Sarchuk,
T.C.J.:—I.R.Q.
Management
Ltd.
(IRQ)
appeals
from
a
reassess-
ment
with
respect
to
its
1984
taxation
year.*
In
its
return
of
income
for
that
year
the
appellant
deducted
from
tax
otherwise
payable
under
Part
1
of
the
Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
c.
63)
(the
"Act")
the
small
business
deduction
as
permitted
by
the
provisions
of
subsection
125(1)
of
the
Act.
In
reassessing,
the
respondent
proceeded
on
the
assumption
that
in
the
taxation
year
in
issue
the
principal
purpose
of
the
appellant's
business
was
to
provide
managerial,
administrative,
financial
and
maintenance
services
to
the
dental
practice
of
Dr.
Roy
Queen
(Queen)
and
that
the
net
income
earned
by
the
appellant
in
that
year
was
income
from
a
non-qualifying
business
within
the
meaning
of
subparagraph
125(6)(f)(iii)
of
the
Act.
Accordingly
the
respondent
determined
the
deduction
allowable
from
tax
otherwise
payable
by
the
appellant
in
the
1984
taxation
year
by
allowing
it
a
small
business
deduction
of
12
2/3
per
cent
pursuant
to
the
provisions
of
subsection
125(1.1).
The
calculations
themselves
are
not
in
dispute.
The
simple
issue
before
me
is
whether
the
Minister's
assumption
that
the
appellant
was
carrying
on
a
non-qualifying
business
within
the
meaning
of
paragraph
125(6)(f)
of
the
Act
was
correct.
The
relevant
portions
of
this
provi-
sion
read:
(f)“
non-qualifying
business”
carried
on
by
a
corporation
in
a
taxation
year
means
(iii)
a
business
the
principal
purpose
of
which
is
to
provide
managerial,
administrative,
financial,
maintenance
or
other
similar
services,
to
lease
property
(other
than
real
property),
or
to
provide
any
such
services
and
to
lease
property
(other
than
real
property),
to
one
or
more
businesses
connected
at
any
time
in
the
year
with
the
corporation;
but
does
not
include
a
personal
services
business;
Three
witnesses
gave
evidence
on
behalf
of
the
appellant;
Queen,
the
president
and
principal
shareholder
of
the
appellant;
Mr.
D.J.
Mills
(Mills),
a
computer
technician
and
former
employee
of
the
appellant;
and
Ms.
Debra
Askew,
a
chartered
accountant.
Dr.
Queen
is
a
clinical
orthodontist.
He
has
a
B.A.
from
the
University
of
Saskatchewan,
a
D.M.D.
and
a
M.Sc.
from
the
University
of
Manitoba.
He
taught
and
did
further
research
in
computerized
diagnosis
of
Trizomic
21
(Mongolism)
at
the
University
of
Manitoba
before
commencing
his
practice
in
Kamloops.
In
May
of
1975
he
was
responsible
for
the
incorporation
of
the
appellant.
He
and
his
wife
were
the
only
shareholders.
Immediately
upon
incorporation
he
entered
into
a
management
agreement
with
the
appellant.
It
is
not
disputed
that
the
original
source
of
revenue
for
the
appellant
was
almost
exclusively
the
management
of
Queen's
orthodontic
practice.
After
several
years
Queen
took
the
first
steps
to
diversify
the
activities
of
the
appellant
and
to
create
for
it
a
variety
of
income
sources.
To
that
end,
in
1981
two
events
occurred.
The
appellant
became
involved
in
developing
specialized
computer
programming
and
in
or
about
October
a
recent
graduate,
Dr.
Wilcox
(Wilcox),
became
associated
with
Queen.
*Its
year
end
for
fiscal
purposes
was
February
29.
Wilcox
and
Queen
were
never
partners.
Both
carried
on
their
individual
orthodontic
practices
albeit
in
common
premises
provided
to
them
by
the
appellant.
These
premises
consisted
in
part
of
eight
operatories.
When
he
came
into
the
practice
in
1981
Wilcox
initially
used
one.
