Cline Associates London Limited v. Minister of National Revenue, [1992] 2 CTC 2581, 92 DTC 2209

Taylor, T.C.C.J.:—In this matter, appeals were filed originally for the taxation years 1984, 1985 and 1986 covering a variety of items disallowed, all of which were withdrawn by the appellant except for one amount.

This was heard in London, Ontario, on May 13, 1992, against the income tax assessment for the year 1984 in which the Minister of National Revenue disallowed a deduction of $51,515 claimed as a “bad debt expense". At the commencement of the trial, counsel for the appellant changed the basis of this claim from "bad debt expense” to an amount deductible under paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), simply as a “business expense”. The parties filed the following agreed statement of facts:

1. The appellant, Cline Associates London Ltd. is now known as U.E. Stamping Ltd. by virtue of Articles of Amalgamation issued January 6, 1992, a copy of which is attached as Schedule "A".

2. During the taxation years under appeal a majority of the issued and outstanding shares of the appellant were owned by Richard D. Cline ("Mr. Cline") and he was its sole director.

^Judge's Note—Schedules A, B and C not reproduced.

3. At all material times the appellant operated a tool and die shop and a stamping business, catering substantially to the automotive industry.

4. As part of its business, the appellant would manufacture a die and then stamp parts using this die.

5. In the early part of 1982, specifically on February 18, 1982, 499732 Ontario Ltd. was incorporated by Mr. Cline and three others, namely John Haig Haigh Mahon, Vicars Edward Hodge and Martin Jacob Van Ryswick. Each were issued one (1) common share at the time of incorporation. This company was incorporated to produce a sponge mop.

6. Later in 1982, on May 4, 1982 the corporate name of 499732 Ontario Ltd. was changed to Val-U-Manufacturing Ltd. ("Val-U")

7. When Val-U was established, the appellant produced the dies to stamp the sponge mop product at a cost of some $25,000. The appellant also agreed to stamp the major component parts for the sponge mop.

8. It was agreed between the appellant and Val-U that the appellant would be paid a percentage of the gross sales of the sponge mop in order to retire the cost of the dies. In addition, the appellant was to be paid an additional percentage of the sale price to compensate it for the stamping process.

9. Sales levels were good in 1983 and Val-U was able to meet its obligations.

10. In 1983 Val-U also acquired the rights to manufacture a new product called a "Super-Dryer". The dies were acquired from the Federal Business Development Bank acting as a secured creditor of a defunct business.

11. The appellant also agreed to perform the stamping operations to create the Super-Dryer for Val-U.

12. On July 17, 1983, Mr. Cline acquired additional shares of Val-U with the result that he held 404 Common Shares out of a total of 804 Common Shares. Attached as Schedule B" is a share sketch showing share transfers for Val-U.

13. In 1984, sales levels for Val-U declined with the result that it was unable to meet its obligations as they fell due.

14. During the course of the 1984 calendar year the appellant made a number of payments to creditors of Val-U including payments to Royal Bank of Canada and Federal Business Development Bank totalling $51,415.26. Attached as Schedule"C" is a list of the payments made with supporting vouchers.

15. The appellant sought to deduct the aforesaid payments for its 1984 taxation year ending December 31, 1984.

16. On May 6, 1985 the appellant acquired the shares of C.N.M. Turcotte who held 400 common shares of Val-U and the appellant also acquired the common shares of Mr. Cline with the result that Val-U became a wholly-owned subsidiary of the appellant.

17. On the same day, May 6, 1985, Val-U was wound up into its parent, the appellant.

18. By notice of reassessment dated June 12, 1989 respecting the appellants 1984 taxation year, the Minister denied the deduction made for the aforesaid payments and added the said amount of $51,515 back into income.

19. By notice of objection the appellant objected to the inclusion of the said amount in its income.

20. By notice of confirmation dated October 17, 1990 the Minister confirmed the earlier assessment.

21. The appellant has appealed to this Court by notice of appeal dated November 19, 1990.

22. The Minister replied to the notice of appeal by reply to notice of appeal dated October 11, 1991.

It was indicated to the Court that the amount of $51,515 consisted of cash advances and bank loan payments as well as material, labour costs and occupancy charges, on behalf of Val-U-Manufacturing Ltd.

The trial was primarily some testimony and documentation, but largely argument, and was summarized by counsel for the appellant in argument as follows:

. . .at the time the expenses were made, or payments were made by Cline Associates on behalf of Val-U-Manufacturing that Val-U was not a subsidiary of Cline Associates at that time.

It was creating component parts for the product that Val-U was manufacturing and selling. It was charging Val-U for making those component parts. So that was the strongest relationship between the two companies, a supplier and manufacturer.

Mr. Cline. . .made a business decision, he said I made the call, I made a business decision to make those payments on behalf of Val-U-Manufacturing to keep it alive, to preserve that customer. He felt that if the products were successful there would be a distinct advantage to Cline Associates, because if the products were successful then it would result in considerable income for Cline Associates in producing the component parts for those products. It is our submission that making those payments, and the decision to make those payments, clearly falls within paragraph 18(1)(a). . .

