Browning Harvey Limited and A. Harvey & Company Limited v. Minister of National Revenue, [1988] 1 CTC 2209, 88 DTC 1164

Goetz, T.C.J.:—The appellant, Browning Harvey Limited (“Browning”), appeals with respect to reassessments of its 1980, 1981, 1982 and 1983 taxation years. The appellant, A. Harvey & Company Limited ("Harvey"), appeals with respect to reassessments by the Minister of its 1982 and 1983 taxation years.

These appeals were heard, in part, on common evidence as both appellants are appealing with respect to the Minister's disallowance of capital losses claimed in 1982 in respect of loans made to Atlantic Freight Lines Inc. ("AFL"). The appellant Browning also appeals with respect to the Minister’s disallowance of expenses relating to cooler sales in each of the years 1980 to 1983 inclusive, the disallowance of expenses relating to the cost of scoreboards and clocks used in advertising in each of the years 1980 to 1983 inclusive, and the inclusion in income of an amount received from Crush Canada Inc. in 1981 and treated by the appellant as a capital receipt.

Browning's principal business is the production and distribution of nationally known soft drinks within the province.

Harvey engages in a number of activities including real estate, freighting, offshore services, fuel supply, waste disposal and soft drink production. Some of these activities are carried on by wholly or partially-owned subsidiaries.

For the purposes of this judgment I propose to deal first with the issues related solely to the appellant, Browning, and then to deal with the issue involving both appellants.

Cooler Sales

In each of the years 1980 to 1983 inclusive, Browning entered into agreements with shopkeepers under which refrigerators, known in the trade as visi-coolers ("coolers"), were to be sold to the shopkeepers. Although the coolers ranged in price from $1,200 to $2,400, each of the agreements provided for a purchase price of $2, $1 payable on the date of execution of the agreement and $1 payable at the end of the seven-year period following the date of the agreement. The agreement further provided that the purchaser had no right of pre-payment of the final instalment of the purchase price.

Mr. Harvey Garrett, Manager of Browning, testified at trial that prior to 1977 the company had sold coolers to the dealers at cost plus a reasonable markup. In 1977, competitors from the United States started giving their coolers away. To meet this competition Browning began to sell the equipment for $2 on a seven-year contract.

Under the terms of the agreement, the shopkeepers were not permitted to use the coolers for any use other than storage and display of Browning's soft drinks, but Mr. Garrett testified that, to gain goodwill, the company permitted them to use the coolers for non-competitive products such as cheese and milk. Failure to comply with any of the terms of the agreement gave Browning the right to repossess the cooler. Clause 4 of the agreement provides as follows:

4. Title. The Purchaser agrees that the Beverage Cooler and title thereto, notwithstanding delivery, shall belong to and be vested in the Vendor until the last instalment of purchase price is paid in accordance with Section 3 hereof and until all other obligations are performed hereunder. The Vendor shall have the right to inspect the Beverage Cooler at any time during normal business hours.

It is the appellant's position that at the time of entering into these sales agreements, the shopkeepers took possession and control of the coolers and became the beneficial owners of the equipment and therefore the appellant properly accounted for the sale by treating the cost of the cooler as an expense.

Counsel for the Minister submits that the outlays in respect of the coolers were of a capital nature and therefore properly disallowed. It was argued that regardless of the form of the agreements between the shopkeepers and the appellant, the substance of the agreement was that ownership and title to the coolers remained in the appellant throughout the currency of the agreement.

In M.N.R. v. Wardean Drilling Limited, [1969] C.T.C. 265 at 271; 69 D.T.C. 5194 at 5197, Cattanach, J. states:

In my opinion the proper test as to when property is acquired must relate to the title to the property in question or to the normal incidents of title, either actual or constructive, such as possession, use and risk.

and further at 271 (D.T.C. 5198):

As I have indicated above, it is my opinion that a purchaser has acquired assets of a class in Schedule B when title has passed, assuming that the assets exist at that time, or when the purchaser has all the incidents of title, such as possession, use and risk, although legal title may remain in the vendor as security for the purchase price as is the commercial practice under conditional sales agreements. In my view the foregoing is the proper test to determine the acquisition of property . . .