According
to
Queen,
“All
he
did
was
see
consults
for
treatment,"
which,
in
the
early
stages
involved
the
transfer
of
some
new
patients
from
Queen
to
Wilcox.
Eventually
Wilcox
developed
his
own
reputation
and
his
own
clientele
to
the
extent
that
by
1984
the
allocation
of
operatories
was
5
1/2
to
Queen
and
2
1/2
to
Wilcox.
Wilcox
and
IRQ
at
all
relevant
times
governed
their
relationship
by
way
of
a
verbal
agreement
by
virtue
of
which
the
appellant
provided
to
Wilcox's
practice
the
same
services
that
it
provided
to
Queen.
Earlier
in
his
career
Queen
had
become
interested
in
the
application
of
computer
technology
to
various
aspects
of
the
dental
profession.
In
particular
he
became
involved
in
the
development
of
a
computer
program
for
diagnostic
purposes.
To
this
end
a
great
deal
of
time
and
effort
was
expended
by
him
in
1982,
1983
and
1984.
In
1983
applications
for
government
grants
were
made,
unfortunately
without
success.
The
cephalometric
diagnostic
program
being
developed
was
in
Queen's
words
”
.
.
.
totally
innovative
in
that
there
was
no
other
such
program
on
the
market.
It
was
designed
to
compute
changes
of
facial
structure
due
to
either
orthodontics
or
surgery
and
was
developed
with
a
view
to
selling
the
programs".
The
program
was
also
intended
to
be
used
in
the
future
to
diagnose
for
other
doctors,
who
would
refer
their
x-rays
and
the
appellant's
staff
would
produce
a
computerized
diagnostic
alteration
to
the
x-ray
to
interpret
for
the
doctor
what
would
be
the
best
treatment
for
the
patient.
This
was
of
particular
use
in
cosmetic
surgery,
reconstruction
of
the
jaws,
etc.
In
these
endeavours
the
appellant
incurred
substantial
expenses,
which
expenses
qualified
as
deductions
for
income
tax
purposes
on
the
basis
that
it
was
carrying
on
scientific
research
and
development.
The
cephalometric
program
itself
generated
no
revenue
in
1984.
Queen
said
that
while
the
appellant
originally
intended
to
market
the
software
program
through
an
associated
company
that
plan
failed
to
materialize.
It
was
not
until
1986
when
the
appellant
entered
into
a
marketing
contract
with
Exan
Corporation
(Exan)
that
some
sales
were
made
and
a
modest
amount
of
income
was
generated.
Because
of
the
sophistication
of
the
equipment
Queen
was
personally
involved
in
marketing
by
demonstrating
the
program
to
groups
of
dentists,
orthodontists
and
plastic
surgeons.
As
part
of
Exan's
sales
efforts
Queen
and
the
appellant's
staff
gave
between
40
and
50
lectures
and
seminars
between
1986
and
1988.
In
addition
to
the
diagnostic
computer
program,
during
taxation
year
1984
the
appellant
began
to
develop
a
financial
software
program
specifically
designed
for
medical
practices
and
other
similar
businesses.
Queen
said
that
in
subsequent
years
the
appellant
also
began
to
provide
accounting
services
for
non-associated
companies.
It
managed
a
construction
company
in
which
Queen
was
involved
and
which
was
building
condominiums
and
later
began
to
manage
buildings,
in
most
of
which
it
was
conceded
Queen
had
an
interest.
It
sought
out
further
business
and
in
later
years
acted
as
a
management
company
for
other
professional
practices.
In
1984
the
appellant
employed
14
people.
Of
these
people
eight
were
utilized
directly
by
the
dentists
on
the
basis
of
one
assistant
per
operatory.
Of
the
remaining
six
employees
three
were
indirectly
involved
in
the
professional
practices
as
general
administrative
staff
in
the
receiving
office,
while
the
remaining
three,
including
Mills,
were
specifically
involved
in
the
research
and
development
of
the
computer
programs.
According
to
Queen
one
of
the
administrative
staff
was
utilized
substantially
in
the
computer
aspect
of
the
appellant's
business.
Mr.
