Chignecto Holdings Limited and Case Realty Limited v. Minister of National Revenue, [1991] 2 CTC 2764, 91 DTC 1354

Margeson, T.C.J.: — It was agreed at the commencement of the hearing that these cases would proceed on common evidence.

These appeals arise from a reassessment by the Minister, dated June 5, 1990, whereby the Minister disallowed the small business deduction in the years 1986 and 1987 for Chignecto Holdings Ltd. (Chignecto). By reassessment of the same date, the Minister disallowed the small business deduction for Casey Realty Ltd. (Casey) for both taxation years 1986 and 1987 and further, included in the appellant's income for 1987 the amount of $20,937.79 which the Minister alleges was received from the tenants as operating expenses. The same amounts are referred to by the appellant as lease escalation payments.

Facts

An agreed partial statement of facts was filed by the parties by consent to be restricted to use in these proceedings only. The agreement provided that the appellant, Casey, did not have more than five full-time employees in the years 1986 and 1987, but the appellant, Chignecto and Casco in combination did have more than five full-time employees.

The parties further agreed that the appellant Chignecto did not have more than five full-time employees in 1986 or 1987 but the appellant, Casey and Casco in combination did have more than five full-time employees in 1986 and 1987.

Mr. Don Casey testified for the appellants that in the years 1986 and 1987 the shares of Casey were owned 100 per cent by Casey Holdings Ltd. (a company not involved in this appeal), which in turn was owned 50-50 by he and his brother. Chignecto and Casco shares were held 50-50 by he and his brother as well. Mr. Casey was also an officer and director of all three companies, Casey, Chignecto and Casco. Generally he said that the companies were involved in the service business. They sought out appropriate properties for purchase, purchased them, renovated them and leased them.

He testified that Casey was formed in the mid-1960s for the purpose of renting commercial properties in various places in Nova Scotia and New Brunswick. In 1971 or 1972, Chignecto was formed and their chief business was commercial rentals. Casco was formed in 1971 and was the construction arm of the business, doing construction, renovations and repairs. He indicated that 80 to 90 per cent of the work was performed on their own properties.

In 1986 and 1987, Mr. Casey was involved in all aspects of the business of all three companies. He said that the renovations by the company were mostly small offices renovated to tenants' specifications. Often times, they also renovated at the end of the lease or when a tenant was expanding, all of which helped them obtain good tenancies and a good occupancy rate. His work in the first three companies took 100 per cent of his time and when they were involved in the actual renovation of a property, that job would take about 50 per cent of his time.

He introduced Exhibit A-l, the contents of which were accepted by the respondent excepting that certain headings contained therein were supplied by the appellant and were not necessarily accurate. This exhibit was prepared under his direction and he was familiar with its contents. The exhibit contained a summary of the employees of the three companies, whether the employees were part-time or full-time during 1986 and 1987 and the schedules attached provided a breakdown by company for each year, detailing time, projects and work responsibilities for each employee.

The witness specified that one employee, Leslie Fillmore was a full-time janitor but other janitorial services were contracted out. Sometimes they also contracted out electrical, plumbing and other trades work that they could not do. In 1986 and 1987 Casco was a sub-contractor for Casey and Chignecto but also for other associated companies not involved in this appeal, as well as outside companies and individuals. In 1986 and 1987, they did not do new construction and the largest project undertaken in those years was the IGA Building in Amherst which involved the renovation of a building that was just a shell and after completion was leased to doctors, as an assessment office and to a printer. It was clear from the evidence that this project was a major job that lasted from March of 1986 to May of 1987 and employed all of the Casco employees. In the end, the project was far over budget and a new company was formed in which the dentists owned two-thirds and Casey one-third.

It was clear from Mr. Casey's evidence that Casey had the office, a telephone listing, the signs on the building and had the only public presence. Each of the companies had its own employees and those employed in construction were employees of Casco and those Casey and Chignecto and also to work for outside people to fill in time or as a favour to them. Much of the time was taken answering tenants' complaints, sending out an employee of Casco to do the work and according to the witness, they did what they had to do to get full occupancy. Most of the rentals were gross rentals and not net rentals.

The witness testified in relation to the lease escalation clauses and said all leases over two years had them. By this system, the landlord sets a base year for costs and anything over that amount in subsequent years gets charged to the tenant. The totals are subject to certification by the company's accountants and it usually takes until six months into the subsequent year to have the figures compiled. The calculations are submitted to the tenants and the landlord gets paid thereafter. The amounts received are then added into income in that year on a cash basis. This system was used consistently until it was questioned by the Minister of National Revenue for the years 1986 and 1987.