In the present case, although legal title remained in the appellant during the term of the agreement, I find that the shopkeepers acquired all the incidents of title at the date of execution of the sales agreement, namely, they acquired possession, use and risk. The agreement clearly provided that the shopkeeper was responsible for maintaining insurance and was able to use the coolers, albeit subject to certain conditions. These conditions, however, are not sufficient to warrant the conclusion that the shopkeepers did not have beneficial ownership. I would further add that the evidence at trial indicated that none of these coolers have been repossessed by the appellant for non-compliance with these conditions. For these reasons I find that the appellant disposed of the coolers at the time the sales agreements were executed.

The remaining question on this issue is whether the revenues from the sales of the coolers were revenues from a business or whether they were receipts on capital account. The respondent in his notice of reassessment reassessed the appellant on the basis that the coolers were capital assets. The appellant's position was that the acquisition and handing over of the coolers was essentially to increase the number of soft drinks sold. Further it was argued that the expense of selling coolers at a loss was an income expenditure in the line of the reasoning of the Privy Council in B.P. Australia Ltd. v. Commissioner of Taxation of The Commonwealth of Australia, [1966] A.C. 224, approved by the Supreme Court of Canada in M.N.R. v. Algoma Central, [1968] S.C.R. 447; [1968] C.T.C. 161.

As I read these two decisions, I take them to stand for the proposition that there is no rigid test distinguishing between business income and capital gains and that ”. . . It is a commonsense appreciation of all the guiding features which must provide the ultimate answer." (per Lord Pearce in B.P. Australia (supra) at page 264-E, cited in Algoma Central (supra) at page 450 (C.T.C. 162) and in Johns-Manville v. The Queen, [1985] 2 C.T.C. 111; 85 D.T.C. 5373 (S.C.C.)).

Under the circumstances of the instant case, I agree that the adoption of “a common sense appreciation of all the guiding features” of the sales of the coolers strongly suggests that the proceeds or rather the losses incurred following these sales of the coolers should have been assessed on the ground that, in the business of the appellant, coolers have increasingly become a necessary accessory in the large scale marketing of soft drinks and that losses on the sales of the coolers should have been characterized as business losses. Among the features which I find most supportive of this conclusion are the following:

— Even before the coolers were sold at $2 per unit, the appellant was selling coolers at cost plus markup to shopkeepers. The practice of selling its coolers at $2 per unit was adopted by the appellant to keep up with the competition which was giving its coolers away;

— There was no evidence adduced at the hearing that the appellant's practice of reselling the coolers at a loss was anything but a bona fide marketing practice;

— At $2 per unit, it is obvious that the coolers were not sold to make a profit from their disposition. Clearly aside from the desire of the appellant to secure its interest in the coolers by retaining title, the purpose for which the sales agreements were entered into was to ensure the appellant of the exclusive sale of its product on the premises of the shopkeepers.

In many respects the present case is akin to the situation in B.P. Australia (supra) succinctly summarized in the following excerpt from the decision of the Supreme Court of Canada in the case of Johns-Manville (supra) (at page 117 (D.T.C. 5377)):

. . . The Privy Council there determined that a payment made by the taxpayer as an inducement to a service station operator to sign an exclusive agency contract was an income expenditure and not a capital outlay. The contract had a life of five years and thus was an asset of sorts which amounted to an opportunity by the taxpayer to market its gasoline exclusively through the operator's outlet. Nonetheless Lord Pearce concluded at 260:

BP’s ultimate object was to sell petrol and to maintain or increase its turnover. There can be no doubt that the only ultimate reason for any lump sum payment was to maintain or increase gallonage.

In respect of this issue, the appellant Browning's appeal is therefore allowed as the resale of coolers was recurrent as well as connected to the income-earning process of the appellant.

