Sanilit Limited v. Minister of National Revenue, [1987] 2 CTC 2078

Rip, T.C.J. [Translation]: —Sanilit Limited ("Sanilit"), the appellant, is appealing from tax assessments in respect of the 1982 and 1983 taxation years in which the Minister of National Revenue, the respondent, ruled that the interest on term deposits in the amount of $76,120.97 for 1982 and $94,404.21 for 1983 was Canadian investment income within the meaning of paragraph 129(4)(a) of the Income Tax Act (the Act) and that accrued interest in the amount of $35,078.83 on the 1983 term deposits should be included in the appellant's investment income in respect of the 1983 taxation year within the meaning of paragraph 12(1)(c) and subsection 12(3) of the Act.

Subsection 129(4) has been amended several times as it applied to the 1982 and 1983 taxation years.* [1] For the years under appeal, paragraph 129(4)(a) read as follows:

129(4) In subsection (3),

(a) “Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which

(A) the amount by which

(I) the aggregate of such of the corporation's taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada,

exceeds

(II) the aggregate of all amounts each of which is the portion of a taxable capital gain referred to in subclause (I) from the disposition by it of a property, other than a designated property, that may reasonably be regarded as having accrued while the property, or a property for which it was substituted, was property of a corporation other than a Canadian-controlled private corporation, an investment corporation, a mortgage investment corporation or a mutual fund corporation

exceeds

(B) the amount by which

(I) the aggregate of such of the corporation's allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,

exceeds

(II) the aggregate of all amounts each of which is the portion of an allowable capital loss referred to in subclause (I) from the disposition by it of a property, other than a designated property, that may reasonably be regarded as having accrued while the property, or a property for which it was substituted, was property of a corporation other than a Canadian-controlled private corporation, an investment corporation, a mortgage investment corporation or a mutual fund corporation, and

(ii) all amounts each of which is the corporation's income for the year from a source in Canada that is property (other than exempt income, any dividend the amount of which was deductible in computing its taxable income for the year, income from real property of a corporation that is not a Canadian-controlled private corporation, or income that, but for paragraph 108(5)(a), would not be income from a property), determined after deducting all outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning income from that property,

exceeds

(iii) the aggregate of amounts each of which is the corporation's loss for the year from a source in Canada that is a property; and . . .

The appellant's thesis is that the interest amounts of $76,120.97 and $94,404.21 were active business income of the corporation for the year as defined by subsection 125(6) of the Act,+ [2] and, with regard to the $35,078.83, the Minister did not take into account the penalty, or the loss of part of the interest, if the appellant were to cash in the deposits before the maturity date. In his notice of appeal, the appellant did not refer to the interest from an active business, which would qualify for the manufacturing and processing tax deduction under section 125.1, but claimed this deduction in its income tax returns for 1982 and 1983. The Minister denied the appellant's right to claim that deduction in his reply to the notice of appeal.

The appellant's agent during the trial was Mr. Hubert Sabourin, president and sole shareholder. Mr. Sabourin was also the only witness. The notice of appeal, the reply to the notice of appeal and three of the four exhibits were written in English although the documentary evidence was in French.

The parties did not submit Sanilit’s articles of incorporation in evidence. Sanilit is in the wood shavings business. It collects and processes wood shavings and resells the product to farmers for mulch. Sanilit’s suppliers are wood manufacturers who cannot freely dispose of their waste because of environmental considerations.

A copy of a contract dated July 1982 between Sanilit, described as the "Contractor", and Trout Creek Planing Mill Ltd., described as the "Owner", was presented in evidence. Mr. Sabourin said that this contract was signed by the parties; he indicated that this document was a typical example of the contracts in his business. For a better understanding of the relationships between Sanilit and its suppliers, I will cite a portion of this contract:

IN CONSIDERATION of the mutual covenants herein contained the parties hereto agree as follows:

1. To construct on the property of the Owner on Highway 11 at Trout Creek, Ontario, a building suitable for a “shavings building”.

