Ontario Craftmatic Ltd. v. Minister of National Revenue; Contour Chair Lounge of Ontario Ltd. v. Minister of National Revenue, [1989] 2 CTC 2342, 89 DTC 553

Taylor, T.C.J.:—These are appeals heard on common evidence at Toronto, Ontario, on July 5, 1989 against income tax assessments which disallowed the following amounts “paid for advertising on U.S. television stations":

("Contour Chair”)

The crux of the dispute was detailed in the notices of appeal and for Craftmatic it stated:

During 1984 and 1985 the Appellant purchased from American Booking Distributors of Craftmatic products leads consisting of the names of potential purchasers located in the Province of Ontario, which leads were generated by spot commercials and sponsorships broadcast by American television stations.

Some of the Ontario leads generated by American broadcasts were provided to the Appellant free of charge but, in most cases and particularly in respect of those leads generated by the Booking Distributor located in Buffalo, New York, the Appellant purchased such leads from the Distributor at a cost based on a reimbursement to the American Distributor of a portion of its expenses in arranging for the commercials or sponsorships.

Again using the Craftmatic documentation, the Minister in the reply to a notice of appeal sets out the challenge for the appellants, and that of Contour Chair is essentially the same.

b) with minor exceptions (eg: sales to non-residents attending trade shows in Ontario) the Appellant's sales are confined to residents of Ontario and the Appellant has the territorial rights to that market;

e) the arrangement for advertising on television in the U.S. is as follows:

i) Responses Technologies Inc. ("Response") of Redondo Beach, California, U.S.A., is the advertising agency for various U.S. and Canadian dealers which sell Craftmatic products;

ii) Response prepares the television commercials at its own expense and retains the proprietary rights to the television commercials shown;

iii) at the request of a U.S. dealer of Craftmatic ("U.S. dealer"), Response negotiates with a U.S. television station for commercial time (regular commercials and program sponsorships);

iv) the U.S. dealer enters into a written contract with the U.S. television Station;

v) the Appellant has verbal contracts with those U.S. dealers who arrange for television commercials or sponsorships which reach Ontario and who agree to include in the dubbing a toll-free telephone listing for Ontario residents;

f) pursuant to the arrangement in paragraph 5(e) above, the formula for allocating the television advertising costs between the U.S. dealers and the Appellant is as follows:

i) both a U.S. and a Canadian telephone number are shown in the television advertisements which enables a tabulation of the sales leads (the "leads") by geographic location;

ii) the cost of broadcasting the television advertisements is shared based upon the Appellant’s and the U.S. dealer's share of the leads;

h) the outlays or expenses, referred to in paragraph 5(g) above, were made or incurred for advertisements directed primarily to a market in Canada and broadcast by a foreign broadcasting undertaking.

6. The respondent relies, inter alia, upon paragraph 18(1)(a) and subsections 19.1(1) and 19.1(4) of the Income Tax Act, R.S.C. 1952, c. 148 as amended, (the "/Act").

The evidence and testimony provided to the Court outlined the general business arrangements and bases for participation among the parties involved and noted above. In my view it did not materially add to or alter the context of the issue, but it was of assistance to the Court in reviewing the area of dispute between the two parties — the interpretation and application of subsection 19.1(1) of the Act. Counsel on both sides presented clearly and forcefully the conflicting viewpoints in argument. In the interest of brevity I will proceed directly to a review of those arguments, and I would quote rather extensively from that for the appellants:

There is no doubt that the sponsorships and commercials were broadcast by a foreign broadcasting undertaking. Our two issues are, firstly, were the expenditures properly characterized as expenditures incurred for an advertisement. If they were not, if they were, as we suggest, expenditures incurred as the cost of acquiring a lead or a list or a business prospect, then that is the end of the matter. But, if Your Honour should decide that they can properly be characterized as expenditures for advertisements, then there is a second issue and that is whether the advertisements in question were directed primarily to a market in Canada.

