Citation: 2009 TCC 256
Date: 20090515
Docket: 2006-1275(IT)G
2006-1277(IT)G
2006-1278(IT)G
BETWEEN:
966838 ONTARIO INC.,
ARTHUR LEE and
SOLIDWEAR ENTERPRISES LIMITED,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J.
[1]
In these three appeals
for the 2001 taxation year, heard on common evidence, the Appellants seek to
deduct, from income, uncollectible advances made by them to Valleycroft
Textiles Inc. (“VTI”) in the following amounts:
(1) Arthur Lee $1,242,127.00
(2) Solidwear
Enterprises Limited $1,943,471.00
(3) 966838
Ontario Inc. $ 425,000.00
[2]
Each of the Appellants
has established that the outstanding balance of their respective advances to VTI
was uncollectible following a voluntary assignment in bankruptcy made by VTI.
[3]
The issue is whether the
Appellants’ advances may be deducted in computing income.
Facts
[4]
Generally the facts are
not in dispute, the parties having filed a Joint Brief of Documents and an
Agreed Statement of Facts, as follows:
STATEMENT
OF AGREED FACTS
THE APPELLANTS
1. The appellant,
Arthur Lee (“Mr. Lee”), is an individual residing in the city of Toronto, Ontario.
2. The appellant,
966838 Ontario Inc. (“966838”), is a corporation incorporated pursuant to the
laws of the province of Ontario
and has its head office in Toronto, Ontario.
3. The appellant,
Solidwear Enterprises Limited (“Solidwear”), is a corporation, amalgamated
pursuant to the laws of the province of Ontario and has its head office in Toronto, Ontario.
RELATIONSHIP OF
APPELLANTS
4. At all
material times, Mr. Lee owned all of the issued and outstanding shares of 966838.
5. At all
material times, Mr. Lee controlled Solidwear through a holding company and
owned all of the common shares and 50 per cent of the Class A Special
Shares of the holding company. The balance of Solidwear’s Class A Special
Shares were held by Mr. Lee’s wife.
6. Mr. Lee ran
the businesses of Solidwear, 966838 and Valleycroft Textiles Inc.
(“Valleycroft”) out of the same office premises, utilizing common office
administrative staff.
FACTS COMMON TO ALL
THREE APPEALS
7. At all
material times, Mr. Lee owned 85 per cent of the share capital of Valleycroft,
as well as an additional 10 per cent of the share capital, indirectly through a
holding company.
8. At all
material times, Solidwear carried on business as a garment manufacturer,
producing highly specialized outerwear garments as well as basic knit apparel.
9. On or about
January 31, 1999, Valleycroft Enterprises Inc., a predecessor in business of
Valleycroft, entered into an agreement (“Agreement”) with the John Forsyth
Company Inc./La Compagnie John Forsyth Inc. (“John Forsyth”) to purchase
all of the assets and undertaking of the Penmans Textile Division of John
Forsyth (“Penmans”). Penmans was a fabric dye house and knitting mill operation
located in Cambridge, Ontario.
10. Following the
acquisition of Penmans, Valleycroft Enterprises Inc. changed its name to
Valleycroft Textiles Inc. (referred to above and hereinafter as “Valleycroft”)
on February 24, 1999.
VALLEYCROFT’S
BANKRUPTCY
11. Valleycroft made a voluntary
assignment in bankruptcy on June 28, 2001.
12. Each of Mr.
Lee, 966838 and Solidwear have established that the outstanding balance of
their respective advances to Valleycroft have become uncollectible for their
respective 2001 taxation years.
SOLIDWEAR’S APPEAL
13. The Minister of
National Revenue (the “Minister”) reassessed Solidwear for its 2001 taxation
year, notice of which was dated March 18, 2005, and disallowed the
deduction Solidwear claimed in respect of its advances to Valleycroft of
$1,943,471.00. The Minister concluded that Solidwear incurred a capital loss on
account of the Valleycroft advances.
