital. This is particularly true when, as here,
the equity features are nothing more than supplementary to and
not definitive of the essence of the transaction. When a court is
searching for the substance of a particular transaction, it
should not too easily be distracted by aspects which are, in
reality, only incidental or secondary in nature to the main
thrust of the agreement.
[28]
The Agreements between the
Investors and Big Comfy appear to be hybrid in character. This
duality is demonstrated through the conflicting results obtained
when contrasting the statement that the investors retain the
appellant as their "exclusive agent and nominee for the
purposes of exploiting [their] interest" with the glaring
absence of any transfer of copyright interest to the investors.
That the contradictory nature of the Agreement appears to have
arisen more from a clumsiness in drafting rather than a
"creativity" in fashioning the Agreements to meet the
various needs of the parties, as envisioned by Justice Iacobucci,
does not change the reality of the incompatible provisions. I
must determine the true substance of the relationship between the
Investors and the appellant.
[29]
Justice Iacobucci further stated in
CDIC that:
As in
any case involving contractual interpretation, the
characterization issue facing this Court must be decided by
determining the intention of the parties to the support
agreements. This task, perplexing as it sometimes proves to be,
depends primarily on the meaning of the words chosen by the
parties to reflect their intention. When the words alone are
insufficient to reach a conclusion as to the true nature of the
agreement, or when outside support for a particular
characterization is required, a consideration of admissible
surrounding circumstances may be appropriate.
[30]
The intentions of the
parties to the Investment Agreements may not be gleaned solely
from the words chosen to be included in the agreements. The
Agreements attempt to retain the appellant as the Investors'
agent to exploit their "interest", while at the same
time the Agreements do not transfer or assign any interest to the
Investors that could be exploited. Further, if the Investment
Agreements did transfer an ownership interest to the Investors,
as the respondent asserts, this would probably have created a
partnership, a relationship which is specifically denied in the
Agreements. Of course, a declaration in an agreement that a
relationship is not a partnership does not preclude me from
determining that in substance the relationship is just that.
However, it does present inconsistent interpretations of the
intentions of the parties as demonstrated through the meaning of
the words chosen by them. It is difficult, therefore, if not
impossible, to gain an accurate understanding of the intentions
of the parties purely through an interpretation of the words
contained in the agreements. I believe that in the circumstance
it is appropriate for me to consider surrounding circumstances
and look to the larger picture of what relationship the parties
to the Investment Agreements were intending to create.
[31] As I have
already stated, the issue in
this case is not whether the investors entered into a loan
agreement with the appellant and a debtor/creditor relationship
exists. The issue is whether the appellant intended to transfer
an ownership interest in a certain asset to the investors, by
virtue of which they would be entitled to deduct an amount in
respect of the production in computing income, by claiming
capital cost allowance or some other deduction, or whether they
intended to create a relationship in which no ownership in the
production was transferred. Big Comfy did not intend to transfer
ownership to the Investors and the Investors did not intend to
acquire an ownership interest. The appellant and the Investors
did not create agreements that were capable of doing
so.
[32]
In assessing intentions of the
parties and the true nature of a relationship established by an
agreement that is hybrid in character it is important to decide
the weight that should be afforded to the conflicting aspects of
the agreement. In CDIC, Iacobucci J. noted
that:
[t]he
weight to be given one aspect of the support agreements over
another in assessing the true intention of the parties. .
.
was the
primary factor that underlaid the differing characterizations of
the transaction by the chambers judge and the Alberta Court of
Appeal.
[33]
The respondent argues that the
Investors' acquired incidents of title in the form of use and
risk. Respondent's counsel referred to M.N.R. v. Wardean
Drilling Ltd. for the
proposition that property is legally acquired when normal
incidents of title, possession, use and risk are acquired.
Counsel suggested that the Investors acquired an ownership
interest in Series IV since they acquired the use of an
asset and the risk associated with it. For example, a production
is used by those who own it through generating revenues by
negotiating distribution and merchandising agreements. Counsel is
of the view that the agreements between the Investors and the
appellant contemplate the Investors' participation in this
use. His analysis of the investors' right to "use"
the asset is largely tied to the clause in the agreement stating
that the investors appointed the appellant as their
"exclusive agent and nominee for the purposes of exploiting
[their] interest". The
"interest" referred to in the agreements, counsel
declared, is not the contractual right to a stream of returns of
revenues or this type of contractual right need not be exploited.
The "interest", he asserts, is the right to participate
in the exploitation of the production, the participation in the
use of an asset. I place
little weight on this appointment provision. As I have noted, the
Agreements do not assign any interest to the Investors that is
capable of being exploited and, in contrast to agreements entered
into by the appellant with Telefilm and Shaw, for example, it
does not assign to the Investors any right in copyright. The
Agreements do not give the Investors an interest in rights to
distribute, copy, license or in any way control the use of the
production. In effect, it may be said that the Agreements attempt
to assign a right to exploit an interest without assigning the
interest itself. The respondent appears to argue that the clause
in the Agreements attempting to assign to the investors a right
to exploit a non-existent interest is indicia of the
investors' right to use the asset. This "use" is an
incident of ownership and establishes the investors'
beneficial ownership of the production and in copyright. The
beneficial ownership thereby creates the interest that may be
exploited. This, to my mind, is circular logic.
[34] In
CDIC, among other things, agreements limited the
Investor's return to the amount of capital invested plus
interest. Respondent's counsel suggested that
Iacobucci J. concluded that the true nature of the
agreements was one of debt rather than an investment of capital
because the investor could not receive more than he invested,
plus interest. Counsel reasoned that where there is a maximum
amount, a limit, to the Investor's return from his
contribution, the investor does not participate in the fortunes
that may result from the use of the asset. On the other hand
where there is no limit, then the investor has an unfettered use
of the asset subject to the extent of the Investor's
proportionate ownership.
