Agricultural and Industrial Corporation and Brimstone Export Limited v. Minister of National Revenue, [1991] 2 CTC 2721

Beaubier, T.C.J.:—These matters were heard on common evidence at the City of Calgary, Alberta, on July 11, 1991.

The only witness was Raymond Learsy, the president of Agricultural and Industrial Corporation. He and trusts of his family are the sole owners of that corporation.

Agricultural and Industrial Corporation (hereinafter called A&l) is incorporated in the State of New York, U.S. During its 1984 and 1985 taxation years it was not a resident of Canada. At all material times it owned all of the issued shares of Brimstone Export Ltd. (hereinafter called Brimstone).

Brimstone was incorporated in Alberta, Canada, on August 16, 1965. It was mainly in the business of buying raw sulphur and selling it in large volumes. Brimstone had a small office in Calgary which was operated by a secretary during its fiscal year ending January 31, 1984. In its fiscal year ending January 31, 1985, it paid no salaries, but it did pay rent of $818. Brimstone's gross revenue in fiscal 1984 was $4,527,441; in 1985 it was $250,239.

During the years 1984 and 1985 Brimstone was heavily involved in litigious disputes. There were two actions, each of which was vital to its operations.

The first was an anti-dumping action concerning Brimstone in the U.S. This arose out of a notice of “Preliminary Results of Administrative Review of Antidumping Finding and Tentative Determination to Resolve in Part” issued December 27, 1982, by the International Trade Administration of the U.S. Department of Commerce respecting Brimstone's sulphur sales in the U.S. A hearing followed on January 27, 1983, followed by a “Final Result of Administrative Review of Antidumping Finding" on November 28, 1983, which provided for ". . . the assessment of antidumping duties on elemental sulphur imports from Canada . . ."(Exhibit A-3, Tab 10). Mr. Learsy testified that at the time Brimstone was earning about 50 cents per ton sold. The dumping duty penalty would have been about $18 U.S. per ton. Therefore Brimstone commenced action, Court No. 83-12-01817, in the U.S. Court of International Trade challenging the International Trade Administration's finding (Exhibit A-3, Tab 10, Motion dated November 25, 1987, by Beker Industries Corp.). This dispute was finally settled on March 2, 1988.

The second was an action with Burza Resources Ltd. (hereinafter called Burza) respecting a contract in which Burza and Brimstone appointed each other, respectively, as exclusive agents for "sourcing" Alberta sulphur and for the sale of Alberta sulphur. Burza tried to take over Brimstone's customers and sell directly to those customers, thus eliminating Brimstone as a middleman. For this purpose Brimstone's Calgary solicitors requested all Burza documentation by letter to A&l dated September 11, 1984 (Exhibit A-3, Tab 9), which asked for ”. . . all invoices, correspondence between the parties, telephone memorandums, or any other notes or records ... ". Mr. Learsy had dealt almost exclusively with Burza on behalf of Brimstone and as a result he was personally involved in all of the Burza litigation, including the examinations for discovery.

Because Burza was Brimstone's sole supplier of Alberta sulphur it also created a problem of reliable supply and timely delivery of sulphur. Sulphur is a major ingredient of sulphuric acid which in turn is a major chemical in the U.S. chemical industry. Thus, a failure in timely delivery of railroad car loads of sulphur could shut down the plant of a chemical industry purchaser. Even the possibility of unreliable delivery could destroy sales or sales negotiations.

During 1984 and 1985 Brimstone paid A&l the following amounts:

The appellants alleged that these amounts were paid to reimburse A&l for expenses incurred by A&l on behalf of Brimstone respecting the two actions and, in addition, for A&l's services for accounting, administration and sales services for Brimstone and for office space and other overhead expenses necessary for the foregoing services.

In his amended replies to the Brimstone appeals, the Minister made, among others, the following assumptions for each of 1984 and 1985:

(c) $100,000 of the said amount constitutes a reasonable expense recovery for the performance of a service by Agricultural and Industrial Corporation.