MR. LEE’S APPEAL
14. The Lee advances to Valleycroft
totalled $1,242,127.37 as follows:
|
Date
|
Cheque No.
|
Payee
|
Amount
|
|
Dec. 14/98
|
6231
|
The Toronto
Dominion Bank
|
$50,000
|
|
Feb. 1/99
|
97
|
The John Forsythe
Co.
|
$154,000
|
|
Feb. 3/99
|
98
|
Valleycroft
Textiles
|
$150,000
|
|
Feb. 9/99
|
99
|
Valleycroft
Textiles
|
$100,000
|
|
Feb. 24/99
|
6
|
Valleycroft
Textiles
|
$100,000
|
|
May 10/99
|
35
|
Valleycroft
Textiles
|
$150,000
|
|
Jun 17/99
|
40
|
Valleycroft Textiles
|
$150,000
|
|
Jun 17/99
|
41
|
Valleycroft
Textiles
|
$127,127.37
|
|
Jan. 6/00
|
82
|
Valleycroft
Textiles
|
$261,000
|
15. The Minister
reassessed Mr. Lee to disallow the amount of $1,242,127 claimed as a deduction
in the computation of Mr. Lee’s income for the 2001 taxation year. The Minister
concluded that the Valleycroft Deduction was a business investment loss
pursuant to paragraph 39(1)(c) of the Income Tax Act, and, thereby
allowed Mr. Lee a corresponding allowable business investment loss deduction
(“ABIL”) pursuant to paragraph 38(c) of the Income Tax Act.
966838’S APPEAL
16. Ontario Garment
Finishers [1997] Limited (“OGF”) amalgamated with Valleycroft on February 1,
2000, and continued in business as Valleycroft. The debt of OGF to 966838,
which remained outstanding upon the amalgamation, became an obligation of
Valleycroft. Valleycroft signed a written acknowledgment dated February 1, 2000
to 966838 acknowledging that 966838 had made various loans to it in the total
amount of $425,000.00.
17. By reassessment,
notice of which was dated December 28, 2005, the Minister disallowed 966838’s
claim for a deduction in the amount of $425,000.00 for its fiscal year ended
August 31, 2001. The Minister concluded that 966838 incurred a capital loss on
account of the Valleycroft advances.
18. The parties may
tender additional evidence provided that the evidence is not contrary to the
facts admitted above.
[5]
The Appellant Arthur
Lee has been involved in the garment business since 1985, primarily in the Toronto area. He holds a controlling interest in a number of
corporations, including the two corporate Appellants, Solidwear Enterprises
Limited (“Solidwear”) and 966838 Ontario Inc. (“966838”), and VTI.
[6]
At all times relevant
to these appeals, Solidwear carried on business as a garment manufacturer,
producing specialized outerwear garments as well as basic knit apparel. Mr. Lee
was the President and sole director of Solidwear.
[7]
Mr. Lee was also the sole
director and President of both 966838 and VTI. According to 966838’s Notice of
Appeal, 966838 was used primarily as a vehicle for financing various
businesses, including Solidwear and VTI.
[8]
VTI operated a knitting
mill and fabric dye house in Cambridge,
Ontario, which had been acquired
in January, 1999. It was intended that this would create an integrated
manufacturing enterprise by providing fabrics to Solidwear, thereby eliminating
the need to purchase fabric from out of the country suppliers and ensuring that
Solidwear had a reliable source of high quality fabrics.
[9]
In addition to Mr. Lee,
Morris Sederoff, the comptroller (accountant) for the Appellants from about
1999 to June 2001, also testified on behalf of the Appellants. Mr. Sederoff explained
that the acquisition of the knitting mill operated by VTI was aimed at controlling
costs.
[10]
The advances at issue
in these appeals were made under varying circumstances. Mr. Lee personally advanced
a total of $1,242,127.37 to VTI in the following instalments:
|
Date
|
Amount
|
|
Dec.
