74712 Alberta Ltd. (Formerly Cal-Gas Ltd.) v. Minister of National Revenue, [1990] 2 CTC 2001, 90 DTC 1401

Teskey, T.C.J.:—The appellant, 74712 Alberta Ltd. formerly Cal-Gas and Equipment Ltd. (Cai-Gas) appeals its reassessments for the taxation years 1983, 1984 and 1985.

Issue

The only issue before the Court is whether Cai-Gas can deduct in computing income the interest paid on a 1.7 million dollar loan from the Wells Fargo Bank (Wells).

Facts

On September 30, 1979, Jack Anderson owned 80 per cent of Pioneer Machinery Company Ltd. (Pioneer), 68 per cent of Cal-Gas Ltd., 100 per cent of Trennd Investments Ltd. (Trennd), 51 per cent of Chinook Auto Electric Ltd. (Chinook), 90 per cent of Trennd Investments (1979) Ltd. (Trennd 1979) and 98 per cent of Allied Equipment Ltd. (Allied) which in turn owned 100 per cent of Lethbridge Crane Service Ltd. (Lethbridge). See chart # 1 attached [not reproduced].

As a result of corporate restructuring on October 1, 1979, Jack Anderson still owned 90 per cent of Trennd 1979 which in turn owned 100 per cent of Trennd, 69 per cent of Cai-Gas, 80 per cent of Pioneer and 100 per cent of Allied which in turn owned Lethbridge. See chart # 2 [not reproduced].

The reason for this corporate restructuring was to have Trennd 1979 become the banker for the group. Trennd 1979 arranged with the Canadian Imperial Bank of Commerce (C.I.B.C.) for a common operating line of credit. It was common practice even before this that the companies controlled by Jack Anderson supported each other. The companies had different business cycles. Pioneer and Allied were busy and had high receivables during the summer. Cal-Gas and the automotive companies were busy during the winter with high receivables and during the summer no activity and low receivables.

In February of 1980, Trennd was wound up.

In April of 1980 C.I.B.C. agreed to lend Trennd 1979 an amount that would cover the daily operating requirement for the group of companies. The loan was limited to the receivables of all of the companies as a group. Trennd 1979 being only a holding company had no other business than the borrowing of money and lending the same to the group of companies. During the relevant period of times, Trennd 1979 would loan to its subsidiaries their required funds at an interest rate of one half of one per cent over what it paid for the same money from C.I.B.C.

Cal-Gas was a rapidly growing company. It required operating funds for about eight months of the year. Cai-Gas also had substantial capital expenses carrying its own separate debt of between $ 1,500,000 to $2,000,000. When the Cai-Gas business was down and the receivables were up, then it received a benefit from the support of the other companies. Although the C.I.B.C.'s operating loan was $3,300,000, however it was agreed that during the period January 1 to March 31 during the term of the commitment, this would be increased to meet the requirements of Cal-Gas.

The group of companies authorized C.I.B.C. to transfer funds back and forth between the group of companies and/or Trennd 1979. Cal-Gas in September of 1980 also borrowed money directly from United Dominion Corporation (Canada) Limited (United) for the purchase of more equipment which Trennd 1979 guaranteed.

The loan arrangement with the C.I.B.C. required that each company assign its receivables to the bank and each company guaranteed the indebtedness of Trennd 1979 to the C.I.B.C.

In the fall of 1981 and in early 1982, all assets of Allied were sold, Chinook ceased operation, Pioneer and Lethbridge were placed in receivership. Thus, Trennd 1979 ended up having as its only asset a 69 per cent interest in Cal-Gas. In the fall of 1981, the bank insisted that a consultant of its choice be retained to assess the liability of all the businesses. As a result, Peat Marwick and Partners conducted an investigation and recommended that all the companies be put into receivership. The C.I.B.C. called the loan demanding payment from all entities. Jack Anderson was successful in staving off the bank so that Cal-Gas could continue to operate with a limited credit line. Cai-Gas also obtained a loan from the Toronto Dominion bank for an additional $150,000 which allowed Cal-Gas to carry on in a limited fashion.