(d) The remaining amount paid to Agricultural and Industrial Corporation was not shown to have been in respect of outlays or expenses made or incurred by the said corporation on behalf of the appellant for the purpose of gaining or producing income from the appellant's business.

The following assessments by the Minister of National Revenue arose out of these payments:

1. (File number 89-2779(IT))

A&l was reassessed for a non-resident tax on the basis that Brimstone failed to deduct or remit tax. Revenue Canada allowed $100,000 in each of 1984 and 1985 as “amount of management fees allowed as expense recovery” with the result that the amounts subject to tax were $100,000 and $368,456 respectively. The tax was assessed on the basis that the amounts taxed were "management fees”, and that A&l should pay non-resident tax pursuant to paragraph 212(1)(a) and subsection 212(4) and section 215 of "the Income Tax Act on the sums of $100,000 in 1984 and $368,456 in 1985.

2. (File number 89-2780(IT))

Brimstone was reassessed by the Minister of National Revenue respecting $100,000 paid to A&l in 1984 and $368,456 paid to A&l in 1985 on the basis that:

(a) Brimstone should pay non-resident tax on the sums of $100,000 in 1984 and $368,465 in 1985 which were paid to A&l and upon which withholding and remission were required pursuant to section 215 and that these sums were management or administration fees in accordance with paragraph 212(1)(a) and subsection 212(4) of the Income Tax Act.

(b) The pleadings of the Minister also state that Brimstone will not be allowed to deduct the amounts of $100,000 for 1984 and $368,456 for 1985 paid to A&l as outlays or expenses made or incurred for the purpose of gaining or producing income from Brimstone's business, and the Minister relies on paragraph 18(1)(a) and section 67 of the Income Tax Act. There is a further plea that in any event, the amounts so paid were not reasonable in the circumstances.

Mr. Learsy testified that A&l did all of the marketing, custom clearances, bonding, shipping, routing of the special cars carrying liquid sulphur, and acted to prevent demurrage charges on rail cars on behalf or Brimstone.

Brimstone originally entered into U.S. sulphur sales of Alberta sulphur in the late 19605. This business had been allowed to lapse when A&l found other business associated with phosphoric acid sales related to the fertilizer market. The fertilizer market in the U.S. became highly competitive after the president of the U.S. embargoed the export of phosphoric acid to the U.S.S.R.

The result was an effort by Brimstone to return to the sulphur business. A&l's consolidated statement (including Brimstone's figures) shows sales of U.S. “$35,729,180 in 1983 and U.S. $13,657,997 in 1984 (A-3, Tab 12). Brimstone's sales of sulphur in 1984 were Cdn $4,197,367. In fiscal 1985 Brimstone had no sulphur sales.

For the period in dispute respecting the dumping charges (January 1,1973 through May 1, 1979 and December 1, 1980 through November 1, 1981), A&I had to recover the files for each shipment, including the documents relating to the purchase, sale, shipping, customs and other matters of the lawyers and had to assemble these documents into individual files for each shipment.

Exhibit A-3 was filed which contains descriptions of certain disbursements that A&l recalculates were incurred on behalf of Brimstone in respect to the deductions claimed for 1984 and 1985. In fiscal 1984 A&l recalculates it incurred expenses of $445,883.92 and billed Brimstone $200,000. In 1985 A&l recalculates it incurred expenses of $243,697.72 and billed Brimstone $468,456.

When A&l first attempted to quantify the actual expenses it incurred for Brimstone the calculations were prepared by William Seizer who determined them to be $200,000 for 1984. This sum was described as a "management fee" in the January 31, 1984 financial statement (Exhibit A-3, Tab 1) which showed a comparable “management fee" of $100,000 for fiscal 1983. There was no evidence respecting the 1983 claim of $100,000. Mr. Seizer was then vice-president of A&l and he was in charge of matters such as this for A&l.