[35]
The respondent therefore argued
that the Investors' unfettered right to share in a percentage
of profits after the recoupment of the principal amount invested
is a further indication of the Investors' right to use the
asset. Earlier in
submissions, however, respondent's counsel described the use
of a production as the ability to "generate revenues by
negotiating distribution and merchandising agreements". The
Investors are entitled to share in the revenues of the production
but they do not have any right in directing the use of the
production to generate those revenues. Further, it was very
unlikely that the Investors would ever realize on this interest
to a share of profit. While this does not change the character of
the interest, it does dictate how much weight should be placed on
the consideration of its importance in determining the true
substance of the agreement. This, again, is illustrated through
comments by Iacobucci J. in CDIC.
. . . It is
also true, at least in theory, that by fully exercising their
warrants the Participants would own 75 percent of the common
shares issued by CCB. However, it is evident on the face of the
record that this possibility was not only a mere hypothesis, but
it was unlikely to occur. . . . Undoubtedly, the warrants are an
equity feature of the transaction supporting a conclusion that
the advance was an investment. However, in the facts of this
case, only minimal weight should be given to this factor in the
overall characterization of the agreement.
[36]
While the entitlement to share in
profits is indicative of some measure of the Investors' right
to use the asset, the connection is tenuous as the Investors do
not have any right to direct the use of the asset and that little
weight should be placed on this aspect.
[37]
Respondent's counsel further
argued that the sum contributed by the Investors was linked
directly to the asset, Series IV episodes, rather than tied to
the business of the Big Comfy as a whole. By making the Series IV
episodes, the production, the object of the investment and
repayment, counsel suggests that the Investors shared in the risk
that Series IV would not be profitable. Counsel suggests that the
Investors recognized their risk since the Investment Agreements
require the appellant to provide insurance, including a
completion guarantee, naming the Investors as beneficiaries. This
sharing of risk, counsel submits, is indicative of an incident of
ownership. Again I would place little weight on this aspect. The
Investors' risk was strictly limited to the amount of their
investment. While the object of the investment was the production
of Series IV, the Investors were not exposed to any claims by
creditors of the series beyond the amount of their original
investment. For example, suppliers, employees and actors could
not look to the investors for satisfaction of their claims if the
production failed. Respondent's counsel appears to argue that
since the Investors had incidents of ownership, they became
beneficial owners of the production and unwittingly entered into
a partnership with the owners. As the Investors were in substance
beneficial owners, they would be exposed to the same risk as the
appellant with regards to the production. The creditors,
therefore would be entitled to look to the Investors for payment.
This, argues counsel, demonstrates that the investors acquired a
normal incident of ownership, being risk. Again, I find the
rationale that the conclusion of the analysis (finding that the
investors acquired beneficial ownership in the production)
somehow expands the original basis for the determination (that
the investors acquired incidents of ownership) to be circular
logic.
[38]
The Agreements featured aspects of
both debt and equity. The Agreements did not, however, assign any
right in copyright to the Investors, nor did they transfer
outright any interest in ownership, beneficial or otherwise. At
no time did the Investors attempt to take a deduction in relation
to the production. The sums advanced by the Investors were
treated as liabilities on the books of the appellant. As a whole,
the Investment Agreements and the surrounding circumstances
indicate that both the Investors and the appellant did not intend
the Agreements to transfer interests in ownership. The able
submissions of respondent's counsel do demonstrate features
of the relationship which could be held to demonstrate certain
incidents of ownership held by the Investors. I do not believe,
however, in light of the above analysis that much weight should
be attributed to these aspects of the Investment Agreements. The
relationship between the appellant and the Investors was not a
partnership and the Investors did not obtain any interest in the
ownership of the production. The Investors, therefore, were not
entitled to a deduction "in respect of" the production
and the appellant is not precluded by virtue of the exception
found in subsection 125.4(4) from claiming the federal tax credit
for a film or video production available under section 125.4 of
the Act.
[39] The appeal
is allowed with costs.
Signed at
Vancouver, British Columbia this 9th day of May 2002.
J.T.C.C.
COURT FILE
NO.:
1999-4643(IT)G
STYLE OF
CAUSE:
Big Comfy Corp. and
Her Majesty
the Queen
PLACE OF
HEARING:
Toronto, Ontario
DATE OF
HEARING:
March 20, 2002
REASONS FOR
JUDGMENT BY: The Hon. Judge Gerald J.
Rip
DATE OF
JUDGMENT:
May 9, 2002.
APPEARANCES:
Counsel for
the
appellant:
Richard B. Thomas
Counsel for
the
respondent:
Franco Calabrese
COUNSEL OF
RECORD:
For the appellant:
Name:
McMillan Binch
Barristers &
Solicitors
Firm:
Royal Bank Plaza
Suite 3800, South Tower
Toronto,
Ontario M5J 2J7
For the
respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa,Canada
1999-4643(IT)G
BETWEEN:
BIG COMFY
CORP.,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Appeal heard
on March 20, 2002 at Toronto, Ontario, by
the
Honourable Judge Gerald J. Rip
Appearances
Counsel for
the
Appellant:
Richard B. Thomas
Counsel for
the
Respondent:
Franco Calabrese
JUDGMENT
The appeal
from the assessment made under the Income Tax Act
("Act") for the 1996 taxation year is allowed
with costs and the matter is referred back to the Minister of
National Revenue for reassessment and reconsideration on the
basis that the appellant is entitled to claim a federal tax
credit for a film or video production in accordance with section
125.4 of the Act.
Signed at
Vancouver, British Columbia, this 9th day of May 2002.
J.T.C.C.
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