Mills,
an
electrical
engineering
technologist,
was
at
one
time
the
owner
of
a
company,
Micro-Pro
Systems
Ltd.,
which
since
1981
had
been
employed
by
the
appellant
as
a
consultant.
In
this
fashion
Mills
was
involved
in
developing
the
appellants
computer
system
and
in
establishing
software
guidelines
for
a
financial
and
practice
management
package
that
Queen
was
considering.
In
January
1984
Mills
became
an
employee
of
IRQ
and
remained
with
it
until
August
1989.
He
stated
that
one
of
the
principal
reasons
he
accepted
the
position
was
that
Queen
had
conducted
marketing
surveys
for
his
cephalometric
system
to
determine
whether
it
was
worthwhile
developing
for
sale
and
had
determined
that
it
was.
Mills’
principal
responsibility
was
the
development
of
what
he
called
“the
Set-system",
a
computer
system
for
analyzing
head
x-rays
and
doing
surgical
pre-planning
and
analysis
reports
of
those
x-rays.
While
still
a
consultant,
Mills
directed
two
IRQ
employees
in
the
preliminary
stages
of
this
project,
and
upon
accepting
employment
with
IRQ,
became
their
supervisor.
Mills
testified
that
after
he
joined
IRQ
the
activities
of
his
employer
increased
and
diversified.
He
referred
to
IRQ
some
of
his
previous
clientele
for
whom
he
performed
computer
hardware
maintenance.
Later
IRQ
began
doing
payrolls
for
certain
clients
utilizing
a
payroll
package
that
Mills
had
developed.
Ms.
Debra
Askew
is
a
chartered
accountant
practising
with
the
firm
of
Sellmer
and
Associates
in
Kamloops,
British
Columbia.
Although
neither
she
nor
her
firm
were
the
appellant's
accountants
during
the
taxation
year
in
issue
she
was
able
to
obtain
and
review
all
of
its
relevant
documents
for
the
taxation
years
1983
to
1986,
including
financial
statements
and
the
appellant's
income
tax
returns.
Working
on
the
assumption
that
the
profitability
to
the
appellant
with
respect
to
Wilcox's
revenue
input
was
substantially
greater
than
the
gross
revenue
figures
indicated,
she
analyzed
the
financial
statements
in
an
effort
to
allocate
the
operating
and
administrative
costs
between
Queen
and
Wilcox
based
on
the
number
of
chairs
used
by
each.
From
this
she
drew
certain
conclusions
as
to
the
percentage
use
of
the
appellant's
fixed
assets
and
the
contribution
of
each
doctor
to
the
appellant's
net
operating
income.
Her
analysis,
as
I
understand
it,
proceeded
as
follows.
In
fiscal
year
1984,
for
all
practical
purposes,
the
management
fees
charged
to
Queen
and
to
Wilcox
represented
the
sole
source
of
income
for
the
appellant.
In
that
taxation
year
the
management
fees
charged
by
the
appellant
to
Wilcox
were
calculated
on
50
per
cent
of
his
gross
income
while
those
charged
to
Queen
were
based
on
cost
plus
15
per
cent.
These
fees
totalled
$625,133
of
which
$381,399
(61
per
cent)
were
generated
by
Queen
and
the
balance
of
$243,734
(39
per
cent)
by
Wilcox.
Ms.
Askew
then
took
the
totality
of
expenses
disclosed
on
the
financial
statement
of
the
appellant
for
that
year
which
included
operating,
administrative
and
research
and
development
expenses.
Excluding
that
portion
of
expenses
allocated
to
research
and
development
she
allocated
the
expenses
to
each
of
Queen
and
Wilcox
based
on
the
number
of
chairs
used
by
each.
In
explaining
the
method
she
said:
Right,
and
the
breakdown
is
based
on,
for
example
the
313,000
under
the
column
Queen
is
based
on
455,000
times
5.5
divided
by
8,
which
was
his
share
of
the
operatories.
And
as
a
result
a
reasonable
allocation
of
his
share
of
the
profits
and
expenses.