Mr. Learsy testified that the $200,000 was a "nominal charge" and A&l later realized that it did not reflect the real cost.

At about this time Mr. Seizer ceased to be an employee of A&l and the task of recalculating Brimstone's expenses and of amending the statements was turned over to Mrs. Jeannie Papp, who has since died. In the case of the 1984 salaries claimed, the recalculations were supported by photocopies of the U.S. equivalent of T-4 slips for the annual wages of the persons in respect of whom claims were made. In other cases some photocopies of the supporting documents were supplied.

The amended fiscal year statement of Brimstone uses the December 31 salaries as the basis of determining time spent in each of fiscal years 1984 and 1985. In 1984, Mrs. Papp calculated that more than 50 per cent of A&l's total staff time of 17 people was spent on Brimstone. Only two people spent as little as 35 per cent of their time on Brimstone. One was a bookkeeper and the other was a salesman. Everyone else, including the executives, allegedly spent a great proportion of their time on Brimstone's sales and on what was essentially the clerical function of assembling documents for the Brimstone disputes. It is to be noted that in 1984, Brimstone's sales constituted approximately one third of the total of A&l's sales.

Cross-examination elicited the fact that A&l had substantially fewer employees in fiscal 1985 than it did in fiscal 1984. (See Exhibit A-3, Tabs 2 and 6.) Once again, in 1985 Mrs. Papp charged more than 50 per cent of A&l's salaries as shown in her schedule (Exhibit A-3, Tab 6) to Brimstone's disputes and sales. She broke the footage of rental space down by the employee percentages to apportion the rent according to office space, out of the total, used by those employees "working all or part of their day for Brimstone.” There is no evidence of A&l's total sales for 1985.

In cross-examination respecting Brimstone's 1984 financial statements (Exhibit A-3, Tab 1), Mr. Learsy was asked why Mr. Seizer had entered $200,000 as a management fee and then a further $72,669 as salaries. Mr. Learsy was unable to explain the salary figure. The evidence is that there are no working papers available to explain how either Mrs. Papp or Mr. Seizer arrived at their figures. Time was not logged by personnel, nor is there a record of day-to-day or other current record keeping of the utilization of A&l's personnel, office space, or other assets, for Brimstone's business.

During his examination-in-chief, Mr. Learsy volunteered to his counsel the information that his counsel would have charged $500,000 to do the documentary work respecting the disputes that was done by A&l for Brimstone and implied that such a fee would have been unacceptable to Brimstone.

With respect to the assessments pursuant to section 212, counsel for the Minister stated in argument that the assessment of Brimstone is the primary assessment for withholding, but that A&l was assessed pursuant to subsection 227(8.3) on account of its joint and several liability for Brimstone's failure to withhold.

The pertinent portions of section 212 respecting this assessment read as follows:

212. (1) Every non-resident person shall pay an income tax ... on every amount that a person resident in Canada pays . . . to him . . . on account... of

(a) ... .a management or administration fee or charge;

212. (4) "management or administration fee or charge" does not include any amount paid ... in satisfaction of,

(b) a specific expense incurred by the non-resident person for the performance of a service that was for the benefit of the payer,

to the extent that the amount so paid or credited was reasonable in the circumstances.

Thus, in the instance before the Court, it must be determined if the expense was a specific expense incurred by A&l that was for the performance of a service that was for the benefit of Brimstone. If so, each expense will be deductible to the extent that the amount paid or credited was reasonable in the circumstances.

The first question then is what is a "specific expense"?

In Canadian Bank of Commerce v. A.-G. Canada, [1962] S.C.R. 729; [1962] C.T.C. 35, 39; 62 D.T.C. 1236 at 1241 (S.C.R. 738), Mr. Justice Cartwright, speaking for a majority of the Court stated as follows:

Inferences (b) and (c) which counsel agreed should be drawn are as follows:

(b) The said requirement relates to a genuine and serious inquiry into the tax liability of some specific person or persons.