14/98
|
$
50,000.00
|
|
Feb
1/99
|
$154,000.00
|
|
Feb
3/99
|
$150,000.00
|
|
Feb
9/99
|
$100,000.00
|
|
Feb
24/99
|
$100,000.00
|
|
May
10/99
|
$150,000.00
|
|
Jun
17/99
|
$150,000.00
|
|
Jun
17/99
|
$127,127.37
|
|
Jan
6/00
|
$261,000.00
|
[11]
The “Lee Advances” were
documented simply as loans and occasionally as shareholder loans, and were evidenced
by promissory notes. Although the notes were issued as interest bearing, a
subsequent agreement clarified that this was in error and that the notes were non-interest
bearing.
[12]
The “Solidwear Advances”
arose from different circumstances. The Royal Bank of Canada (“RBC”) originally financed VTI directly in 1999 but as
of mid‑June 2000, it required that Solidwear be primarily liable for
VTI’s indebtedness because it was more financially secure. The Appellants
rightly characterized this arrangement as RBC lending money to Solidwear,
thereby enabling Solidwear to finance the operations of VTI.
[13]
Following this new
arrangement, VTI issued two promissory notes in favour of Solidwear totalling
$962,403, which appear to correspond with the credit that had initially been
advanced to VTI by RBC. These notes provided for the payment of interest at the
commercial lending rate as set by RBC, plus 1.25% per annum and 2% per
annum respectively. As stated, the outstanding amount advanced to VTI by
Solidwear totalled $1,943,471.
[14]
Mr. Lee testified that
the purpose of the Solidwear advances was to maintain the viability of VTI,
thereby ensuring the continuous supply of fabric to Solidwear. He added that
as a newly created operation, VTI needed operating funds, and that the money
was used to carry on its business.
[15]
The amounts
uncollectible by 966838 (the “966838 Advances”), totalling $425,000, were
initially made by 966838 to Ontario Garment Finishers (1997) Ltd. (“OGF”), a
former subsidiary of VTI. 966838 advanced funds to OGF for the same reason that
Solidwear advanced monies to VTI, namely, to provide funding to a related
corporation in order to create an integrated manufacturing enterprise with
Solidwear at its centre. The repayment of the 966838 advances only became the obligation
of VTI following an amalgamation between VTI and OGF. These advances
resulted in a demand loan in favour of VTI bearing interest at prime rate plus
2% per annum.
[16]
VTI supplied fabrics to
Solidwear for over two years before making a voluntary assignment in bankruptcy
on June 28, 2001. In keeping with the intent to create an integrated
manufacturing enterprise, Solidwear fulfilled most of its fabric needs through
purchases from VTI, which totalled over $7,000,000 during the relevant period. VTI
made a voluntary assignment in bankruptcy on June 28, 2001, after the removal
by the Federal Government of a tariff on imported fabric, which made it
impossible for VTI to compete with cheaper imports.
[17]
The Appellants claimed deductions
from business income in respect of the uncollectible advances. The Minister
reassessed each Appellant and disallowed the deductions claimed. The Minister
concluded that the uncollectible advances resulted in capital losses to
Solidwear and 966838, but permitted Mr. Lee a deduction in respect of an
allowable business investment loss pursuant to paragraph 38(c) of the Income
Tax Act (the “Act”).
Positions Taken by the Parties
[18]
The primary position
taken by the Appellants is based upon their portrayal of the overall
relationship between them and VTI as an integrated manufacturing enterprise. The
Appellants characterize the Solidwear advances as fabric procurement costs
incurred to secure a reliable and controllable source of supply, and as such,
laid out for the purpose of gaining or producing income from Solidwear’s
business. The Lee and 966838 advances, counsel for the Appellants submitted,
were made for the purpose of supporting and furthering the garment manufacture
business, and as such were made in tandem with the Solidwear advances and
formed an integral part of the overall business operations of Solidwear.
Counsel argued that all these advances, once they became uncollectible,
constituted losses arising in the ordinary course of business that were
properly deductible in computing profit pursuant to general principles of
income computation under subsection 9(1) of the Act.
[19]
Alternatively, the Appellants
submitted that they are entitled to a deduction in respect of the uncollectible
advances under subparagraph 20(1)(p)(ii) of the Act on the basis
that the losses were incurred from a money-lending business.