In support of that proposition counsel referred the Court to:

— D.J. MacDonald Sales Ltd. v. M.N.R. (1956), 29 Tax A.B.C. 94, 56 D.T.C. 481;

— The Queen v. F.H. Jones Tobacco Sales Co., [1973] C.T.C.784, 73 D.T.C.

5577;

— L. Berman & Co. v. M.N.R., [1961] C.T.C. 237, 61 D.T.C. 1150;

— Heap & Partners (Nfld.) Ltd. v. M.N.R. (1966), 42 Tax A.B.C. 278, 66 D.T.C. 772;

— Canadian Glassine Co. v. M.N.R., [1974] C.T.C. 63, 74 D.T.C. 6089;

— Panda Realty Ltd. v. M.N.R., [1986] 1 C.T.C. 2417, 86 D.T.C. 1266.

In contrast, counsel for the respondent noted:

. . .what we heard today presents a picture of Val-U and Cline being two separate legal entities, two separate companies. We heard Mr. Marcus' evidence that in fact Val-U was a Client of Cline, but not a major client, a potentially good client. That at the time in question Val-U was not really a big client of Cline. Also we heard that otherwise Cline had a very good client base aside from Val-U, that it did not rely on Val-U for its survival. Should Val-U go down Cline would be fine financially, it didn't need Val-U to survive. We also heard Mr. Marcus' and Mr. Cline's evidence that Cline in making those payments was really trying to keep Val-U alive. It was a decision on Cline’s behalf but there was no obligation to pay whatsoever, no guarantees, no guaranteeing of debts, nothing, it was purely a decision on behalf of Cline. Cline was basically trying to save one of its many clients from bankruptcy.

My submission is that it would be too wide an interpretation of section 18 to allow such deductions for such expenses claimed.

For jurisprudence counsel referenced:

— Panelling Unlimited of London Inc. v. M.N.R., [1982] C.T.C. 2178, 82 D.T.C. 1178;

— Archer Truck Services v. M.N.R. (1970), Tax A.B.C. 545, 70 D.T.C. 1356;

— Weed-Master (Western) Ltd. v. M.N.R., [1972] C.T.C. 2364, 72 D.T.C. 1296;

— Walker and Hall Ltd. v. M.N.R. (1963), 34 Tax A.B.C. 133, 63 D.T.C. 997.

Counsel for the appellant relied generally on the fact that the major shareholder of the corporation Mr. Cline had made a business decision, and that such a decision should be considered as falling within the parameters of the relevant jurisprudence.

Counsel for the respondent disposed of the case law presented by the appellant, supra, as follows:

I would like to distinguish all these cases on this fact that there is always a guarantee involved in every situation.

Counsel for the respondent apparently did not notice the critical comments of the learned Justice in Berman, supra, on page 247 (D.T.C. 1156) thereof:

Even if the appellant had not been legally bound to make the payments that did not prevent them from having been made in accordance with the ordinary principles of commercial trading.

and

. . .the appellant made the payments in question as a business person intending to continue in business would reasonably do and that, consequently, they were made in accordance with the ordinary principles of commercial trading or well accepted principles of business practice

and

. . the appellant made the payments in question as a business person intending to continue in business would reasonably do

[Emphasis added.]

As I see it, a businessman making good on an amount for which he was guarantor, even when recognizing that it would be in his best interests to do so, would have little decision to make, certainly the payment would not be entirely "voluntary". On the other hand, a businessperson paying an amount without a legal responsibility to do so might well be doing so directly “in accordance with the ordinary principles of commercial trading".

I am not persuaded that the absence of a "guarantee" dooms this appeal to failure.

Although not dealt with in detail in the body of the argument, in my view, one point upon which counsel for the respondent appeared to stand in support of the assessment was contained in her closing remarks:

I refer to. . .Weed-Master (Western) Ltd. v. M.N.R., [1972] C.T.C. 2364, 72 D.T.C. 1297. In that case the appellant company paid suppliers on behalf of its subsidiary. The Board decision in that case was that the outlays that the appellant made to put the subs back on their feet was of a capital nature.

[Emphasis added.]

While some comments made in Weed-Master, supra, might lead counsel to the “capital” conclusion regarding a“ subsidiary”, the task of overcoming the determination on a similar point made by the Supreme Court of Canada in Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294, 84 D.T.C. 6305 would face counsel. Also in High field Corporation Ltd. v. M.N.R., [1982] C.T.C. 2812, 82 D.T.C. 1835, on page 2826 (D.T.C. 1845), it was noted:

. . .at this point I am not persuaded by the proposition that loans from a parent to a subsidiary cannot constitute a business or a part of a business, for inclusion as a deduction under paragraph 18(1)(a)

In addition, the fact that the remarks seemed to be put by in counsel as a general observation rather than a specific argument, based on evidence, leaves the Court unimpressed. In this matter there was not a "subsidiary" relationship during the time relevant, and therefore the particular reference from Weed-Master, supra, might not be helpful at all.