She
went
on
to
explain
the
rationale
for
the
allocation
of
the
expenses
as
follows:
Exactly;
the
income
is
the
actual
income
received
from
both
of
those
different
practices
calculated
in
the
different
manners
as
you
mentioned.
The
costs,
on
the
other
hand,
we
were
trying
to
determine
the
most
reasonable
way
to
allocate
the
expenses
to
that
revenue
source
and
based
on
the
physical
space
in
the
practice
and
the
way
that
is
normally,
when
orthodontists
and
dentists
refer
to
income
the
one
thing
they
use
is
the
number
of
chairs
that
are
being
used.
In
IRQ
the
two
practices
together
had
eight
operatories
or
eight
chairs
and
of
those
operatories
Dr.
Wilcox
was
utilizing
two
and
a
half
of
them
and
Dr.
Queen
was
utilizing
five
and
a
half.
So
we
based
our
allocation
of
the
costs
on
the
actual
usage
of
space
and
resources.
The
allocations
so
determined
were
described
by
Askew
as
relative
contributions
to
net
operating
income.
They
amounted
to
$34,905
(approximately
28.5
per
cent)
by
Queen
and
$86,237
(approximately
71.5
per
cent)
by
Wilcox.
Her
calculations
for
the
taxation
year
in
issue
and
for
1983,
1985
and
1986
are
shown
in
Ex.
A-1,
tab
8,
while
two
graphs
demonstrating
each
respective
orthodontists
contribution
to
net
operating
income
are
found
in
Ex.
A-1
at
tabs
9
and
10.
In
cross-examination
Ms.
Askew
conceded
that
the
purpose
of
her
analysis
was
to
"come
up
with
some
sort
of
contribution
on
a
net
profit
basis
rather
than
a
gross
revenue
basis”
for
the
purposes
of
this
appeal
and
that
this
was
not
the
type
of
analysis
that
would
necessarily
be
done
for
the
purpose
of
preparing
the
appellants
financial
statements.
Ms.
Askew
was
also
referred
to
the
appellant's
financial
statement
for
the
taxation
year
in
issue
and
in
particular
to
item
6
of
the
notes
to
financial
statements
which
reads:
6.
Economic
Dependence
and
Related
Party
Transactions
The
Company
is
economically
dependent
upon
the
orthodontic
practice
of
Dr.
L.R.
Queen
and
as
its
principal
source
of
revenue.
During
the
year
the
company
charged
Dr.
Queen
$381,399
in
management
fees
(1983
-
$440,362).
.
.
.
When
asked
whether
that
statement
was
in
accordance
with
generally
accepted
accounting
principles
and
she
responded:
It's
not
based
on
our
firm’s
review
of
these
financial
statements,
and
also
as
far
as,
economically
as
far
as,
if
you
look
at
cash
flow,
definitely
he
(sic)
is
dependent
on
the
practice
of
Dr.
Queen
on
a
cash
flow
basis
to
support
the
other
activities
that
he
[sic]
is
involved
with.
Appellant's
Position
Counsel
for
the
appellant
submitted
that
in
determining
the
principal
purpose
of
a
business
it
is
necessary
to
look
at
a
number
of
factors
including
revenue
generated,
profit
generated,
resources
used
and
employees
used.
Counsel
distinguished
C.R
Management
Ltd.
v.
M.N.R.,
[1983]
C.T.C.
2754;
83
D.T.C.
673,
a
decision
that
specifically
dealt
with
the
provisions
of
subparagraph
125(6)(f)(iii)
of
the
Act.
In
that
case
two
lawyers
entered
into
a
partnership
and
incorporated
the
taxpayer
C.R.
Management.
It
immediately
entered
into
a
management
contract
with
the
law
firm.
When
a
new
partner
was
added
he
became
a
shareholder
in
the
management
company
and
a
party
to
the
management
contract.
Counsel
for
the
appellant
submitted
that
this
was
an
obvious
situation
where
the
provisions
of
subsection
125(6)
of
the
Act
applied
because,
as
the
Court
found,
virtually
all
of
the
activities
of
that
management
company
related
to
the
legal
practice.