In cross-examination Mr. Casey admitted that both Chignecto and Casey had rental properties in 1986 and 1987 and that nearly 100 per cent of their income came from rentals. Casco's income was from hourly rates charged to the other companies and outside people. The outside jobs included work on a tavern, personal work for the shareholders, repairing of roofs, wallpapering and other repair work. Casey also built a new shop on land owned by another company.

The witness said that the term “full-time employee" to him was one who worked 35 to 40 hours a week and had no other job. He said that he amalgamated the companies after he took over and used Casey Realty Ltd. for acquisitions. He had signing authority for all three companies. Casco made money he said by marking up the cost of its services by 50 per cent. He said that in the IGA Building, Casey contracted out the insulation, the stucco work and electrical work to companies other than Casco.

Enid Craft gave evidence that she was employed by Casey and was familiar with Exhibit A—I and had prepared it from company records and from her knowledge. She did the accounting for all three companies here, all the banking, accounted for revenues, was in charge of accounts receivable and accounts payable. She also kept time records and fielded complaints from tenants. She said that in 1986, Casey had 26 tenants, Chignecto had 19 and in 1987, Casey had 34 tenants and Chignecto had 20.

The witness regarded the operation as that of one company with different arms, Casco doing the repairs and Casey and Chignecto as real estate companies. She said that at the end of the year they adjusted the work of Mr. Casey and herself on an arbitrary basis and that Schedule E in that regard has to be changed. Further, she indicated that sometimes she and Mr. Casey worked for all three companies in one day and had to estimate the percentages of their work day that was spent for each company. She agreed that until the reassessment took place all these escalation payments were treated on a cash basis and not the accrual basis.

Issues

The issues are whether or not Casey and Chignecto are entitled to the small business deduction under section 125 of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and whether Casey must add into income in the year 1987 the so-called lease escalation payments or operating expenses amounting to $20,937.79.

Appellants’ Position

The appellants submit that the three companies in question here are associated companies for the purposes of subparagraph 125(7)(e)(ii) of the Income Tax Act. They say in order for them to be successful in this appeal they must show that it was "active business income". This term is defined in paragraph 125(7)(a) which also excludes “a specified investment business” as defined by paragraph 125(7)(e) unless the companies came under the exceptions contained in subparagraph 125(7)(e)(i) or (ii). They admit that they did not have more than five full-time employees when considered separately but do meet the requirements of subparagraph 125(7)(e)(ii) when considered jointly.

The appellants also initially argued that paragraph 129(6)(b) assists them here but this paragraph was not pleaded, was not developed in argument and I do not consider it germane to my decision. The respondent also objected to it being argued at the time of the appeal.

The appellants suggest that the purpose of the legislation is to provide relief to small businesses by reducing tax effectively from 40 per cent to 20 per cent. It is possible to have two or more associated companies qualify under this section although they must share the dollar limit among them.

The appellants submit that the evidence is clear and established that the three companies in question carried on a single, integrated business. They were dependent on each other, they had a common purpose and agreed to combine their efforts to achieve their common purpose. If they had acted alone, there would have been no question that they were carrying on an active business according to their argument. The companies operated as separate entities, kept separate records, had separate cheques but they treated it as one with a common manager. They received rental revenues from property but the prime thrust of their income was from an active business.

In support of this contention they refer to the IGA Building where all three companies directed their efforts to the completion of the work.

The appellants refer to the case of Lor-Wes Contracting Ltd. v. The Queen, [1985] 2 C.T.C. 79; 85 D.T.C. 5310, in support of the proposition that one must look at the statute with a view to determining its object and spirit, "words-in- total-context approach" and the Federal Court decided that no distinction could be made between the logging company itself and the taxpayer and that the Court regarded the work of the road builders and the use of their equipment as being "used by them, primarily for the purpose of logging”.

In the case at bar, the appellants argue that you must look at what business they are in, at the whole picture and not just what individual employees are doing. Thus applying the principle enumerated in the Lor-Wes case, supra, it would be too narrow an interpretation to find that the principal purpose of the appellants here was to earn income from property as they provided a variety of services in the years in question.

The appellants refer to Canadian Marconi Co. v. The Queen, [1986] 2 C.T.C. 465; 86 D.T.C. 6526, as the leading case showing the Supreme Court of Canada leaning towards the business side in its interpretation that anything that is legal is a business. The Court held that income received from or generated by an activity done in pursuit of its stated objects is presumed to be income from a business, although this was a rebuttable presumption.