On this subject of the financial relationship between Cline, supra, and Val-U, supra, however, the majority shareholder in each case was the same individual, Mr. Cline. Counsel for the respondent did not take the position that this factor created any impediment and I am accordingly not required to deal with that possibility. Neither the notice of confirmation of the assessment by the respondent, nor the reply to notice of appeal took the position that the item was disallowed because it was on account of capital, and counsel for the respondent did not seem to deal with this aspect during examination or cross- examination. Nevertheless, counsel for the respondent did emphasize that “capital” point, without support, in her closing remarks as follows:

The Minister’s position is that basically Cline was trying to help one of its clients and that the cash advances and all the payments made were in fact capital advances and could not be deductible as business expenses.

As I see it, the relationship between paragraphs 18(1)(a) and (b) of the Act (formerly paragraphs 12(1)(a) and (b) were stated quite specifically by the Supreme Court of Canada in Bannerman v. M.N.R., [1959] C.T.C. 214, 59 D.T.C. 1126 at 217 (D.T.C. 1127):

Under paragraph 12(1 )(a) of the present Act it is sufficient that an outlay be made or expense incurred with the object or intention that it should earn income, but since in one sense it might be said that almost every outlay or expense was made or incurred for that purpose, a line must be drawn in the individual case depending upon the circumstances and bearing in mind the provisions of paragraph 12(1)(b).

As far as I am aware that prescription still obtains—that" almost every outlay or expense was made or incurred for that purpose"—(to earn income).

I would add the comment on page 125 (D.T.C. 5074) from Johnston Testers Ltd. v. M.N.R., [1965] C.T.C. 116, 65 D.T.C. 5069:

In this case it is clear beyond all doubt that the expenditure was made “for the purpose of gaining or producing income” within the meaning of paragraph 12(1)(a) of the Income Tax Act, using as a criterion for such conclusion that it was made based on good commercial practice, and bearing in mind that it did not have to be incurred in gaining or producing the income of the particular period in which it was expended and that no causal connection had to be established between any particular receipt of income and this expenditure, and that it was an extraneous and non-recurring item of expenditure. And it should be noted that all this is true whether this expenditure be classified as an income expense or disbursement, or as a capital outlay or disbursement.

[Emphasis added.]

It was adequate and fulfilling for counsel for the appellant to establish the nature of the amounts involved, and their legitimate relationship to the profit making structure of Cline, supra,—and this he did. On the basis of the information provided at the trial, the amount at issue qualifies for the deduction sought under paragraph 18(1)(a) of the Act, and it is not denied by virtue of the exclusion contained in paragraph 18(1)(b) of the Act.

Before finalizing these comments, I should like to note that the issue of the expenditure in question having been made by Cline, supra, on behalf of Val-U, supra—a customer of Cline, supra, seemed to be a constantly disturbing feature to the respondent—although not adequately argued, only tangentially referenced.

Counsel for the respondent:

The question I have today is what if Cline decided to bail out all of its clients, would it be able to claim all of these payments, or these cash advances as business expenses. That is what opening up section 18 might entail. If all businesses who decide that they have a potentially good client who is in jeopardy, decide to help them out and bail them out, decides to claim these expenses as current business expenses what is going to happen with section 18.

[Emphasis added.]

In fact bailing out Val-U was not the business of Cline.

Neither party provided the Court with a reasonable argument which dealt directly with the view the Court should take of advancing funds to a customer rather than a supplier, and all the relevant cases submitted seemed to deal with suppliers. The simple argument for "supplier" obviously is that in advancing funds to a supplier in time of financial stress, a businessman is maintaining that "source of supply"—a vital part of remaining in business, allegedly. I see no reason that the same logic should not be applicable to provide working funds or advances to a customer, presumably a valued customer, for the purpose of keeping that customer in business. If there is a critical difference— for purposes of the application of paragraph 18(1)(a)—between those two, a supplier and a customer, it has not been brought forward for me to consider in this appeal.

Summary

In the end analysis, I conclude that in making the payments at issue Cline, supra, Was not acting in an unreasonable or irrational way, lacking adequate consideration for its own commercial interest. The payments come under the provision of paragraph 18(1)(a) of the Act and are not excluded on the basis of any evidence provided to the Court. And further, the fact that Va/-U, supra, was a customer not a supplier has not been shown to be a deterrent to claiming the deduction.

The appeal for $51,515 in 1984 is allowed, with costs. The appeals against all other amounts for the years 1984, 1985 and 1986 are dismissed. The entire matter is referred back to the Minister of National Revenue for re-examination and reassessment according to these reasons for judgment.

Appeal allowed.