That
was,
counsel
argued,
not
the
case
with
IRQ.
Counsel
urged
the
Court
to
consider
several
cases
in
which
Income
Tax
Regulation
1100(12)
of
the
Act,
which
speaks
of
“principal
business”,
was
interpreted
by
the
Courts.
These
are:
Combined
Appraisers
and
Consultants
Co.
v.
M.N.R.,
[1979]
C.T.C.
2970;
79
D.T.C.
770,
Canada
Trust
Co.
v.
M.N.R.,
[1985]
1
C.T.C.
2367;
85
D.T.C.
322,
and
Hady
Construction
(1971)
Ltd.
v.
M.N.R.,
[1980]
C.T.C.
2135;
80
D.T.C.
1101.
Counsel
also
referred
to
Interpretation
Bulletin
IT-371.
Counsel
contended
that
the
following
facts
supported
his
client's
position:
(a)
although
Queen
contributed
the
most
revenue
in
terms
of
management
fees
to
the
appellant
in
1984,
that
fact
is
not
as
critical
as
the
fact
that,
as
demonstrated
by
the
analysis
performed
by
Ms.
Askew,
Wilcox
produced
the
greatest
net
operating
income.
Counsel
argued
that
operating
income
should
be
roughly
equated
with
either
accounting
profit
or
gross
revenues;
(b)
of
the
14
employees
only
five
were
used
in
Queen's
practice;
three
others
may
have
been
shared
by
Queen
in
the
reception
area.
Counsel's
calculation
was
based
on
the
operatory
chair
allocation
formula
utilized
by
Ms.
Askew;
(c)
although
Queen
was,
in
1984,
the
greater
user
of
the
physical
assets
this
use
was
diminishing.
(Askew
analysis
Ex.
A-1,
tab
8.)
Counsel
also
submitted
that
I
was
entitled
to
take
into
account
both
the
activities
of
the
appellant
in
taxation
year
1984
as
they
related
to
the
diversification
of
its
business
and
the
results
of
this
diversification
in
subsequent
years.
He
argued
that
in
1984
the
principal
purpose
of
the
appellant
was
not
the
narrow
servicing
of
Queen's
professional
practice
as
it
had
been
in
previous
years
but
that
it
had
begun
to
move
away
to
include
management
services
for
Wilcox
and
other
functions
as
well.
These
encompassed
not
only
the
addition
of
Wilcox
as
a
client
but
also
the
development
of
third
party
accounting
services;
the
development
of
building
management
services
in
subsequent
years
and
its
ongoing
involvement
in
the
development
of
the
cephalometric
diagnostic
programme
which
led
to
the
marketing
of
the
programme
in
1986
and
subsequent
years.
Counsel
submitted
that
it
was
not
appropriate
to
look
at
a
particular
year
in
isolation
and
argued
that
it
was
appropriate
to
consider
the
direction
or
trend
of
the
corporation.
Based
on
the
foregoing
counsel
submitted
that
the
principal
purpose
of
IRQ
was
not
to
supply
those
services
set
out
in
subparagraph
125(6)(f)(iii)
as
assumed
by
the
respondent.
Respondent's
Position
The
respondent's
position
is
that
the
evidence
adduced
fails
to
establish
on
a
balance
of
probabilities
that
the
principal
purpose
of
the
appellant's
business
was
not
to
provide
managerial,
administrative,
financial
and
maintenance
services
to
the
practice
of
orthodontics
of
Queen.
Conclusions
I
am
satisfied
that
the
Minister's
position
is
correct.
It
is
fair
to
say
that
paragraph
7
of
IT-371
accurately
reflects
the
criteria
relied
on
by
the
Courts
in
the
decisions
cited
by
counsel
in
determining
whether
or
not
a
business
is
the
taxpayer's
principal
business
as
that
term
is
used
in
Income
Tax
Regulation
1100(12).
It
reads:
7.
There
is
no
standard
set
of
criteria
that
may
be
looked
to
where
the
nature
of
each
of
a
taxpayer's
businesses
is
known
but
it
must
be
determined
which
of
them
is
his
principal
business;
the
significant
factors
of
each
case
must
be
searched
out
and
evaluated.