2. The Owner will at its own expense supply the materials and labour to construct such building (save and except as set out in paragraph 3) in accordance with the engineers plans to be supplied by the Contractor.

3. The Contractor will supply and install the steel frame on the Owner's foundation and after the building is completed by the Owner the Contractor will supply and install the electrical from the 100 amp disconnect within the building for the machinery to be installed by the Contractor.

4, The Contractor will supply, install and maintain in the said building all equipment necessary to bag the shavings and without limiting the generality of the foregoing such equipment will include:

bagger

stapling machine

air compressor

paper bags

staples

trailers to move finished products from building

Except as hereinafter set out the said bagging equipment will remain the property of the Contractor.

5. The Owner will transport all shavings from its Planing Mill in Trout Creek to the said shavings building and will supply the labour to bag such shavings and load same on to the Contractor's trucks.

6. The Owner shall pay all operating expenses of such building including hydro to run equipment and heating if necessary.

7. The Contractor shall purchase all of the shavings bagged by the Owner and shall pay to the Owner the sum of 67¢ (45¢ for material and 22¢ for labour) per full bag of shavings for the period ending December 31, 1983 and thereafter the price per bag for each year will change on the 1st day of January for the following year. The amount of the increase or decrease in payment shall be pro rated to the direct proportionate increase or decrease for the year 1983 in The Consumer Price Index for Canada published by The Dominion Bureau of Statistics for the Dominion of Canada for “all items”.

8. The contract period will be eight (8) years commencing January 1, 1983 and ending December 31, 1990 or a minimum amount of 1,000,000 bags whichever shall first occur.

In the 1982 and 1983 taxation years, the appellant invested in term deposits amounting to $550,000 and $600,000 respectively. Each term deposit was invested for a year, but one deposit would mature every month. Mr. Sabourin explained that the $550,000 and $600,000 had been divided into 12 parts, and "that every month, one of the deposits matured, which allowed me to have one-twelfth of that money available every month without being penalized for cashing it in ahead of time. And that was still a one-month term/'Sanlit never cashed in any deposit prematurely, but instead renewed each deposit. Mr. Sabourin said that he spent one and a half to two hours every month arranging for this monthly investment. The term deposits were made with the banks where Sanilit did its business, the Bank of Montréal, The Caisse Populaire and the Société Hypothécaire de la Banque de Montréal. The appellant also invested in treasury bills. Mr. Sabourin conducted the negotiations by telephone at the end of every month. He telephoned the Bank of Montréal, the Royal Bank of Canada, the Bank of Nova Scotia and the Caisse Populaire to ascertain the interest rates.

In his notice of appeal, the appellant said that "these funds are held in the corporation as a reserve to offset future decline in markets and expansions [sic] therefore should be regarded as active business income.”

Mr. Sabourin testified that the term deposits were kept with a view to expansion. He also explained that Sanilit has five- or ten-year contracts, depending on the mill, committing it to collect the shavings for a definite period. "Therefore, I need monetary guarantees to back me up, as security for my obligations [to the mills]. That is why I chose to leave this money at the company's disposal. Because of that fact, therefore, that money is active participation.”

Mr. Sabourin also explained that the mills, his customers, wanted the appellant to be solvent and reliable and to have funds to back up his undertakings.

Finally, he testified that, with the money in the bank, he could get a better price for his purchases because he could pay the vendor at the time of purchase.

Sanilit's fiscal year ends on June 30.

Sanilit’s assets and liabilities on June 30, 1982 and June 30, 1983 are shown on the balance sheet of June 30, 1983 as follows:

SHAREHOLDERS’ EQUITY

CAPITAL STOCK

Authorized —

3,500 redeemable preference shares

with a par value of $10 each

5,000 common shares, no par value

Issued and fully paid —
200 common shares	2,000	2,000
RETAINED EARNINGS	815,371	815,371
	817,371	817,371
	$1,217,385	$1,217,385
The shares of Hubert Sabourin Inc. are held by Mr. Sabourin.