The appellants refer to the “principal purpose" test as outlined in Interpretation Bulletin No. IT-73R4 and say that by applying that test to the present factual situation, where we have an integrated business doing much more than basically receiving rent, it is impossible to say that the principal purpose was to earn income from property and therefore the appellants were not "a specified investment business” and that is the end of the matter.

In the alternative, the appellants submit they qualify under the exception provided in subparagraph 125(7)(e)(ii) because there were two or more companies sharing a common business and these companies had more than five full-time employees. This section is specifically there to offer relief to associated companies who would not qualify individually because to do otherwise would have the effect of treating different companies dramatically differently. The appellants refer to Woodlin Developments Ltd. v. M.N.R., [1986] 1 C.T.C. 2188; 86 D.T.C. 1116 in support of their proposition that two or more companies can share a common business. That case involved the question as to whether or not income was from a partnership or joint venture.

In final argument on this point the appellants say that Casco had over five employees and was definitely carrying on an active business and Casey was associated with it and falls squarely under subparagraph 125(7)(e)(ii). Chignecto did not require more than five full-time employees but it was associated with the other two, not in isolation, and the business referred to in the subparagraph is the business that it was sharing with the other companies and together they met the test and Chignecto is also an active business.

On the second issue of the lease escalation payments the appellants say that the method adopted and used by the company was consistent over the years and was indicated for each year. They admit that generally accepted accounting principles require them to be accrued but due to practical problems in having information available they reported them in the following year. They did this consistently since 1970 until the issue was raised by Revenue Canada in 1986. As a result of the action by Revenue Canada, the companies are now being taxed for two years' escalation payments in 1987. The appellants question whether the Minister has the right, in effect, to adjust the 1987 year without removing the 1986 figure from the assessment which has already been included.

The argument of the appellants is that the Minister must assess on a consistent basis. There is nothing in the statute that allows a "doubling up" which is what we have in this case. The appellants say that the only issue here is what is the proper figure for the 1987 assessment and that the 1986 amount is not a proper component thereof. They refer to Alger B. Ferris v. M.N.R., [1964] C.T.C. 491; 64 D.T.C. 5304, and distinguish it on the basis that subsection 141(6) of the Income Tax Act allowed the “doubling up" in that year. They distinguish the facts in that case from those at bar by saying that what was involved in that case was an attempt by the taxpayer to avoid paying taxes by changing the method of reporting. There is no such specific provision in the Income Tax Act now referable to this case even though subsections 10(3), 13(6) and 28(3) of the Act make such provision for other situations. To allow the “doubling up" here would be tantamount to reading into the Income Tax Act a provision which is not there.

The appellants further distinguish Wilchar Construction Ltd. v. The Queen, [1981] C.T.C. 415; 81 D.T.C. 5318 since in that case the taxpayer changed his approach during the appeal, the result of which was to make a reassessment in the year 1969 statute-barred. The Court applied estoppel against the taxpayer. The appellants say that the facts here do not warrant estoppel as the taxpayer was not attempting to avoid paying taxes and it is the Minister who is trying to change the method of reporting.

The appellants agree that in this case the taxpayer's method of reporting was incorrect and a change is appropriate and required, but in Wilchar, supra, the taxpayer's method was correct and the Court did not change it. The result of the decision in Wilchar, supra, according to the appellants leads to no incorrect consequence, but to leave a system in place in this case would be to lead to an incorrect consequence and therefore Wilchar, supra, is inapplicable here.

In the end, the appellants argue that the $20,930 should properly be added to. the 1987 income as it has accrued in 1987 but then the amount already reported in his 1987 income should be excluded therefrom and included in the 1986 income. Further, they ask that the amount reported in the 1986 income should be removed and included in its 1985 income (that year is not under reassessment).

Respondent's Position

The respondent's position is that the basic facts are not in dispute and that he accepts the information contained in Exhibit A-1. However, he disputes the conclusion to be drawn from the evidence as put forward by the appellants.

The respondent says that the fact that the companies carried on an integrated business is irrelevant to the issue here. He argues that they did not amalgamate before 1986 and were acting as three companies and not as one. We must look at the case from that point of view according to the respondent and the real issue is what is meant by the definition of a "specified investment business" under paragraph 125(7)(e). This does not mean a business carried on by a number of corporations. It uses the term "corporation". In any event, he argues that the principal purpose of the corporations here separately or jointly was to derive income from rents, to maintain properties for tenants and to collect rents.