In
the
Department's
view
the
following
are
among
the
factors
which
may
be
relevant:
(a)
the
profits
realized
by
each
of
the
businesses;
(b)
the
volume
and
the
value
of
the
gross
sales
or
transactions
of
each
busi-
ness;
(c)
the
value
of
the
assets
of
each
business;
(d)
the
capital
employed
in
each
business;
and
(e)
the
time,
attention
and
effort
expended
by
the
employees,
agents,
or
officers
in
each
business.
I
agree
the
criteria
expressed
in
IT-371
are,
as
counsel
argued,
reasonably
applicable
in
the
interpretation
of
the
meaning
of
the
phrase
"principal
pur-
Ç
pose"
found
in
paragraph
125(6)(f)
of
the
Act,
and
I
proceed
with
those
guidelines
in
mind.
It
was
for
all
practical
purposes
conceded
that
in
the
taxation
years
prior
to
1984
the
appellant's
principal
purpose
was
to
provide
the
services
enumerated
in
subparagraph
125(6)(f)(iii)
to
Queen's
dental
practice.
The
evidence
does
not
satisfy
me
that
in
the
taxation
year
in
issue
there
had
been
any
substantial
degree
of
change
in
the
principal
purpose
of
the
appellant's
business.
It
is
not
disputed,
and
indeed
it
was
so
pleaded
in
the
appellant's
notice
of
appeal,
that
IRQ
derived
61
per
cent
of
its
revenue
from
the
practice
of
Queen.
I
am
not
convinced
that
the
"contribution
to
operating
income”
analysis
performed
by
Ms.
Askew
warrants
the
weight
attached
to
it
by
counsel
for
the
appellant.
I
am
also
not
prepared
to
completely
disregard
the
accountant's
notes
to
the
financial
statements
for
the
taxation
year
in
issue.
These
statements
were
prepared
by
Dunwoody
and
Company,
a
well-known
and
reputable
firm
of
chartered
accountants.
They
clearly
indicate
that
the
appellant
was
economically
dependent
on
Queen
as
its
principal
source
of
revenue
in
the
taxation
year
in
issue.
As
the
accountants
for
the
appellant
for
a
number
of
years,
both
prior
to
and
after
the
taxation
year
in
issue,
it
is
not
an
improper
inference
to
draw
that
they
were
quite
familiar
with
the
appellant's
business
and
financial
status
and
that
their
notes
to
the
financial
statements
accurately
reflect
their
perception
of
the
appellant's
financial
position.
With
respect
to
counsel's
submission
that
the
allocation
of
employees
demonstrated
Queen's
diminishing
importance
in
the
scheme
of
things
I
comment
only
that
the
number
of
employees
utilized
does
not
necessarily
reflect
the
earning
capacity
of
the
individual
for
whom
they
work.
One
further
comment
is
warranted
that
is
in
relation
to
counsel's
argument
regarding
the
appellant's
plans
in
1984
and
the
results
demonstrated
in
subsequent
years.
While
it
is
true
that
research
and
development
took
place
in
1984
and
1985
and
that
deductions
were
permitted
to
the
appellant
in
respect
of
expenses
incurred
in
that
regard,
it
is
also
noteworthy
that
these
activities
produced
no
income
whatsoever
until
at
least
1986.
While
I
agree
that
it
may
not
be
wise
to
look
at
a
particular
taxation
year
in
isolation,
it
seems
to
me
that
attributing
the
evidentiary
weight
to
those
activities
suggested
by
counsel,
is
to
take
a
speculative
rather
than
an
objective
view
of
the
evidence.
This
I
am
not
prepared
to
do.
The
evidence
adduced
fails
to
satisfy
me
that
the
respondent
erred
in
assessing
IRQ
on
the
basis
that
it
was
carrying
on
a
non-qualifying
business
within
the
meaning
of
paragraph
125(6)(f)
of
the
Act.
The
appeal
is
dismissed.
Appeal
dismissed.
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