Sanilit’s gross profits for its 1982 and 1983 fiscal years are shown in its balance sheet and are determined as follows:

The net income from the business' activities, before paying officers’ salaries and taxes was $223,460 in 1982 and $116,625 in 1983.

No evidence was led regarding any general standard or accepted commercial practice whereby a financial reserve would be required in order to operate a business or the appellant's suppliers might demand a pro forma account on entering into a contractual relationship with the appellant. It is clear that a company needs a reasonable financial reserve to carry on business; usually the reasonable reserve has a direct or ancillary relation to the business. In this appeal, Mr. Sabourin testified that his business required a $550,000 reserve in 1982 and a $600,000 reserve in 1983; the respondent claims that these reserves were too high and did not have a direct or ancillary relation to his business. If 1 find that these reserve amounts are too high, I must dismiss the appeal, because there is no evidence that the said reserve amounts would be reasonable in the circumstances.

Mr. Sabourin said that he found support for his position in paragraphs 8 and 9 of Interpretation Bulletin IT-73R3, dated April 15, 1980, which reads as follows:

8. It is the Department's view that income of any nature that is ancillary to the activities involved in carrying on a business is income from that business, notwithstanding the fact that it could also be described as income from property or from a source specified in subdivision d of Division B of Part I. The amendment to subparagraph 129(4)(a)(ii) (applicable to taxation years after May 6, 1974) that distinguishes income from property that is "used or held . . . in the course of carrying on a business" from other income from property supports this view. This amendment is considered to have been added for purposes of clarification only and is not interpreted to mean that such was not the intention of the legislators in respect of earlier years.

9. Dividend and interest income from property held for long-term investment is rarely categorized as income from an active business unless there is a clear relationship to a business carried on by the corporation e.g., investment of reserve funds in long-term bonds by a general insurer. On the other hand, short-term investments are usually categorized as income from an active business, but exceptions to this rule include investment of the proceeds from the sale of a business formerly carried on by the corporation or investment of the portion of the corporation's capital that is clearly in excess of the amount required to carry on existing levels (or planned levels on a short-term basis) of business activity, having due regard for cyclical business fluctuations.

An interpretation bulletin is merely a means by which the Minister of National Revenue, who administers the Act, makes public his interpretation of the Act and it cannot contradict a clear legislative text. Nonetheless, this administrative interpretation has real weight and, in case of doubt about the meaning of the legislation, becomes an important factor (per de Grandpre, J, Hare I v. Deputy Minister of Revenue (Quebec), [1978] S.C.R. 851 at 859 [1977] C.T.C. 441 at 448.

In Canadian Marconi Company v. The Queen, [1986] 2 S.C.R. 522; [1986] 2 C.T.C. 465, the Supreme Court of Canada reviews situations when investment income may be active business income. Canadian Marconi Company (C.M.C.) owned and actively managed a large and profitable portfolio of short-term interest-bearing securities. The portfolio was created on the forced sale of its broadcasting interest and was eventually to be liquidated in order to purchase a business similar to or complementary with C.M.C.'s electronic equipment manufacturing business. For the taxation years 1973 through 1976 inclusive, C.M.C. claimed a tax credit in respect of the interest earned, relying on section 125.1 of the Act. It maintained that this interest was part of its “Canadian manufacturing and processing profits" a portion of which is eligible for deduction under that section, because the interest received was income from an active business. "Canadian manufacturing and processing profits" are defined to be such portion of "the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under rules prescribed for that purpose by regulation.”

In his reassessments, the Minister held the interest income to be income from property and not from an active business. C.M.C. unsuccessfully appealed the reassessments to the Federal Court (Trial Division) and the Federal Court of Appeal.

The Supreme Court of Canada allowed the appeal.