The respondent refers to Temax Investments Inc. and Mayon Investments Inc. v. M.N.R., [1991] 1 C.T.C. 2245; 91 D.T.C. 364 and says it is directly on point. Here the respondent says the “principal purpose" was to derive income from rent and not the "peripheral services". Therefore, the appellants are not entitled to the deductions sought unless they fall under the exclusion in subparagraph 125(7)(e)(ii).

The respondent refers to Exhibit A-1 and argues that there is a real question as to whether the 2438.50 hours of service provided by Casco to Casey during the renovation of the IGA store on Prince Arthur Street, is the kind of service contemplated by subparagraph 125(7)(e)(ii). The services provided in 1986 and 1987 were construction services. If this work is excluded, then Casco did very little work for Casey and they would not have required more than 5 full-time employees. Casey would have required only one full-time employee and that was the janitor. His argument is that other than the IGA work, Casey required only about 1500 hours of work which is the equivalent of one full-time employee. Chignecto had no full-time employees even though Dan Casey was paid by Chignecto. He obviously did nothing for that company.

The argument of the respondent is that you must look at each company separately and it is irrelevant that they are integrated. The principal purpose was to derive income from rents and therefore both Casey and Chignecto were specified investment businesses. Further, the exclusive clause in subparagraph 125(7)(e)(ii) applies where the services provided are qualified services (i.e., managerial, administrative, financial, maintenance or other similar services). It does not mean services similar to those provided by the corporation in question. Here the respondent says the services provided by Casco to Casey and Chignecto were not such services.

On the issue of the operating expenses or lease escalation payments the respondent says that this was an error in treatment by the taxpayer which perpetrated itself. He admits that there is a "doubling up" in 1987 but it cannot be corrected otherwise. He says the doubling up is not in accord with generally accepted accounting principles but it is within the spirit of the Income Tax Act and that is to require taxes to be paid and because the taxpayer has made the error, he should not be allowed to benefit from it. If the appellant is successful he argues that some years will be statute-barred and the taxpayer may get away without paying taxes on the amount in one year.

The respondent refers to and relies upon Wilchar, supra, and says that all the elements of estoppel are present in the case at bar. He admits the facts are different from Wilchar, supra, but the elements of estoppel are applicable to any case and not just to a factual situation as set out in Wilchar, supra.

The respondent distinguishes Ferriss, supra, on the basis that the case was decided under a previous section that allowed the cash or accrual system to be used and that it was therefore reasonable to have a section in the statute that covered conversions. At the present time, only the accrual method is permitted and it is not strange that there is no such section in the Act now to cover conversions except as in the specified cases outlined by the appellants.

The position of the respondent is that the Court cannot presume that the Minister is entitled to soften the effect of the statute where there is no provision for conversions and he is required to follow the statute. Further, he says, it is a reasonable result because the taxpayer might escape a year's taxes because of his own error.

Analysis and Decision

There is no real argument between the parties that in order for the appellants to be successful on the first issue they must satisfy me on the balance of probabilities that their income was derived from an active business as required by subparagraph 125(1)(a)(i) of the Income Tax Act. That requires the determination as to whether they were specified investment businesses, which are excluded from the definition of active business by virtue of paragraph 125(7)(a). That term is defined by paragraph 125(7)(e) as follows:

(e) “Specified Investment business?'.—"specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), unless

(i) the corporation employs in the business throughout the year more than five full-time employees, or

(ii) in the course of carrying on an active business, any other corporation associated with it provides managerial, administrative, financial, maintenance or other similar services to the corporation in the year and the corporation could reasonably be expected to require more than five full-time employees if those services had not been provided;

Subparagraph 125(7)(e)(ii) would afford relief to the appellants even if they are specified investment businesses if they meet the criteria set out therein. I shall deal with paragraph 125(7)(e) and subparagraph 125(7)(e)(ii) separately. It is clear from the evidence that subparagraph 125(7)(e)(i) is not available to the appellants here.

The thrust of the appellants' argument is that the appellants received their income from an active business and that even though they obtained rental income from property, that was not the principal purpose of their business. They argue that you do not look at the companies separately for the purposes of paragraph 125(7)(e) but altogether. The respondent argues contrary to that and I must agree with the respondent's submission on that point at least insofar as a consideration of paragraph 125(7)(e) is concerned.

That section uses the term corporation and in the context of this case it means Casey and Chignecto. It does not refer to any other corporations whether they are integrated or not. When one then asks, what was the principal purpose of these two companies, it is obvious that it was to obtain income from property even though the chief witness for the appellants testified that the companies were involved in the service business. They are involved perhaps peripherally in the service business but that was not their principal purpose.