[20]
The Respondent’s
position is that the advances made by the Appellants to VTI are properly
characterized as losses of capital, the deduction of which from income is
expressly disallowed by paragraph 18(1)(b) of the Act. In support
of this, the Respondent argued that the creation and maintenance of the supply of
fabric through VTI was viewed by the Appellants as a long-term investment as
part of Mr. Lee’s business plan. The Respondent adds that the funds
advanced by Mr. Lee, either directly or indirectly, through other
corporations he controlled, were for the purpose of protecting his substantial capital
investment in VTI.
[21]
In the Respondent’s
view, the advances to VTI were not primarily made for the purpose of increasing
the profitability of the Appellants’ business in the short term, but to provide
working capital to VTI, a company which the Appellants hoped would continue to
supply fabric to Solidwear for many years to come. In this way, the Respondent
described the advances as being made to obtain an advantage of an enduring
nature. She further argued that it would be improper to view the Appellants as an
integrated business unit, if doing so resulted in ignoring their separate legal
existence for tax purposes.
[22]
She added that none of
the Appellants were engaged in the business of lending money, and
therefore, the deduction contemplated by subparagraph 20(1)(p)(ii)
is not available.
Analysis
[23]
As stated by Iacobucci
J. in Canderel Ltd. v. R., [1998] 1 S.C.R. 147, at paragraph 29, it is
appropriate to begin the consideration of profit with subsection 9(1) of the Act.
That subsection provides as follows:
9(1) Subject to this Part, a
taxpayer’s income for a taxation year from a business or property is the
taxpayer’s profit from that business or property for the year.
[24]
While not defined
in the Act, it is accepted that profit is inherently a net concept that
allows for business expense deductions. At paragraphs 51 and 52 of Canderel,
Iacobucci J. explained that in ascertaining profit, the taxpayer is free to
adopt any method which is not inconsistent with (a) the provisions of the Act;
(b) established case law principles or “rules of law”; and (c) well-accepted
business and accounting principles.
[25]
The Act
provides, at paragraph 18(1)(b):
18(1) In
computing the income of a taxpayer from a business or property no deduction
shall be made in respect of
…
(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;
[26]
Before
considering the income or capital issue, I will deal with the Appellants’
alternative argument under subparagraph 20(1)(p)(ii). That provision expressly
allows for deductions from income in respect of uncollectible loans or lending
assets under certain circumstances.
[27]
For a taxpayer to
obtain the deduction provided for in clause 20(1)(p)(ii)(A), it must be
established that:
16 …
(a) the debts to be
deducted arise from loans;
(b) the ordinary
business of the taxpayer must include the lending of money;
(c) the loans
giving rise to the bad debts must have been made in the ordinary course of the
taxpayer’s business of lending money; and
(d) the loans
giving rise to the bad debts must have become uncollectible in the year.
[28]
In Loman Warehousing
Ltd. v. Canada, 99 DTC 1113, aff’d 2000 DTC 6610 (F.C.A.), Bowman J.
explained at paragraph 25:
25 The expression “whose ordinary
business includes the lending of money” requires a determination of just what
the taxpayer’s “ordinary business” is. The ordinary business of the appellant
is warehousing, not lending money to other companies in the group. Some
effect must be given to the word “ordinary”. It implies that the business of
lending money be one of the ways in which the company as an ordinary part of
its business operations earns its income. It also implies that the lending of
money be identifiable as a business. …
[Emphasis
added]
[29]
It cannot be said that
the ordinary business of Solidwear included the lending of money. The ordinary
business of Solidwear was manufacturing outerwear garments and knit apparel. No
evidence was presented that would facilitate a finding that money-lending is
one of the ways in which Solidwear, as an ordinary part of its business
operations, earns its income.
[30]
The cases advanced by
the Appellants as supportive of Solidwear’s entitlement to deductions under
subparagraph 20(1)(p)(ii) are distinguishable on their facts. In both
Wesco Property Developments Ltd. v. Canada (M.N.R.), 89 DTC 590, and
Discovery Research Systems Limited v. Canada, 94 DTC 1510, the
connection between the lending activity and the taxpayer’s ordinary business
was clearly evident. Such is not the case with Solidwear. Further, Solidwear
would not have made the advances but for the actions taken by RBC. The
Solidwear advances were not part of its ordinary business operations, and no
deduction under clause 20(1)(p)(ii)(A) is available.