Clocks and Scoreboards

The appellant Browning purchases scoreboards and clocks and instals these in various locations throughout the province of Newfoundland. These clocks and scoreboards display the various logos of the company's products and are considered to be a useful advertising tool which triggers an impulse to buy these products. The appellant's position is that the expenses incurred in respect of the clocks and scoreboards are an advertising cost and are fully deductible from income in the year incurred.

The respondent has treated these costs as capital in nature and by reassessment has disallowed their deduction. As counsel for the Minister pointed out, this issue has already been considered by the Tax Review Board in Browning Harvey Limited v. M.N.R., [1983] C.T.C. 2341; 83 D.T.C. 311, and I am in complete agreement with the decision reached by Guy Tremblay, Esq., Member, (as he then was) who concluded that the electronic scoreboards brought into existence "an advantage for an enduring benefit”. The same conclusion applies to the clocks in the present case.

The costs related to clocks and scoreboards are clearly capital in nature and not deductible as current expenses. The appeal in respect of this issue is therefore dismissed.

Crush Canada Inc. Payment

In 1981 the appellant Browning received the sum of $800,000 from Crush Canada Inc. ("Crush"). The appellant treated this amount as a capital receipt and claimed capital gains for that year. The Minister reassessed the appellant's income for that year on the basis that only $100,000 of the amount received had been in respect of capital. The balance of $700,000 was treated by the Minister as taxable income.

For approximately 25 years prior to the date of the Crush payment, the appellant had produced a rival line of fruit-flavoured soft drinks under a franchise agreement. These drinks bore the brand names of Sun Crest and NuGrape. In early 1981, the appellant entered into negotiations with Crush for a franchise agreement to sell Crush products in Newfoundland and Labrador. In a letter from Crush to the appellant dated February 23, 1981, Crush set out a summary of the agreement reached between the parties. Clause 5 of this letter states as follows:

(5) A condition of our agreement is that Browning Harvey will obtain the rights of production and distribution for the brands Sun Crest and NuGrape, under terms as summarized in our letter of January 20, 1981 (copy attached), and assign these rights to Crush Canada Inc.

In a letter dated April 10, 1981, Sun Crest Company of Canada ("Sun Crest") confirmed its intention to cancel the existing franchise agreement and enter into a new agreement with the appellant for a period of five years in consideration of a lump sum payment of $100,000. It was also agreed that the appellant could assign this new franchise agreement to Crush. An agreement stipulating these terms was executed on April 30, 1981. The agreement specifically consented to the assignment of the franchise rights to Crush.

On April 20, 1981, the appellant and Crush executed a five-year franchise agreement which provided, inter alia, that the appellant would begin production and distribution of Crush's products on or before April 30, 1981, would not bottle, sell or distribute beverages similar to those of Crush without written consent, and would spend specified amounts on advertising and promotion of Crush products over the term of the agreement. The agreement also provided for the sale of Crush for five years of Browning’s franchise rights in Sun Crest. Clause 8 of this agreement stipulates:

8. Subject to compliance by Browning Harvey with the conditions hereof, Crush Canada agrees to pay to Browning Harvey the sum of $800,000 which payment shall be made on the date of introduction.

(The clause originally specified a consideration of $750,000 but this was changed to $800,000 by agreement of the parties.)

The appellant’s position is that the funds received by it from Crush was a capital receipt. The appellant's notice of objection, at page 12, states as follows:

The payment in 1981 from Crush Canada Inc. to the taxpayer (from which would be deducted the companion payment made by the taxpayer to Suncrest) was an inducement made to the taxpayer to take the Crush products. The money was paid by Crush to induce the taxpayer to bottle its beverages for at least five years.