On the first issue we submit, Your Honour, that the evidence is absolutely clear that the Appellant buys leads and not advertisements. . . . He incurs no obligation to anyone for the cost of the advertisements. He has an obligation to pay the American distributors on a cost per lead basis, but he is paying for the leads and not for the advertising. The cost of the advertising is the means by which the price is arrived at, but the nature of the transaction is the acquisition of the property rights in the name or the lead itself and not the advertising. We submit that the evidence is unequivocal in that regard. It is quite clear that there is no obligation to pay the foreign broadcasters, there is no obligation to pay at all if there are no leads. The evidence is consistent with what are we looking at. We are looking at the cost per lead, the cost per lead, the cost per lead, not the cost of the advertising.

The Appellants’ name, business premises, telephone number, address, nothing appears in any of these ads. The people who respond to the tag numbers do not call the Appellant, they call an answering service. They do not know from the ads whether the Appellants even exist. They would have trouble in fact finding the Appellants were it not for the fact that once the Appellants get the lead from the answering service they follow up by contacting the people who enquired by telephone or by direct mail. I suggest to you it is an unusual advertisement which does not tell the interested listener or watcher how to contact the person doing the advertising. I suggest that that is more evidence that in fact what the Appellants are acquiring with their expenditures is the leads and that they are not paying for advertising.

If Your Honour should decide that the expenditures should properly be characterized as expenditures for advertising, then the next issue is whether they were directed primarily to a market in Canada. As seems to befall me always, we have an issue on which there is no jurisprudence.

If the advertisement was directed partly into one country and partly into another country and it cannot be said that one has primacy over the other, then section 19.1 does not, in our submission, apply. À mixed purpose does not bring the section into play unless one of the purposes can be clearly seen to overwhelm the other.

The evidence today is that these ads would have been run without the Ontario contribution, so if there is any primacy with respect to the advertisements or the sponsorships that were run, it is a primacy directed mainly to the American market.

I submit to Your Honour that it is quite clear these expenditures would usually and ordinarily and would otherwise be deductible by the taxpayer in calculating the income. As such, section 19.1 should in accordance with established jurisprudence be read strictly. The taxpayer should not be brought within the exception to the ordinary deduction unless the section clearly applies to the taxpayer. In this case, neither the facts nor the law clearly catches the taxpayer here.

We submit, Your Honour, that such a small change in technique as to how the lead purchases are acquired should not have such a momentous effect on a taxpayer unless those consequences are clearly and obviously intended by or are inevitable from the language of the section.

In reply the comments of counsel for the respondent included:

Your honour, as my friend has pointed out, there are no reported decisions on the meaning of section 19.1 of the Income Tax Act. The provision was enacted in 1976 as part of Bill C-58, which was enacted to discourage Canadian taxpayers from placing advertisements aimed primarily at Canadians in foreign newspapers, magazines, periodicals, et cetera, and on foreign radio and television. Subsection 19.1(1) was specifically enacted to discourage Canadian advertisers from reaching their domestic markets by way of U.S. signals.

I have a copy of the original bill, as well as a portion of the speech that was made in the House of Commons at the time of the second reading of the bill. Unfortunately, the technical notes that are attached to the bill are not of much assistance in determining the precise meaning of section 19.1. The bill was enacted as a package, a complete piece of legislation which included the section which is under scrutiny today. In the Hansard extract which is dated November 17, 1975, we have an excerpt of the speech given by Mr. Jim Fleming who was the Parliamentary Secretary to the Minister of Communication at the time. He attempts in his speech to give explanation in detail of why the amendments as brought in by Bill C-58 were essential.

I would submit that the situation that is aimed at through Bill C-58, and in particular section 19.1 of the Act, is exactly the circumstances of the facts of these particular cases. A closer look at the wording of subsection 19.1(1) requires that the expense be an otherwise deductible outlay or expense. It must be made or incurred for an advertisement directed primarily to a market in Canada. There is no dispute that this is being broadcast by a foreign broadcast undertaking. The two issues then are basically whether the expenses claimed by the taxpayer were advertisements, and if they are advertisement expenses, whether the expense or outlay was for an advertisement directed primarily to a market in Canada.

