Electrical Industries (Western) Limited v. Minister of National Revenue, [1990] 2 CTC 2590

Beaubier, T.C.J.: —This case was heard in Edmonton, Alberta, on July 16 and 17, 1990.

The appellant appeals reassessments by the Minister of National Revenue which deny the deduction of capital cost allowance for its 1983, 1984 and 1985 taxation years, allow the deduction of an amount pursuant to subsection 125(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) for its 1986 taxation year, and which deny the deduction of a non-capital loss for its 1981, 1982 and 1983 taxation years. The reassessments were in relation to certain equipment (fixed assets) purchased by the appellant in 1983 and sold by the appellant in 1986. The reassessments are based upon Regulation 1102(1)(c) which states as follows:

1102.(1) The classes of property described in this Part and in Schedule II shall be deemed not to include property

(c) that was not acquired by the taxpayer for the purpose of gaining or producing income;

Therefore, the question is whether or not the fixed assets were purchased by the appellant for the purpose of gaining or producing income.

The appellant called one witness, Mr. Thomas Earl Mugleston. The respondent did not call any witness.

Mr. Mugleston acquired the appellant corporation in 1947. At the times in question until some time in 1986, the corporation was owned 50 per cent by Winfield Power Co. Ltd., a holding corporation controlled by Mr. Mugleston, and the other 50 per cent by other employees of the corporation or family members of other employees of the corporation.

The appellant was always in the electrical and pump repair and supply business, dealing basically with equipment of less than 500 horsepower. It is clear from the evidence that throughout its history from 1947 until 1986, the appellant was a tightly controlled and profitable business operation. During the period from 1947 to 1986, the appellant survived five or six down-turns in the economy comfortably and did well. Mr. Mugleston stated that most of the down-turns only last nine months. The company grew throughout from total sales of $88,000 to a maximum total sales figure of 3 to 4 million dollars. It repaired electrical motors and sold parts and drives and had a number of lines of smaller North American-made pumps.

During the same period, Mr. Mugleston himself became a director of a number of companies in western Canada which were involved in other businesses. He participated in 15 to 20 acquisitions over those years and all were financially successful until the acquisition in question before the Court.

In June of 1983, through a wholly-owned subsidiary called Damont Supply Ltd., the appellant had a 48 per cent interest in Damont Pumps Ltd. ("Damont") a corporation operating a similar business in Regina, Saskatchewan and with the Canadian rights to sell a substantial line of Japanese pumps. The purchase of the 48 per cent interest was from Saskatchewan Economic Devel- opment Corporation and required the purchaser to buy Saskatchewan Economic Development Corporation out in staged purchases to be completed by 1986. This was accomplished according to the terms of payment by the appellant and a shareholder of the appellant, Intor Management Ltd.

The contract also required that Damont Pumps Ltd. maintain a presence in Saskatchewan, but due to the serious and unrelenting problems of Damont Pumps Ltd., Saskatchewan Economic Development Corporation released the purchaser from this requirement and Damont Pumps Ltd. was moved in its entirety to Alberta in 1983 or 1984. These problems included personnel, unmarketable acquired inventory, and problems in the Saskatchewan and Alberta markets themselves.

In late 1983, Mr. Mugleston was introduced by a broker to the chance to buy the assets of B & B Electrical Industries Ltd. of Edmonton. Mr. Mugleston saw this as a way to assist in resolving Damont's problems. Mr. Mugleston's plan was to purchase the fixed assets of B & B Electrical Industries Ltd. and rent them to Damont so that Damont could operate a business similar to B & B's. Mr. Mugleston and the appellant were of the view that Damont could not pay rent for approximately two years but that thereafter substantial rent could be paid to pay the current rent and make up for the lost rent over the first two years. The evidence before the Court is that the purpose of purchasing the fixed assets was to rent the fixed assets to Damont. B & B operated a similar business to the appellant’s, but on larger equipment of up to 10,000 horsepower. An offer was written on 1 December 1983 and an agreement was signed on 22 December 1983. The assets purchased by the agreement were accounts receivable, inventory, prepaid expenses, goodwill and in addition, fixed assets (consisting of office furniture, equipment, vehicles and other assets valued at $660,000). The total price was $1,419,000. Consideration was cash, assumption of liabilities, and a chattel mortgage for the balance. The appellant took a bank loan to handle the cash portion of the purchase.

Prior to the purchase, Mr. Mugleston prepared a schedule by hand (Exhibit A-9) in which he projected the profits and the manner in which the purchase price would be paid based upon a profit margin which consists of 15 per cent of the entire purchase price, which he considered to be practical in his experience. The appellant also received a commitment letter from its bank on December 16, 1983 (Exhibit A-10) to finance the purchase. A debenture was registered December 29, 1983 securing the bank loan executed by the appellant and by Damont Pumps Ltd.

The appellant thereupon allowed Damont Pumps Ltd. to use the fixed assets to carry on business but did not rent the fixed assets to Damont. In fact, however, the appellant did earn income as a consequence of the business done thereafter by Damont. The appellant referred large pump work to Damont and Damont referred small pump work to the appellant and each received a discount from the other of 15 per cent of the retail price on the work so referred.

Mr. Mugleston states that the appellant did not rent the fixed assets to Damont Pumps Ltd. because that company could not pay the rent and "booking" such rent through was not sensible in Damont's circumstances.

Because of Damont's condition, no rent was ever charged, paid, or “booked”. In 1986, the fixed assets were sold at their then depreciated value to B & B Electric Industries (1986) Ltd., a corporation owned by Winfield Power Co. Ltd. (the holding corporation controlled by Mr. Mugleston) which also ceased to have any snares in the appellant in that year. At that time, Damont Pumps Ltd. had debts of approximately $3,500,000.

The Court had the opportunity to see Mr. Mugleston on the stand and he is a frugal, profit-orientated and farsighted businessman. This has caused his success and the success of the appellant. Mr. Mugleston was quite frank to state that he did not at any time anticipate that the fixed assets purchased would, in themselves, be capable of yielding a profit if subsequently sold.

The Court concludes that the appellant purchased the fixed assets for the sole purpose of gaining or producing income therefrom and for no other purpose. The appellant, in the Alberta economy of those days, had over 35 years of continuous profitable operations in the same business as the fixed assets would be used. If the appellant had not thought the fixed assets could be rented to Damont Pumps Ltd. at a profit, then the persons controlling the appellant could have closed Damont Pumps Ltd. down at much less cost to themselves than ultimately occurred. It is quite credible in the practical business world that the appellant would not contract for, charge or "book" rent for the years in question in the expectation that Damont Pumps Ltd. would be turned around and that the rent shortage would be made up. On two occasions during the period in question, Damont Pumps Ltd. missed out on large tenders by a mere $10,000.

The appeal is allowed for the taxation years 1981 to 1986 inclusive and the reassessments are therefore referred back to the Minister for reconsideration and reassessment on the basis that the appellant was entitled to deduct in computing the income the amounts of $67,000 in 1983, $120,326 in 1984, $95,616 in1985, and to deduct resulting non-capital losses realized in 1984 and 1985 in computing its taxable income for the 1981, 1982 and 1983 taxation years.

The appellant is awarded party-and-party costs.

Appeal allowed.