In support of its position that these payments were capital and not income, the appellant cited the case of Maison de Choix Inc. v. M.N.R., [1983] C.T.C. 2241; 83 D.T.C. 204, in which the Tax Review Board held that inducement payments given to certain prospective tenants to get them to enter into leasing agreements were not disguised forms of rent reduction but, rather, were paid in respect of the tenant's ability to attract clientele and its business expertise. On this basis it was held that the payments were of a capital nature. On appeal to the Federal Court of Canada, the parties consented to judgment whereby the Minister agreed that the amounts in question did not constitute rent reductions but that they constituted capital receipts which were not taxable.

Counsel for the Minister, however, cited the case of French Shoes Ltd. v. The Queen, [1986] 2 C.T.C. 132; 86 D.T.C. 6359, in which the Federal Court held that moneys received by a taxpayer as an inducement to sign a lease formed part of the taxpayer's revenue for the year in which they were received. In his decision at page 138 (D.T.C. 6363-64), Mr. Justice Teitelbaum concluded:

I am satisfied that the $50,000 received by plaintiff is part of its revenue. When a taxpayer receives an inducement to sign a lease, then those moneys received must form part of the taxpayer's revenue for the year in which the inducement was received. An inducement is not a “windfall”, it is an incentive, a reason for doing something. Taxpayers and lessors use inducements as a form of doing business. For the lessor, it rents out space and for the taxpayer it is a benefit received. In the end, the receipt of the benefit helps to make a profit. It is part of the taxpayer's revenue that is derived because of, and is part of, its business activity.

In the present case, the money, $50,000, received by plaintiff is part of its business revenue.

Although each case must be judged on the facts of that particular case, I am of the opinion that incentive payments, inducements, generally form part of the revenue of the taxpayer. The payment is received as a result of the business activity carried on by the taxpayer and would not have otherwise been received.

In the present case the appellant characterized the payment as "an inducement" to enter into the agreement with Crush. The contract provided that payment of the amount in question was subject to the appellant's compliance with the terms of the contract which regulated the business relationship between the appellant and Crush. In this respect I find it impossible to conclude that the moneys received from Crush did not form part of the appellant's revenue.

Furthermore, I cannot accept the appellant's submission that the moneys were payable solely in respect of the transfer of the Sun Crest franchise to Crush and were therefore on capital account. Although the assignment of the franchise formed part of the agreement, there were a number of other conditions stipulated and clause 8 of the agreement clearly provides that payment was subject to Browning's compliance with the conditions of the agreement. As the assignment was only one of the conditions, I cannot accept that this payment applied only in respect of the assignment.

For the above reasons, the appellant Browning's appeal in respect of this issue is therefore dismissed.

Payments to AFL

The appellant Harvey owned approximately 70 per cent of the outstanding common shares of Browning at all times material to the issue before this Court. Both appellants were shareholders in Atlantic Freight Lines Inc. ("AFL"), a company incorporated on April 27, 1981, with shareholdings as follows:

In July 1982 the appellants’ shareholdings were reduced to 25 per cent each and CSL's shareholding increased to 50 per cent.

A shareholders' agreement was entered into on December 29, 1981, setting forth provisions in respect of “various aspects of the structure, operations and management" of AFL. Clauses 2.2 and 2.3 provided as follows:

2.2 The parties declare that it is intended that the issued share capital of the Corporation shall be nominal and that the Corporation will borrow such funds as it may require for purposes of the acquisition of assets and for operating capital.

2.3 Where guarantees of the shareholders may be required for the purpose of enabling the corporation to borrow funds in order to acquire assets or furnish working capital or in respect of any other financial obligation or requirement of the Corporation, such guarantees shall be provided jointly and severally by Harvey and Browning to the extent of 51% of the various amounts concerned and to the extent of 49% by CSL.

In accordance with the terms of this agreement, the appellants entered into a number of guarantees on behalf of AFL.