Wilson, J. confirmed the principle established by case law, which is English rather than Canadian, that in the case of a corporate taxpayer there is a rebuttable presumption that income received from or generated by an activity done in pursuit of an object set out in the corporation's constating documents is income from a business. In the case of C.M.C., these constating documents provided that one of its objects was an investment business. Wilson, J. added at page 531 (C.T.C. 470):

Indeed, even if CMC's investment objects were not expressed, I believe that a broader form of the presumption should apply. In a general sense CMC was incorporated to earn income by doing business. There is no reason why any income earned by it should not be considered as prima facie income from a business so long as it is recognized that the presumption is a rebuttable one. This approach has commended itself to courts even where no express object was contained in the constating documents: see, for example, Supreme Theatres Ltd. v. The Queen, 81 D.T.C. 5136 (F.C.T.D.), and Fontaine Watch Co. v. Minister of National Revenue, 60 D.T.C. 535.

The question whether particular income is income from business or property remains a question of fact in every case. However, the fact that a particular taxpayer is a corporation is a very relevant matter to be considered because of the existence of the presumption and its implications in terms of the evidentiary burden resting on the appellant.

Wilson, J. concluded that the taxpayer's business strategy is not relevant in determining whether the appellant's income was from business or property; the relevant inquiry is whether in fact the taxpayer was in fact in the investment business.

Ensite Limited ("Ensite") claimed that the interest it earned from investments was “foreign investment income". Ensite, which had to finance its plant in the Philippines with foreign currency in order to comply with Philippine law, became involved in an elaborate arrangement to minimize the risks of devaluation and currency controls. Ensite made U.S. dollar deposits with the commercial banks, which then made the peso loans in an equivalent amount to its Philippine branch. In return for the U.S. dollar deposits, Ensite received certificates of deposit which were then used to secure the peso loans. The certificates were “enforceable” against any branch of the commercial banks outside the United States. The pesos were obtained in exchange for U.S. dollars by the commercial banks from the Central Bank of the Philippines under agreements guaranteeing the rate of exchange of any conversion back to U.S. dollars.

In 1976, Ensite claimed a “dividend refund" under paragraph 129(1)(a). The tax scheme contemplated that an increase in a corporation's "foreign investment income" might result in an increase in its “dividend refund". Ensite included the interest from its U.S. dollar deposits in the Philippines in the calculation of its "foreign investment income".

The Minister reassessed the return and refused to recognize the interest as "foreign investment income" as defined in paragraph 129(4)(b), because it was "income from property used or held by the corporation in the year in the course of carrying on a business”. Ensite's dividend refund was therefore reduced. The Federal Court, Trial Division allowed an appeal from that reassessment, but its judgment was overturned on appeal.

Ensite's appeal was subsequently dismissed by the Supreme Court of Canada.

Wilson, J. discussed the reasons given by the judges of the Federal Court of Appeal in The Queen v. Marsh & McLennan, Ltd, [1984] 1 F.C. 609; [1983] C.T.C. 231. In Marsh & McLennan, Ltd, the point in issue was whether the investment by the appellant, an insurance broker, of funds received as premiums from his clients, which had not yet been remitted to the insurer, were "income from property used or held by the corporation in the course of carrying on a business" within the meaning of the exclusion in subparagraph 129(4)(a)(ii) of the Act as it applied in 1976. To assist in determining whether the property was used or held in the course of carrying on a business, Wilson, J. adopted the test of Le Dain, J. who asked the following at page 621 (C.T.C. 243):

Was the fund employed and risked in the business? In my opinion it was, because an amount equivalent to this notional fund was committed to the carrying on of the business in order to meet the company's obligations to the insurers.

Wilson, J. said (at page 518; C.T.C. 463) that the wording of the test employed by Le Dain, J. emphasized that the holding or using of the property must be linked to some definite obligation or liability of the business.