(c) The Minister has reason to believe that such person or persons under investigation are among those referred to in the Special Case.

The purpose of the requirement, then, is to obtain information relevant to the tax liability of some specific person or persons whose liability to tax is under investigation; this is a purpose related to the administration or enforcement of the Act. As I have reached the conclusion that the existence of this purpose is established by the material in the record, I do not find it necessary to examine the arguments addressed to us on the question of the incidence of the burden of proof.

[Emphasis added.]

This case was the subject of review by the Supreme Court of Canada in James Richardson & Sons, Ltd. v. M.N.R., [1984] C.T.C. 345; 84 D.T.C. 6325. At pages 350-51 (D.T.C. 6239-30), Madam Justice Bertha Wilson, speaking for the Court, stated as follows:

The Canadian Bank of Commerce case, however, makes it clear that the subsection is not to be construed that broadly. It establishes through the majority judgment written by Mr. Justice Cartwright as:

(a) the test of whether the Minister is acting for a purpose specified in the Act is an objective one and has to be decided on the proper interpretation of the subsection and its application to the circumstances disclosed;

(b) the obtaining of information relevant to the tax liability of some specific person or persons whose liability to tax is under investigation is a purpose related to the administration or enforcement of the Act;

Accordingly, while I agree with Le Dain, J. that the court in the Canadian Bank of Commerce case did not say that the purpose in that case, namely the obtaining of information relevant to someone's tax liability, was the only purpose for which a requirement could validly be made under subsection 231(3), it did nevertheless insist on a prerequisite to that particular purpose, namely that the someone's tax liability be the subject of investigation, and it is that prerequisite which the appellant submits is missing in this case.

. . . If the tax liability of its customers or one or more of them were the subject of a genuine inquiry, then the Minister would clearly be entitled under subsection 231(3) to single out the appellant even although innocent taxpayers' trading activities were disclosed in the process. But it cannot, in my opinion, be singled out otherwise. It cannot be compelled under subsection 231(3) to provide the random sample for a check on general compliance by the entire class. This is the purpose of sections 221(1)(d) and 233.

[Emphasis added.]

Jowitt's Dictionary of English Law, 2nd ed., describes “specific goods" as: "goods identified and agreed upon at the time a contract of sale is made . . .”. In Re Net Book Agreement (1957), [1962] 3 All E.R. 751 at 774, Buckley, J. stated:

To satisfy the requirements of the subsection the alleged benefit must be “specific”. We are content to adopt one of the interpretations of this word suggested by counsel for the registrar, and accepted by counsel for the respondents, that is to say that it means explicit and definable.

A discussion relating to the meaning of the word "incurred" was undertaken by Thorson, P. in Thomas D. Trapp v. M.N.R., [1946] C.T.C. 30; 2 D.T.C. 784 at 38 (D.T.C. 787),.when he discussed the meaning of "disbursement or expenses". He stated :

The term “incurred” is frequently used with regard to expenses and, in ordinary use, is sometimes equivocal in meaning; it may mean either that the expenses have been paid or that an obligation to pay them has been assumed.

Therefore, to be a "specific expense incurred", it must be an explicit and identifiable expense that has been paid, or in respect to which an obligation to pay has been assumed by A&l.

The services performed by A& I were for the benefit of Brimstone. But was the amount paid or credited by Brimstone "reasonable in the circumstances"? A similar question, relating particularly to the word "reasonable" was dealt with by Cattanach, J. in Canadian Propane Gas & Oil Ltd. v. M.N.R., [1972] C.T.C. 566; 73 D.T.C. 5019. The question related to whether:

. . . an amount can reasonably be regarded as being in part the consideration for disposition of depreciable property of a taxpayer of a prescribed class and as being in part consideration for something else, . . .

within paragraph 20(6)(g). In respect to this Cattanach, J. stated at pages 577-80 (D.T.C. 5028-29):

I should think that "reasonable" as used in the context of section 20(6)(g) does not mean from the subjective point of view of the Minister alone or the appellant alone, but rather from the point of view of an objective observer with a knowledge of all the pertinent facts.