AFL was in the business of water transportation between Montreal and St. John’s. During 1981 CN entered into the same market and AFL's revenues dropped due to increasingly competitive pricing. Mr. Robert French, secretary-treasurer of both AFL and Harvey, testified that due to substantial losses in 1981 and early 1982, it was decided in mid-1982 that the operation of AFL should be closed down and a new company formed in merger with Clare Transport of Montreal, a subsidiary of Northmont Holdings Ltd. ("North- mont"). Atlantic Container Express Inc. ("ACE") was thereafter incorporated, with Northmont and AFL each owning 50 per cent of its outstanding shares.

A shareholders' agreement (the "ACE agreement"), executed July 2, 1982, sets forth the rights and obligations of Northmont and AFL in respect of their shareholdings and the management and operations of ACE. Section 2 of the agreement pertains to capitalization and borrowing. Clause 2.2 states:

2.2 The parties shall each lend the sum of nine hundred thousand dollars ($900,000) to the Corporation which shall be advanced equally as and when required and in no event any later than December 31, 1982 (the “Shareholder Loans") . . .

It was understood by the parties, and stipulated in the agreement, that funding would be balanced between debt and equity, but that borrowing from financial institutions would be minimized to reduce the impact of high financial charges. The agreement also called for the shareholders to provide guarantees where required to enable ACE to borrow funds in respect of any financial obligations of the company.

The appellant Harvey was an intervenant to this agreement. Clause 40.2 states, in part:

40.2 AND TO THIS AGREEMENT INTERVENED A. HARVEY & COMPANY LIMITED, a corporation incorporated under the laws of Newfoundland and having its head office and principal place of business at St. John's, Newfoundland which declares as follows:

(g) That is [sic] hereby guarantees the performance and fulfillment by AFL of all its obligations under the foregoing agreement; provided however that its liability as guarantor hereunder shall be limited to fifty per cent (50%) of any liability of AFL in such regard . . .

Similarly, CSL guaranteed AFL's liability to a maximum of 50 per cent.

Although Mr. French testified that AFL's operations were to be closed down, it is clear that AFL continued to operate as a business entity. Although AFL was no longer directly involved in the container shipping business, it retained ownership of the container ship, Bonaventure II, which had been purchased for a price of $3,126,749.94 on November 1, 1981. In accordance with the ACE agreement, this vessel was on charter from AFL to ACE. In light of this and AFL's ownership of 50 per cent of the shares of ACE, it is impossible to conclude that AFL had ceased to operate.

During the year 1982, each of the appellants advanced loans to AFL of $978,213. This included payments of $671,962.50 made on December 14, 1982. In preparing their 1982 financial statements, the directors of each company determined that these advances to AFL were uncollectable and recorded these amounts as bad debts. These amounts were claimed as capital losses by the appellants in their 1982 tax returns. The appellant Browning carried back $348,415 of this amount to 1981 against a capital gain in that year. The balance was carried forward and has not been utilized to date. The appellant Harvey utilized $100,301 in its 1982 taxation year, $49,746 in 1983 and the balance has been carried forward. The Minister, in reassessing the appellants’ returns for these years, disallowed all claims for capital losses in respect of the loans.

The appellants’ position is that if the Minister was correct in disallowing these amounts as capital losses, they must be regarded as being on account of income and deductible in the manner of the loans in M.N.R. v. Freud, [1968] C.T.C. 438; 68 D.T.C. 5279. In my opinion, the Freud case has no application to the present issue. Freud was a clear case of speculation with no intention of deriving income from an investment. I would further note the comments of Mr. Justice Pigeon who stated at page 443 (D.T.C. 5282-83):

It is, of course, obvious that a loan made by a person who is not in the business of lending money is ordinarily to be considered as an investment. It is only under quite exceptional or unusual circumstances that such an operation should be considered as a speculation. However, the circumstances of the present case are quite unusual and exceptional. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. .. . it is clear that the monies were not invested to derive an income therefrom but in the hope of making a profit on the whole transaction.