[31]
I have also concluded that
the Lee advances were not made in the ordinary course of a business of lending
money. Unlike Solidwear, Mr. Lee was a shareholder in VTI. Le Dain J. in Chaffey
v. Canada (M.N.R), 78 DTC 6176 (F.C.A.) at paragraph 10 stated:
10 … In my opinion shareholder’s
advances do not constitute the business of lending money; they are simply a
particular form by which capital is put into a company. The loans made by the
partnership did not have as their principal object the accommodation of persons
in return for income in the form of interest; they were merely a device for the
financing of projects through which profit was to be made by other means.
[32]
A shareholder relationship
does not automatically preclude a finding that there was a business of lending
money; however, a taxpayer would need to put forth clear evidence that the
purpose of the advances related to the taxpayer’s ordinary business, and not merely
to a financing objective. In direct examination, Mr. Lee stated that the loans
were made in effect to assist his business VTI to succeed. Furthermore, the Lee
advances obviously did not have as their principal object the accommodation
of persons in return for income in the form of interest because they were
interest-free.
[33]
In contrast to my
findings above respecting Mr. Lee and Solidwear, I conclude that the
ordinary business of 966838 did include the lending of money, and that the
advances it made to VTI were made in the ordinary course of that business. As
indicated above, these advances were secured by a demand loan from VTI bearing
interest at prime rate plus 2% per annum.
[34]
The Minister assumed
that 966838 was in the business of investing capital in related corporations, but
maintained the position that it was not in the business of lending money. In my
view, for the purposes of clause 20(1)(p)(ii)(A), it is not material
whether a taxpayer’s business could be characterized as one of investing
capital, provided that as an ordinary part of that business, the taxpayer
engaged in the business of lending money. 966838’s financial statements for the
relevant time period show considerable interest income and report that loans
receivable are its most substantial assets. Other interest-bearing loans made
by 966838 included a $25,000 loan made in 1997 to Golf Mania Inc. that bore
interest at 10% per annum, and a $350,000 demand loan made in 1997 to 1243314
Ontario Ltd. that bore interest at prime rate plus 2% per annum. It appears
that almost the entire business operations of 966838 consisted of lending
money. This is not surprising, given the Appellants’ position that 966838 was
incorporated as a financing vehicle. In conclusion, the 966838 loans
are deductible under clause 20(1)(p)(ii)(A).
[35]
Respondent’s counsel
referred to Orban v. M.N.R., 54 DTC 148. That case and the cases
referred to suggest that in order to qualify as a money‑lender, it
is necessary to publicly advertise one’s willingness to lend money “to all and
sundry”, and that it is insufficient merely to lend money on a few occasions at
remunerative rates of interest. No such requirements are provided for in the
language of clause 20(1)(p)(ii)(A). The requirements, as I understand
them, are first, that the taxpayer’s ordinary business include, as part of it,
the business of lending money, and second, that the loan is made or
acquired in the ordinary course of that business. 966828 met these
requirements.
[36]
I now turn to the
Appellants’ primary argument with respect to the Lee and Solidwear advances to
the effect that they are entitled to a deduction in keeping with the general
principles of computing income under subsection 9(1) of the Act.
[37]
Earlier, with respect
to the section 20 argument, I concluded that the Lee advances and
Solidwear advances were not made in the ordinary course of a business of
lending money. The following comments of Pigeon J. in Canada (M.N.R). v. Freud, [1969] S.C.R. 75, at page
82 are therefore a useful starting point:
It is, of course, obvious that a loan made by
a person who is not in the business of lending money is ordinarily to be
considered as an investment. It is only under quite exceptional or unusual
circumstances that such an operation should be considered as a speculation. …
[38]
Losses suffered from loans
made or securities given for the purpose of providing working capital give rise
to capital losses and not business losses. For example, in Stewart
& Morrison Ltd. v. Canada (M.N.R.), [1974] S.C.R. 477, 72 D.T.C.