Wilson, J. discussed the tests set out by the Federal Court of Appeal ([1983] C.T.C. 296; 83 D.T.C. 5315) in Ensite in relation to the relevant statutory provisions: sections 125, 125.1, 129(1) and 129(4) before and after the amendment of the latter. She explained that the legislative scheme was to draw a distinction between active business income which would fall under sections 125 and 125.1 and other sources of income which would fall under section 129. She wrote:

However, it was clearly arguable that income from property which was immersed in the trading activity of the corporation could qualify as active business income. The aforementioned amendment which added the words "other than a property used or held by the corporation in the year in the course of carrying on a business” in parentheses after the words "that is a property" removed this argument and preserved the distinction between active business income and other sources of income: see Arthur R.A. Scace, The Income Tax Law of Canada (3rd ed. 1976), at page 257. The rebuttable presumption that corporate income is income from a business (see: Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, released concurrently herewith) is of no application here as it would tend to collapse the distinction between active business income and other sources of income which Parliament clearly intended to preserve in its amendment of s. 129(4) of the Act.

It would seem to follow that the legislative intention underlying the amendment was to catch income from property that is employed or risked in the taxpayer's business to such an extent that the income from it could be characterized as active business income. The use of words such as "employed" and "risked" appropriately implement Parliament's intention.

Subsection 129(4) has been amended since the amendment discussed by Wilson, J. When this subsection was amended by S.C. 1979, c. 5, subsection 41(2) and (3), the legislator added subsection 129(4.1) by S.C. 1979, c. 5, subsection 41(4), amended by 1980-81, c. 47, Schedule I, item 12, applicable from the date of Royal Assent, February 19, 1981. Subsection 129(4.1) read as follows in 1982 and 1983:

129(4.1) For the purposes of paragraph (4)(a) and subsection (6), "income" or "loss" of a corporation for a year from a source in Canada that is a property includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada but does not include income or loss

(a) from any other business,

(b) from any property that is incident to or pertains to an active business or a non-qualifying business carried on by it, or

(c) from any property used or held principally for the purpose of gaining or producing income from an active business or a non-qualifying business carried on by it.

The legal effect of subsection 129(4.1) is similar to the legal effect of the words in parentheses added by the amendment of subsection 129(4), referred to by Wilson, J. It should be noted that paragraph 129(4.1)(c) uses the word "principally" following the words "used or held”. The addition of subsection 129(4.1) limits the property used or held for the purpose of gaining or producing income from an active business by the corporation. Subsection 129(4.1) preserves the distinction between active business income and other sources of income.

Accordingly, I must decide whether Sanilit's term deposits are property that is incident to or pertains to an active business carried on by the corporation; or whether this property is used or held principally for the purpose of gaining or producing income from an active business by the corporation; or whether Sanilit is carrying on another business, namely, an investment business.

In my opinion, the term deposits are not incident to nor do they pertain to the business carried on by Sanilit. I agree that the term deposits were available to Sanilit's customers if the appellant did not fulfill its contractual obligations or if the business failed. But this situation is not the "risk" to which Le Dain, J. alluded. Wilson, J. wrote at page 520 (C.T.C. 464):

But "risked" means more than a remote risk. A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would “have a decidedly destabilizing effect on the corporate operation themselves": March Shipping Ltd. v. Minister of National Revenue, supra, at p. 374. This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset in the long term (see, for example, Bank Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307 (Scot Ct. of Session)) from an investment made in order to fulfil a mandatory condition precedent to trade (see, for example, Liverpool and London and Globe Insurance Co. v. Bennett (1951), 32 T.C. 101 (Eng. H.C.J.). Only in the latter case would the withdrawal of the property from that use significantly affect the operation of the business. The same can be said for a condition that is not mandatory but is nevertheless vitally associated with that trade such as the need to meet certain recurring claims from that trade: see, for example, The Queen v. March & McLennan, Ltd., supra, and The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319 (F.C.A.).