The evidence before me does not support a conclusion that the amounts in question were loans made in the ordinary course of business. While the evidence indicates that Browning advanced funds to a number of companies within the "Browning-Harvey Group”, it does not follow from this that the lending of money formed part of the ordinary business of the appellants. (See. Chaffey v. M.N.R., [1974] C.T.C. 598; 74 D.T.C. 6478.) I cannot therefore accept the appellants' submission that the amounts in question are deductible as doubtful debts pursuant to paragraph 20(1)(l) of the Income Tax Act.

I find, instead, that these amounts were clearly outlays of capital. In the case of Stewart & Morrison Limited v. M.N.R., [1972] C.T.C. 73; 72 D.T.C. 6049, the Supreme Court of Canada held that advances of working capital to a subsidiary by way of loans are capital in nature. Mr. Justice Judson stated at page 74 (D.T.C. 6050-51):

. . . The parent company provided working capital to its subsidiary by way of loans. These loans were the only working capital the American subsidiary ever had with the exception of the sum of $1,000.00 invested by Stewart & Morrison Limited for the acquisition of all of the issued share capital of its subsidiary. The money was lost and the losses were capital losses to Stewart & Morrison Limited. The deduction of these losses has been rightly found to be prohibited by paragraph 12(1)(b) of the Income Tax Act.

Clause 2.3 of the AFL shareholders’ agreement (set out above) required the appellants' guarantees in respect of funds borrowed to acquire assets, furnish working capital or to meet any other financial obligations of the company. The amounts under appeal arose as a result of the appellants' obligations under this agreement and were clearly capital outlays.

In order for the appellants to claim a capital loss in respect of the advances to AFL, the appellants must prove that the debt was disposed of in that year. Subsection 50(1) of the Act deems a debt to have been disposed of where it is established that it became a bad debt in that year:

50. (1) For the purposes of this subdivision, where

(a) a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to him in respect of the disposition of personal-use property) is established by him to have become a bad debt in the year, or

the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, at the end of the year and to have reacquired it immediately thereafter at a cost equal to nil.

Counsel for the appellants argued that the appellants regarded AFL as insolvent and the debts in question to be uncollectable in 1982. He referred to the 1982 financial statements of the appellants which declared the advances were not recoverable and deducted them accordingly as extraordinary losses. Further reference was made to the substantial losses incurred by AFL over the years.

Questions, however, arise as a result of subsequent advances made by the appellants to AFL in 1983 and later years. The evidence indicated that these amounts were advanced to AFL who in turn advanced them to ACE to cover general operating cash requirements. The minutes of a board of directors' meeting of the appellant Harvey, held February 22, 1983, indicate that at least a portion of these funds were advanced "with a view to maintaining the prospect of recovering past losses through Government intervention".

[Emphasis added.]

In my opinion, the evidence of the witnesses at trial strongly indicates that a primary purpose behind the incorporation of ACE was the potential availability of government subsidization. While evidence was given at trial that the appellants did not anticipate that these subsidies would cover past losses, this clearly contradicts the minutes of the directors' meeting noted above. I would also note that the alleged losses have now been fully recovered by the appellants as a result of subsidies received by ACE. I cannot accept that these subsidies were not a major motivating factor for the continuance of the operations of AFL.

Generally speaking, a bad debt is one which is proven to be uncollectable. I am of the view that, on the balance of probabilities, at the end of the year 1982, the appellants were reasonably optimistic that government subsidies would repay those amounts advanced to AFL. On that basis I am unable to conclude that the loans advanced to AFL were bad debts at the end of 1982.

As a result of this finding, it is not necessary for me to deal with the issue of whether these loans were incurred for the purpose of gaining or producing income from a business or property within the meaning of subparagraph 40(2)(g)(ii) of the Act.

The appellants’ appeals in respect of their payments to AFL are therefore dismissed.

Disposal of the appeals

Considering the foregoing reasons, the appeal of Browning is allowed in part, with costs on one-third of the scale, and the matter referred back to the respondent for reconsideration and reassessment on the basis that the disposition of the coolers resulted in a loss of income. In all other respects, the Browning appeal is dismissed.

The appeal of Harvey is dismissed.

Appeals allowed in part.