6049, the taxpayer set up a subsidiary, supplied the capital needed and
guaranteed a bank loan to enable the subsidiary to operate. Judson J. concluded
at page 479:
… The parent company provided working capital
to its subsidiary by way of loans. These loans were the only working capital
the American subsidiary ever had with the exception of the sum of $1,000
invested by Stewart & Morrison Limited for the acquisition of all of the
issued share capital of its subsidiary. The money was lost and the losses were
capital losses to Stewart & Morrison Limited. The deduction of these
losses has been rightly found to be prohibited by s. 12(1)(b) of the Income
Tax Act.
[39]
In respect of the
Lee advances, it is significant that Mr. Lee was a shareholder in
VTI. In Easton v. Canada, [1998] 2 F.C. 44 (F.C.A.), Robertson J.
explained that generally an advance made by a shareholder to or on behalf of
the corporation will be treated as a loan extended for the purpose of providing
the corporation with working capital. He explained the consequences of this in
the event the loan is not repaid, at paragraph 16:
16 … In the event the loan is not
repaid the loss is deemed to be of a capital nature for one of two reasons.
Either the loan was given to generate a stream of income for the taxpayer, as
is characteristic of an investment, or it was given to enable the corporation
to carry on its business such that the shareholder would secure an enduring
benefit in the form of dividends or an increase in share value. As the law
presumes that shares are acquired for investment purposes it seems only too
reasonable to presume that a loss arising from an advance or outlay made by a
shareholder is also on capital account. The same considerations apply to shareholder
guarantees for loans made to corporations. …
He added that there are two recognized
exceptions to the general proposition that losses experienced on such loans are
of a capital nature, at paragraph 17:
17 … First, the taxpayer may be able to establish that
the loan was made in the ordinary course of the taxpayer's business. The
classic example is the taxpayer/shareholder who is in the business of lending
money or granting guarantees. The exception, however, also extends to cases
where the advance or outlay was made for income-producing purposes related to
the taxpayer's own business and not that of the corporation in which he or she
holds shares. …
[Emphasis added]
[40]
It has been accepted
that the first exception does not apply. The Appellants have concentrated
their efforts on the second exception as underlined. As explained by Robertson
J., this exception extends to cases where
the advance or outlay was made for income-producing purposes related to the
taxpayer's own business and not that of the corporation in which he or she
holds shares.
[41]
Correctly, the Respondent
took the position that it would be improper to view the Appellants as an
integrated business unit, if doing so meant ignoring their separate legal
existence for tax purposes. Solidwear, VTI, and Mr. Lee are of course all
separate persons for tax purposes, notwithstanding the Appellants’ characterization
of the business arrangement between them as an integrated enterprise.
[42]
The existence of a
corporation cannot be ignored so as to benefit the taxpayer when he has himself
used this structure because it was advantageous to him at the time. In
the Supreme Court of Canada judgment in Kosmopoulos v. Constitution
Insurance Co. of Canada, [1987] 1 S.C.R. 2, Wilson J. stated at paragraphs
12 and 13:
12 As a general rule a corporation is
a legal entity distinct from its shareholders: Salomon v. Salomon & Co.,
[1897] A.C. 22 (H.L.). …
She added:
13 There is a persuasive argument that
“those who have chosen the benefits of incorporation must bear the
corresponding burdens, so that if the veil is to be lifted at all that should
only be done in the interests of third parties who would otherwise suffer as a
result of that choice”: [L.C.B. Gower, Modern Company Law
(4th ed. 1979)], at p. 138. Mr. Kosmopoulos was advised by a
competent solicitor to incorporate his business in order to protect his
personal assets and there is nothing in the evidence to indicate that his
decision to secure the benefits of incorporation was not a genuine one. Having
chosen to receive the benefits of incorporation, he should not be allowed to
escape its burdens. He should not be permitted to “blow hot and cold” at the
same time.