In 1982, the C.I.B.C. would not re-finance the loans and again demanded payment from all entities on its loan to Trennd 1979. Cai-Gas then arranged a loan from Wells for $ 1,700,000. This money was paid by Cai-Gas directly to the C.I.B.C. who then released Cal-Gas from all liabilities, guarantees and assigned back its account receivables. There was no evidence that Cal-Gas owed any money to Trennd when the $1,700,000 from Wells was received and paid directly to the C.I.B.C. At the time of the Wells loan, there was owing to the C.I.B.C. by Trennd 1979 approximately $2,200,000. Jack Anderson personally paid off the difference, namely the sum of $500,000. Cai-Gas received a non- interest-bearing promissory note for $1,7000,000. from Trennd 1979. The note was worthless as Trennd 1979 did not have any assets. In 1982, Jack Anderson received the Cai-Gas shares from Trennd 1979 and thus became a 85 per cent owner of Cal-Gas.

The $1,700,000 loan was sufficient to remove all demands and pressure by the C.I.B.C. and allowed Cal-Gas to conduct its business efficiently from that time on. It was able to service the debt. Counsel for the appellant in argument stated that the loan has been paid off, however this fact was not given in evidence.

At the time the $1,700,000 was borrowed from Wells, the book value of the Cal-Gas assets was $3,500,000. Cal-Gas was in the industrial propane distribution business. It had propane tanks on location in the heavy oil fields where the oil storage facilities had to be heated in the cold winter months. Because of having these tanks in place, the total value was in excess of the book value. If the tanks had been taken off location and stored in one location and sold at public auction, they would have sold for next to nothing. There was a large goodwill factor having the tanks in place. Jack Anderson tried to sell Cai-Gas as a going concern at the time and was unable to find a buyer. Jack Anderson and the other shareholders decided that they would attempt to bail out Cal-Gas and keep it going. They wanted to preserve the income-producing capacity of Cal-Gas. That is, they wanted to protect not only the capital asset but the employees' reputations. By making the deal and borrowing the $1,700,000 from Wells, Cal-Gas kept its unsaleable life. Between 1982 and 1987, Cai-Gas had annual profits of between $300,000 and $500,000. Profits for 1988 were way down to $50,000 up to $250,000 for 1989. It expects a profit of $500,000 for 1990.

Statutory Provision

The provision in the Income Tax Act the applicant must come within to enable it to write off the interest on the Wells loan is paragraph 20(1)(c), the relevant portions are:

20. Deduction permitted in computing income from business or property.

(1) . . . in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) interest—an amount paid in the year . . ., pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property. . .

Respondent's Position

The respondent argues that the money borrowed from Wells does not fall within the provisions of subparagraph 20(1)(c)(i) as interpreted by the Supreme Court of Canada in The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32; [1987] 1 C.T.C. 117; 87 D.T.C. 5059.

Appellant's Position

The appellant argues that the Court should look at the entire transaction and that the true purpose of the borrowed money was for Cai-Gas to maintain the use of its unsaleable assets (including its accounts receivable) or to preserve its assets (i.e. its very existence) and therefore there was a business purpose and the borrowing then falls within the provisions of subparagraph 20(1)(c)(i). It argues that the Bronfman,supra, facts can be distinguished in that there was no alternative available than the borrowing. If the money had not been made available to Cal-Gas, the producing assets would have been liquidated for next to nothing.

Analysis

Although both the appellant and respondent referred this Court to various decisions of various courts, the leading authority is Bronfman, supra. The Chief Justice set out the main issue involved therein at page 119 (D.T.C. 5060):

The issue is whether the interest paid to the bank by the trust on the borrowings is deductible for tax purposes; more particularly, is an interest deduction only available where the loan is used directly to produce income or is a deduction also available when, although its direct use may not produce income, the loan can be seen as preserving income-producing assets which might otherwise have been liquidated.