Normally to an informed vendor and purchaser of a business there is a conflict of interest between them. It is to the purchaser's advantage to have a high price allocated to depreciable property in order to claim a high capital cost allowance. It is to the advantage of the vendor to have the price of depreciable property as low as possible to avoid recapture of capital cost allowance.

In my view there was no hard bargaining between the vendors and the appellant in the transactions as to the allocation of amounts to depreciable property.

For the foregoing reasons I have concluded that the apportionment between depreciable property and something else was in effect unilaterally done by the appellant and that there was in reality no genuine negotiated apportionment as a result of bargaining between the parties to the agreement from which it follows that the allocations in the agreements are not decisive of what is reasonable.

The onus of demolishing the Minister's assumptions falls on the appellant and, in my view, for the reasons expressed, the appellant has failed to discharge that onus. Accordingly it cannot be said that the assumptions of the Minister in assessing the appellant as he did were not warranted. The appeals are, therefore, dismissed with costs.

[Emphasis added.]

The decision of Mr. Justice Cattanach was not appealed.

In the circumstances of the instant case Brimstone was wholly owned by A&l. There is no evidence of any bargaining whatsoever between the parties respecting the amount. The evidence is that Brimstone “passively acquiesced thereto" to adopt words used by Cattanach, J. Moreover, the evidence is that it did so retroactively, so far as the work done respecting the 1984 taxation year is concerned.

No working papers respecting the expenses were submitted and there was no first-hand evidence from either person who prepared the calculation of expenses. Mr. Learsy offered evidence of his own activities and of those of one other employee, Mr. Richards, on behalf of Brimstone. There is no evidence as to how the Proportion of work performed by the various employees was arrived at and the evidence as to the apportionment of rental expenses is such that they cannot be accepted as submitted. Except in the cases of Mr. Learsy and Mr. Richards, what hours were allegedly devoted to Brimstone's activities, and the relative importance of the work done are not in evidence.

There is no written agreement in evidence between Brimstone and A&l concerning the payment of expenses.

Mr. Learsy was the man in charge of both A&l and Brimstone. The records in evidence respecting these corporations is that he is an astute and successful businessman. The corporation moved to other goods when the market changed. Staff was reduced substantially from one year to the next. Accountants were changed, both on staff and retained, during the immediate period following the years in question in this case.

No businessman such as this and no reasonable person would accept fees levied for employees' services based on a time period different from that for which the account was submitted. Nor would such persons accept a very substantial bill for services rendered without a strict accounting respecting the file the services were rendered on and an itemization respecting each alleged service or disbursement. Yet in the case before the Court, this was done in the manner described.

The expenses submitted to the Court were not explicit and definable so that the accounts between A&l and Brimstone could be identified by the cases in which Brimstone was involved, by the sulphur sales, or respecting anything else in which Brimstone was involved or even by way of the fiscal year of Brimstone in respect to which they were incurred. Moreover, the accounts submitted to the Court would not enable a reasonable person to properly determine whether the charges related to Brimstone's affairs at all.

The evidence submitted is not sufficient to establish the amount of time claimed in respect to Mr. Learsy and all of the other employees excepting only Mr. Richards. The evidence respecting the allocation by Mrs. Papp as to rental space is, of its own description, without suitable substance. Mr. Seizer's and Mrs. Papp’s numbers were arbitrary.

The appellant has failed to establish that the amounts in question constituted a specific expense incurred for the performance of the service by A&l that was for the benefit of Brimstone.

In light of the foregoing findings, the appellant also failed to establish that the amounts in question constituted outlays or expenses made or incurred for the purpose of producing income or that they were reasonable in the circumstances.

The appeals are therefore dismissed.

Appeals dismissed.