[43]
This reasoning negates
Mr. Lee’s submission that he is personally entitled to a business deduction,
since the garment manufacturing business was being operated not by him but by
Solidwear and VTI. His evidence attests to the fact that the loans were not
made so that he could personally earn business income, but in order that his corporations
could do so. I find as a fact his advances were made to provide VTI with
sufficient working capital to carry on its business, thereby securing an
enduring benefit to him in the larger context of his garment manufacturing
enterprise. Consequently, Mr. Lee’s advances do not meet the second Easton exception, as they were made for the
income-producing purposes of his corporations. It was these corporations that owned
and operated the manufacturing business, not Mr. Lee. The losses resulting from
the Lee advances are therefore capital in nature.
[44]
Turning to the Solidwear
advances, I accept that they were made to provide VTI with operating funds, ensuring
a continuous supply of fabric to Solidwear. This was the most cost-effective
way to operate the garment manufacturing enterprise.
[45]
Appellants’ counsel argued
that the Solidwear advances were made for the purpose of earning income
pursuant to paragraph 18(1)(a). I cannot agree that if advances were
made for the purpose of producing income from business, it follows that
losses in respect of such advances are automatically on account of revenue. As explained
by Abbott J. in the Supreme Court of Canada decision in British Columbia
Electric Railway Co. v. Canada (M.N.R.), [1958] S.C.R. 133, since the main
purpose of every business undertaking is presumably to make a profit, viewed
from a distance both income expenses and capital outlays fit within the
language of paragraph 18(1)(a). Both are ultimately made “for the
purpose of gaining or producing income”. Consequently, determining whether an
outlay is made for the ultimate purpose of gaining or producing income does not
assist in characterizing the expenditure as on account of income or capital. In
this regard, the remarks of Strayer J. in Morflot Freightliners Limited v.
Her Majesty the Queen, 89 DTC 5182 are relevant. He explained, at
pages 5184-5185:
… Normally payments made by a parent company
to a subsidiary to help finance the operations of a subsidiary are regarded as
capital payments. …
It has frequently been said in cases of this
nature that one must try to characterize a situation from a practical business
point of view to determine the intent with which the money was provided. … I
believe the critical distinction here is as between the preservation of an
enduring asset on the one hand and the expenditure of money for direct and more
immediate gaining of profit through sales, or, as in this case, the earning of
commissions. … Even though, as in the present case, the continuing
successful existence of the subsidiary would have a substantial bearing on the
success of the parent and in this sense might be said to be related to the
production of income from the plaintiff’s business, this does not alter the
fact that the money advanced to the subsidiary was to obtain an advantage of an
enduring nature and this made it a capital expenditure. … [Emphasis
added]
[46]
The present facts resemble
those in Stewart & Morrison Ltd. In that case, as in the
present appeals, a related corporation required capital to operate. Although it
carried on business in its own name and right, it was controlled by its parent,
in a manner similar to the control exercised by Mr. Lee over VTI, Solidwear,
and 966838. As in Stewart & Morrison Ltd., financing for the related
corporation was arranged by the controlling entity.
[47]
The Solidwear, Lee and
966838 advances provided the primary source of financing that enabled VTI to
operate. From Solidwear’s perspective, VTI was financed with the intention of
providing it with the enduring benefit of a continuous source of supply of
fabric. The Courts have consistently held that where an outlay is made with the
intention of securing an asset or advantage of enduring benefit, the outlay
is capital in nature (see Gifford v. Canada, [2004] 1 S.C.R. 411).
[48]
Counsel for the Appellants
argued that this intended benefit did not last beyond the fiscal period in 2001
as a result of VTI’s bankruptcy, and so therefore could not be considered
an asset or advantage of an enduring nature. This may be so, but it is the intended
purpose for the advance at the time it is made that is relevant, not whether
the asset or advantage acquired proved to be enduring: see Gifford v. Canada,
at paragraph 22. Clearly, the Solidwear advances and losses were capital in
nature.