First of all, for the Appellants, they only had one market and that was Ontario, part of Manitoba and I believe there was a portion around Ottawa that was not part of their market. But, their market was in Canada. They had no other market. They are not marketing Craftmatic beds and Contour chairs in the U.S. They have one market only and that is a market that is in Canada. They make no sales to the U.S. Clearly, they are not making outlays or expenses for advertising in U.S. markets. That is what Craftmatic of Buffalo was doing. They are advertising expenses for markets in the U.S. The Appellants are paying for advertising which is directed primarily and only to a market in Ontario. That is the only market they are interested in. They display a toll-free number for Canadian residents, for their Canadian market, and they only pay for the advertisements based on advertisements that generate responses in the Ontario market.

And finally from counsel for the appellant again:

Your Honour, perhaps one of the least recognized consequences of Stubart' [1] when it was first released was that it would apparently condemn us all to a life of reading draft legislation and political speeches. I will not be the first to suggest that attempting to divine Parliamentary intention in the plain statutory language is a dangerous exercise at best. The excerpts from the speech of the Honourable Mr. Fleming read by my friend indicate the intention of the legislation is to prevent Canadians from advertising on American stations in situations where there will be some Canadian viewers who will receive that message. With all due respect to Mr. Fleming, if that is what he thought the legislation was accomplishing I suggest that he is mistaken in that. It would have been a very easy matter to deny the deduction of all advertising on foreign broadcasting stations if that is what they had intended. It would also have been a comparatively easy exercise to deny that portion of the expenditures which might reasonably be regarded as referable to a Canadian market. That is language with which those of us who read the Income Tax Act are reasonably familiar. That is not the language that was chosen to be adopted by Parliament. In this somewhat new area of divining the intention, I am uncertain, Your Honour, what persuasive authority could be given to a single speech by a single Member of Parliament in the House, the Parliamentary Secretary to the Minister of Communications, not even the Parliamentary Secretary to the Minister of Finance. In any event, I suggest to Your Honour that what the section has done is it has prohibited the deduction of expenses incurred for advertising directed primarily to a market in Canada. There was no intention apparent from those words to deny the deduction of all expenditures incurred with reference to foreign broadcasting operations. There is no intention to deny a deduction where there is both a U.S. market and a Canadian market. There is no intention to deny cost sharing where the markets overlap. The intention clearly was to prevent taxpayers from incurring expenditures for foreign broadcasting advertisements where the advertisements were directed primarily to a market in Canada.

The issue then becomes were the advertisements directed primarily to a market in Canada. That is, is it a Canadian beer company selling Canadian beer not largely available in the United States and advertising on the U.S. television? Is Canadian Tire advertising on U.S. television? Is there some other indication that the primary purpose for the advertisement is to reach the Canadian market? If there is, section 19.1 clearly applies. But, if it is not clear that the primary purpose of the advertisement is to reach the market in Canada, then section 19.1 clearly does not apply.

Analysis

The task for both counsel in this matter is not an easy one — there is, as both agree, little or nothing in the way of jurisprudence which would cast some light on the question before this Court. It is for this Court, as I see it, when prior enlightenment from the higher Courts is lacking, to interpret the plain words of the enacted legislation, in a manner as relevant as possible to the taxpayers affected by those words. It is a perfectly appropriate exercise for taxpayers and their advisers to dissect the words of the Act in an effort to produce some comfort and flexibility, or at least some intellectual relief. It is equally valid for taxpayers to arrange their affairs and transactions within certain parameters, in a fashion which reduces to the minimum the imposition of income tax. All such exercises are subject to testing eventually if necessary in the Courts. The fact that the circumstances outlined in this case may appear to the Minister to strain the bounds of the legislative provision is quite irrelevant. The only question for the Court is whether "an otherwise deductible expense — (is deductible) — for an advertisement directed primarily to a market in Canada —” (Subsection 19.1(1)).