Under the heading Direct and Indirect Uses of Borrowed Money, the Chief Justice said at page 128 (D.T.C. 5066 and 5067):

I acknowledge, however, that just as there has been a recent trend away from strict construction of taxation statutes (see Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [84 D.T.C. 6305] at pp. 573-79; [1984] C.T.C. 294 at 313-316 and The Queen v. Golden, [1986] 1 S.C.R. 209, [86 D.T.C. 6138] at pp. 214-15; [1986] 1 C.T.C. 274 at 277), so too has the recent trend in tax cases been towards attempting to ascertain the true commercial and practical nature of the taxpayer's transactions. There has been, in this country and elsewhere, a movement away from tests based on the form of transactions and towards tests based on what Lord Pearce has referred to as a "common sense appreciation of all the guiding features" of the events in question: B.P. Australia Ltd. v. Commissioner of Taxation of Australia, [1966] A.C. 224 at 264; [1965] 3 AIl E.R. 209 at 218 (P.C.). See also F.H. Jones Tobacco Sales Company Ltd., [1973] F.C. 825 at 834; [1973] C.T.C. 784 at 790 (T.D.); [73 D.T.C. 5577] per Noel A.C.J.; Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation (1946), 8 A.T.D. 190 (High Ct.), at 196 per Dixon J; and Cochrane Estate v. M.N.R., [1976] C.T.C. 2215; 76 D.T.C. 1154 (T.R.B.), per Mr. A.W. Prociuk, Q.C.

This is, I believe, a laudable trend provided it is consistent with the text and purposes of the taxation statute. Assessment of taxpayers' transactions with an eye to commercial and economic realities, rather than juristic classification of form, may help to avoid the inequity of tax liability being dependent upon the taxpayer's sophistication at manipulating a sequence of events to achieve a patina of compliance with the apparent prerequisites for a tax deduction.

This does not mean, however, that a deduction such as the interest deduction in subparagraph 20(1)(c)(i), which by its very text is made available to the taxpayer in limited circumstances, is suddenly to lose all its strictures. It is not lightly to be assumed that an actual and direct use of borrowed money is any less real than the abstract and remote indirect uses which have, on occasion, been advanced by taxpayers in an effort to achieve a favourable characterization. In particular, I believe that despite the fact that it can be characterized as indirectly preserving income, borrowing money for an ineligible direct purpose ought not entitle a taxpayer to deduct interest payments.

In my view, the text of the Act requires tracing the use of borrowed funds to a specific eligible use, its obviously restricted purpose being the encouragement of taxpayers to augment their income-producing potential. This, in my view, precludes the allowance of a deduction for interest paid on borrowed funds which indirectly preserve income-earning property but which are not directly "used for the purpose of earning income from . . . property".

. Even if there are exceptional circumstances in which, on a real appreciation of a

taxpayer's transactions, it might be appropriate to allow the taxpayer to deduct interest on funds borrowed for an ineligible use because of an indirect effect on the taxpayer's income-earning capacity, I am satisfied that those circumstances are not presented in the case before us. It seems to me that, at the very least, the taxpayer must satisfy the Court that his or her bona fide purpose in using the funds was to earn income.

Conclusion

Even though the Supreme Court of Canada acknowledged that there might be exceptional circumstances where it would be appropriate to allow the taxpayer to deduct interest on funds borrowed for an ineligible use because of an indirect effect on the taxpayer's income-earning capacity, and Cal-Gas had no other business alternative but to borrow the money, the circumstances herein are not those exceptional to warrant this Court from not applying the principle laid down in Bronfman, supra.

Even though the $1,700,000 borrowed from Wells was paid directly to the C.I.B.C., it was in essence loaned to Trennd 1979. Cal-Gas received from Trennd a worthless non-interest bearing promissory note. The funds borrowed from Wells were used by Cai-Gas to pay off a debt owed by Trennd 1979 to the C.I.B.C. which covered debts incurred by the other subsidiary companies. This was the direct use of the borrowed funds which falls outside the provisions of subparagraph 20(1)(c)(i). The indirect effect of this borrowing, besides allowing Cai-Gas to remain in business, also saved Jack Anderson substantially the same amount as he had personally guaranteed the debts.

The Chief Justice in Bronfman, supra, page 129 (D.T.C. 5067-68) directed this Court and others to deal with "what the taxpayer actually did, and not what he might have done". Therefore, even though it appears this matter could have been structured differently to avoid this pitfall, that is immaterial.

For the reasons set out above, the appeal is dismissed.

Appeal dismissed.