[49]
Counsel for the Appellants
forcefully emphasized that the losses in respect of the Solidwear advances are
deductible pursuant to an “integral part of business operations” theory of loss
deductibility. While Solidwear might have treated VTI as an important source of
fabric, sight must not be lost of the fact that it was at all material times a
separate corporate entity. Mr. Lee cannot have it both ways, treating the
corporations as separate entities or lifting the corporate veil depending on
his needs at any given time.
[50]
The “integral part of
business operations” theory appears to have arisen from Associated Investors
of Canada Ltd. v. Canada (M.N.R.), [1967] C.T.C. 138, which is readily
distinguishable from the present facts. In Associated Investors,
the Appellant employed salespeople on a commission basis but allowed a
minimum drawing account. The difference between commissions earned and amounts
drawn were carried on the Appellant’s books as accounts receivable. The Appellant
made the decision to write down these accounts. The Minister refused to allow a
deduction in computing income on the grounds that the advances were capital
transactions.
[51]
In Associated
Investors, Jackett J. did not appear to view the “integral part of
business” explanation as a deviation from established principles governing the
classification of expenditures as on account of either income or capital. He expressly
found that the advances did not result in the acquisition of any asset or
advantage of an enduring nature (see paragraph 17). The emphasis
remained on the intended purpose of the expenditure. Given the finding that the
Solidwear advances were made with the intention of creating an advantage of an
enduring nature in the form of a reliable source of fabric, the Associated
Investors case is of no assistance to the Appellants.
[52]
Counsel for the Appellants
also referred me to Canada v. F.H. Jones Tobacco Sales Co., 73 DTC 5577
(F.C.T.D.), Canada v. Lavigueur, 73 DTC 5538 (F.C.T.D.), and Panda
Realty Limited v. M.N.R., 86 DTC 1266. The common element in these
cases is that the principal object and purpose for the advancement of funds or
the provision of a guarantee was the preservation of a stream of income. In
this way, the advancement of funds or the provision of a guarantee could be
seen as directly attributable to gaining or producing income. Such a motivation
on the part of the taxpayer distinguishes these cases from others, such as Cathelle
Inc. v. The Queen, 2005 TCC 360, or Stewart & Morrison Ltd., in
which the primary purpose of the advance or guarantee was found to be the
provision of working capital. As explained above, the Solidwear advances fall
within this second category.
[53]
The Appellants also
relied on Williams Gold Refining Co. of Canada v. Canada, 2000 DTC 1829,
the facts of which bear some resemblance to those of the present appeals. In
that case, the appellant company claimed to be entitled to deductions in
respect of bad debts in excess of $628,000 owed to it by a related company,
W.G.R. Hollowforms Ltd. The objectives for creating the related company were
twofold. One was to improve the profitability of the appellant by devoting some
of the space in the buildings it occupied and some of the time of its employees
to the new business. The other objective was to create an additional market for
products manufactured by the appellant.
[54]
As in the present appeals,
one of the issues in Williams Gold Refining was whether the amounts
in question could be deducted pursuant to the ordinary principles
governing the computation of profit. After referring to Stewart & Morrison
Ltd. and Morflot Freightliners Limited, Bowie J. found that the
purpose of the Williams Gold loans was not to capitalize a new business venture
but to improve the profitability of the appellant by providing an expanded
market for its products and reducing overhead. He stated at paragraph 20:
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 … 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. [Emphasis
added]
[55]
Having concluded that
the Solidwear advances were for the purpose of providing working capital to
VTI, Williams Gold Refining is distinguishable and of no assistance to
the Appellants. I would only add that in light of British Columbia Electric
Railway Co. and Stewart & Morrison Ltd., the principles of loss
deductibility as applied in the F.H. Jones Tobacco line of cases should
be approached with caution and not as loopholes through which losses from
financing activities may be deducted from income.
[56]
The appeals in respect
of the Lee advances and the Solidwear advances are therefore dismissed. The appeal
in respect of the 966838 advances is allowed, with the result that 966838 is
entitled to a deduction under clause 20(1)(p)(ii)(A). One set of costs is
awarded to the Respondent being the predominantly successful party.
Signed at Ottawa, Canada, this 15th day of May, 2009.
“C.H. McArthur”
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