A major argument proposed by counsel for the appellants was that the outlay was not for "advertising", but rather for the purchase of "leads". In my view, the main distinctions which can be seen between the circumstances surrounding this expenditure and any other for "advertising" are that an agent was used to prepare and present the televised communications to the public; that neither the name of the appellant nor its own telephone number appeared on the television screen; and that the cost of the television production and transmission was shared with another party. None of these elements detracts from the basic nature of the communication as "advertising" — they would certainly not affect such a designation for a public relations program done in Canada, and there is no question that the appellant could have done the same thing, alone and without the assistance of any agency — perhaps not as efficiently or economically but that is simply a business decision and not the crux of the issue. That aspect of the argument is not sufficient to adversely affect the assessment. This also holds true for the proposition that in the event the advertising did not produce any responses from the public to the 800 telephone number, then the appellant would not be charged at the specified rate for the number of calls. That is simply an internal business arrangement which does nothing to affect the nature or the content of the product being communicated by television to the public. The proposition of counsel for the appellant in argument — "I submit that the fact they do not have to pay if no leads are generated is conclusive proof” is rejected. I would add, to whatever degree the "spirit of the Act" should be considered the use of the euphemistic term "payment for leads" in substitution for the plain language "advertising" does not accomplish the objective the taxpayer seeks in this appeal.

The only other point to consider then, is whether this advertising was directed primarily to a market in Canada. In addition to the earlier argument, counsel for the respondent relied heavily on certain statistics which indicated that the customer responses (leads) from certain television stations (particularly Buffalo, New York) were greater for the appellants than for the U.S. market.

In my view, the fact that the appellants “had only one market and that was Ontario, part of Manitoba” (above) has little bearing on the issue. That is simply the geographical territory for which the appellants had some franchise rights. Neither does the specific customer response ratio (leads) in my opinon provide an answer to the question, or give clear support for the assessments. It seems to me that both counsels emphasized areas of the dispute and arguments which are not critical to the determination of the meaning of the phrase "directed primarily to a market in Canada". Counsel for the appellants essentially adopted the posture that there was global communication (both Canada and U.S.) and if anything, the appellants' participation was only that of attaching itself by way of sharing costs to U.S. advertising, which the U.S. would have been done any way. Counsel for the Minister, on the other hand, looked at the situation almost as two sets of advertising — that done by and for the U.S. interests and that done for the appellants for Canadian interests. But as I see it, the communication of the message itself — regarding the product available — is no more directed at Canada than at the U.S. — nor vice versa. It is simply directed at anyone tuned in within range of the transmitter, no matter where or of what nationality. That would appear to give support to the position of the appellants — but there is still an integral and critical part of the advertisement missing in our discussion so far — the telephone numbers — one Canadian and one American. Clearly the Canadian telephone number is not directed primarily "at an American market" nor the American telephone number directed primarily “at a Canadian market”. In my view the telephone number (Canadian as it applies to these appeals) is the most vital part of the advertisement. I am quite satisfied that when viewed by a potential customer in Canada the ad appears directed precisely at him, and the reverse may be true for a potential customer in the U.S. The alternate telephone number is simply ignored — it means nothing. The advertisement is only complete with the relevant telephone number and is simply directed at everyone and at no one in particular without it. The payments at issue in these appeals are the results of calculations made from the leads provided. Those leads are triggered by the inclusion of the telephone number in the advertisement, and the appellants pay for the market response generated by that telephone number, automatically included as an integral part of the communication. The Canadian telephone number makes the advertisement one which is directed primarily at a market in Canada, just as one might argue that the inclusion of the U.S. telephone number makes it directed primarily at a market in the U.S. — but that is not my problem. If the advertisement contained only a U.S. telephone number, and from the responses generated by that number, the appellants paid for "leads" which somehow originated from Canada, then the appellants' position might have some merit — but that is not the case. The advertising for which the payments at issue are made, is directed at a market in Canada. For the appellants to show otherwise, in these circumstances it would probably be necessary for them to prove that the advertisements including the Canadian telephone number, were directed primarily at a U.S. market — and that they have certainly failed to do.

In the end analysis, the methods used by the appellants in advertising their wares, while ingenious and enterprising, do not support the assertions drawn therefrom. The expenditures are prohibited as a deductible expense by virtue of the wording of the relevant section of the Act.

Appeals dismissed.