With the exception of the reasons for judgment in Atlas Industries Ltd. v. M.N.R., [1986] 2 C.T.C. 2392; 86 D.T.C. 1756, I am not aware of any cases that interpret the expression "that is incident to or pertains to an active business” or, in its French version, "se rapporte directement ou d'une manière accessoire à une entreprise exploitée activement", within the meaning of subsection 129(4.1). In Atlas Industries Ltd, the taxpayer corporation carried on a business of custom fabrication of sheet metal and also carried on a roofing business. During the taxation years in question, the taxpayer invested part of his funds on hand in short-term bank deposits. The balance of his funds was retained in a current non-interest bearing account which, with his receivables, the taxpayer had anticipated would be sufficient for operating purposes. The taxpayer had determined his refundable dividend tax on hand on the basis that interest earned on short-term bank deposits was “Canadian investment income”. The Minister took the position that the interest was not Canadian investment income since the income was from a property which “is incident to or pertains to an active business". The taxpayer successfully appealed to the Tax Court of Canada.

The Associate Chief Judge of that Court explained the purpose of paragraph 129(4.1)(b) at page 2404 (D.T.C. 1764-65):

The starting point I think must be that where a corporation is carrying on an active business and it has income from a source in Canada that is a property, that property is not necessarily to be regarded as being incident to or pertaining to the business. If that was intended, presumably Parliament would have said so.

Giving the words “incident to or pertains to an active business" their grammatical and ordinary sense, and bearing in mind their context, there must I think be some substance between the property and the active business before the exclusion in paragraph 129(4.1)(b) comes into play. The oprations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This I regard to be the basic approach to paragraph 129(4.1)(b). Whether income-producing property has crossed the dividing line into the paragraph will depend on the facts of each case.

I am satisfied that the facts of this appeal are not sufficient to include term deposits in the meaning of “incident to or pertains to an active business". The relationship between the term deposits and the business is weak. There is no evidence the appellant used the term deposits for his business. Mr. Sabourin testified that the appellant kept the term deposits for the expansion of the business but, because of the recession, it was not really a good time to expand. He alluded to an expansion in North Bay (Ontario), but there is no evidence as to the nature of that expansion. I am not convinced that the whole amount of the term deposits was necessary for operating the business. There is no evidence that any creditor, or the bank or even a customer, for example, had insisted that Sanilit hold a reserve. A business needs a minimal reserve and within the whole amount there was a lesser amount represented by that reserve that was incident to or pertained to the business.

It is certain that the appellant used the term deposits for commercial purposes, but that is not enough. I sincerely doubt that the withdrawal of the loans, wages and accumulated bonuses for Sanilit by Mr. Sabourin would have had "a clearly negative effect on the company's operations". The capital in the term deposits came from business activities carried on for some collateral purpose such as expansion. The term deposits were not intimately related to the activities of the business, such as a requirement to settle certain reoccuring claims resulting from its activities.

In my opinion, the fact that Mr. Sabourin spent one and one-half to two hours a month in making inquiries about the term investments does not amount to a business (see: Burri v. The Queen, [1985] 2 C.T.C. 42; 85 D.T.C. 5287 and March Shipping Limited v. M.N.R., [1977] C.T.C. 2527; 77 D.T.C. 371). Sanilit never held itself out to be an investment company; the money that it invested had no business nature.

The interest in the term deposits invested by Sanilit is property income or “Canadian investment income" within the meaning of subsection 129(4) of the Act.

Subsection 12(3) provides that, in computing the income for a taxation year of a corporation, there shall be included any interest on a debt obligation that accrued to it to the end of the year. If the corporation wishes to cancel the term deposit before the maturity date, the amount by which the interest to be paid is decreased or penalized does not matter, that amount of interest attracts income tax in the year in which the deposit was cancelled, not before. The Act cannot be interpreted on the basis of hypothetical situations that may not occur. The $35,078.83 must be included in Sanilit's income in respect of the 1983 taxation year.

The appeal must be dismissed.

Appeal dismissed.