Indeed, in cross-examination the witness said that Casey was formed in the mid-1960s for the purpose of renting commercial properties and further, that Chignecto was formed in 1971 or 1972 and their chief business was commercial rentals. He also testified that Casey and Chignecto both had rental properties in 1986 and 1987 and that nearly 100 per cent of their income came from these sources.

Even if it were possible to consider the activity of Casco together with Casey and Chignecto, I would still find that the principal purpose of the appellants in those years was to derive income from property.

The appellants are not aided in any way on this point by the Lor-Wes case, supra, because I find that the legislation clearly expresses itself in paragraph 125(7)(e) and after considering the “words-in-total-context approach" as suggested in that case, I come to no contrary conclusion.

The appellants have also cited the Canadian Marconi Co. case, supra, but again that case can be distinguished on the facts because there the company's main business was broadcasting and manufacturing and it only got into investment after the sale of some of its assets.

The respondent has referred to Temax Investments Inc., supra. Up until that time, the term "principal purpose" had not been defined but Brulé, T.C.J., decided that "the principal purpose of which is to derive income from property", means, "when the source of revenue, the nature of the assets held and the purpose of the corporation are to derive income from property, such as interest income". In that case, the appellants were not generating the major portion of their income from services they provided but rather from interest from mortgages. In the case at bar I am satisfied that the major portion of the appellants' income was generated from rentals.

Turning now to a consideration of subparagraph 125(7)(e)(ii) it is obvious that this subsection contemplates two or more corporations which are associated. The words “corporation” and "it" could have been more specifically modified to avoid confusion but I am satisfied that the section contemplates a situation such as the factual situation disclosed here. I am satisfied that the appellants were associated with Casco; that Casco carried on an active business during the years in question and the only questions remaining are whether or not those services were as such contemplated by subparagraph 125(7)(e)(ii) and if they were, could the appellants reasonably have been expected to require more than five full-time employees had those services not been provided.

I accept the argument of the respondent again that in considering subparagraph 125(7)(e)(ii) each appellant must stand on its own. I am satisfied that a clear reading of the subparagraph would require on these facts that if you took away the work that Casco provided for Casey in 1986 and 1987, that Casey could reasonably be expected to require more than five full-time employees and that if you took away the work that Casco did for Chignecto in 1986 and 1987, that Chignecto could reasonably be expected to require more than five full-time employees. There is no evidence that Casey provided any services for Chignecto and vice versa so for each appellant we are left only to consider the service provided by Casco to them. I see nothing in the relevant sections of the Act that would enable this Court to simply treat all three corporations as one no matter how closely associated they were.

Considering the question of Casey, it is obvious that it could not reasonably be expected to require more than five full-time employees unless the work on the IGA renovations on Prince Arthur Street qualifies under subparagraph 125(7)(e)(ii). If it does not, then Casey would not qualify for the deduction. I am satisfied that the subsection requires the services to be provided be those listed or similar to those listed. The term "similar" is not defined but a reference to Webster's Ninth New Collegiate Dictionary, refers to: 1: having characteristics in common strictly comparable 2: alike in substance or essentials.

Applying this definition to the subparagraph, particularly the word "maintenance", I am satisfied that the work done on the Prince Arthur Street renovations by Casco for Casey qualifies and consequently Casey is entitled to the small business deduction under subsection 125(1).

On the basis of the evidence before me I am not satisfied that Chignecto could reasonably be expected to require more than five full-time employees in 1986 and 1987 and it is not entitled to the deduction.

On the second issue of the lease escalation payments, it is obvious that there is a “doubling up" so-called in the year 1987 if the amount in question is added in since the 1986 amount has already been included in that year. However, it is clear that the statute does not provide any remedial section which would allow for a conversion under the circumstances as they exist here. It is also clear and accepted by the appellants that the proper method is the accrual method and the error has to be corrected.

The Income Tax Act provides a self-assessing system and no fault can be laid at the Minister's door for not picking up earlier an error perpetuated by the appellants themselves. The result is a hardship to the appellants here but I am bound by what the statute provides and I see no provision that would allow the Minister to soften the effect as requested nor allow me to dictate that he do so.

The appeals will be allowed and the matter referred back to the Minister for reconsideration and reassessment on the basis that Casey is entitled to the small business deduction. The appellant is entitled to no further relief.

The appellant, Casey, will be entitled to 50 per cent of its costs to be taxed on a party-and-party basis as it has been substantially successful.

It is further ordered and adjudged that the appeals of Chignecto Holdings Ltd. are dismissed.

Appeals allowed in part.