Granada Distributors (Canada) Limited v. Minister of National Revenue, [1983] CTC 2554, 83 DTC 511

St-Onge, TCJ:—The appeal of the company Granada Distributors (Canada) Limited came before Mr F J Dubrule, Assistant Chairman of the Tax Review Board on October 21, 1982, but he was unable to render judgment before his death which occurred on March 13, 1983 and the parties hereto agreed that judgment should be rendered, on transcript of the evidence and argument, by a judge of the Tax Court of Canada.

Counsel for the respondent, in his reply to the notice of appeal, has admitted the following paragraphs of the notice of appeal which read as follows:

A. FACTS

1. The Appellant is a corporation incorporated under the laws of the Province of Ontario by letters patent dated January 7, 1970.

2. The Appellant and Granada Television Limited (“Granada”), a corporation incorporated pursuant to the laws of the United Kingdom and a resident of the United Kingdom are both wholly-owned subsidiaries of Granada Group Limited, also a United Kingdom corporation.

3. Granada produces films and productions for television in both film and videotape (its films and videotape productions being hereinafter collectively referred to as “Films”) and distributes the Films worldwide under a number of distributorship contracts.

4. The Appellant distributes films and videotapes of motion pictures and television programs including the Films.

5. On January 30th, 1970, the Appellant and Granada signed an agreement (the “Agreement”) wherein the Appellant was appointed Granada’s exclusive agent in Canada for the distribution of its Films. The Agreement requires the Appelant to pay to Granada a fee equivalent to 50% of its net income from the exploitation of Granada’s Films in Canada by the Appellant (“Rental Fees”) and to re-imburse Granada for its costs involved in preparing, insuring and shipping to the Appellant the Films distributed by the Appellant within Canada. These costs include the cost of all prints, negatives, masters, videotapes, trailers, slides, all customs and excise taxes and other duties payable on entry of the Films into Canada, brokerage costs, transportation, freight costs, handling charges, insurance and advertising costs together with any additional fees payable to writers or talent in the United Kingdom arising out of the additional exploitation of the Films. (All of the aforesaid costs and expenses re-imbursed to Granada by the Appellant are hereinafter referred to as the “non-rent costs”.).

6. The non-rent costs are paid by the Appellant to Granada without markup of any kind and represent in each case the actual expense incurred by Granada for such fee, cost, service of tax.

7. In each of the subject taxation years the Appellant has deducted and remitted withholding tax under Section 215(1) of the Income Tax Act (the “Act”) in accordance with the “Royalties” provisions of Section 212(5) of the Act with respect to the Rental Fees. The Appellant has not deducted or remitted any amount as a withholding tax with respect to the non-rent costs which are pre-paid by Granada on the Appellant’s behalf in order to make the films physically available in Canada for distribution by the Appellant.

8. Both the Films and the copyright in the Films remain at all times the property of Granada and the Appellant acquires only the right to show and distribute the Films within Canada pursuant to the Agreement.

Section 12 of the said agreement stipulates in part the following:

12. Distributors will ensure that upon expiry or termination of this Agreement or upon expiry of Granada’s rights in a programme or in the event that any agent or sub-distributor or representatives has no further use for the material whichever date is the earliest, that such agent or sub-distributor or representatives will deliver to such address as Granada may require all prints, negatives, videotapes or other material whether the same were delivered by Granada or reproduced locally in Canada. Such material will be returned in good condition subject to fair wear and tear. In the event that Granada elects in regard to any programme that any material shall be destroyed Distributors will, if requested by Granada, supply a Certificate of Destruction in lieu of returning the material as aforesaid. If Granada requires any such material to be delivered to an address within Canada then Distributors will be responsible for the expense of so doing. If Granada requires delivery to take place outside Canada then Granada shall bear the expenses actually incurred.

As may be seen, the issue is to interpret the agreement dated January 30, 1970, mentioned in paragraph 5 of the notice of appeal and to decide whether the non-rent costs paid by the appellant to “Granada” pursuant to the agreement were for a right in or to the use of the films.

Counsel for the respondent contended that to obtain a right in or the use of the films in Canada, many costs had to be paid including, inter alia:

1) artists fees

2) print costs

3) transportation cost.

He also contended that because the appellant failed to deduct or withhold amounts as required by the Income Tax Act, SC 1970-71-72, c 63 as amended, it should be inposed both penalty and interest as prescribed pursuant to subsection 227(8) of the Act.

At the hearing, Mr Stephen Ellis, General Manager of Ralph Ellis Enterprises (distribution company of television programs in and outside Canada) explained the following:

1) The ownership in the material remains in the English company whether or not it is reproduced in Canada.

2) Where Granada in England has advanced costs for any of the items, the Canadian company must reimburse it.

3) The costs of artists’ and scriptwriters’ fees, the costs of production, of prints, of transportation could be incurred in a distribution agreement where royalties arise depending upon the arrangements between the parties.

4) There were no facilities in Canada to make the copies, and it was desirable for the English company to keep the master material close at hand to make such copies.

Counsel for the appellant argued the following:

1) The appellant is the exclusive distributor of the products of Granada Television Ltd, and

2) In turn, the former has the right to license third parties to transmit and broadcast the materials that it obtained from its sister company in England.

All the non-rent costs, which the appellant had to reimburse to the English company, were calculated by the latter, and there is no evidence to know whether there was any profit made on the reimbursement of the artists’ and scriptwriters’ fees. As to the other non-rent costs, both parties agreed that there was no mark-up.

Counsel for the appellant explained the various types of costs as follows:

.. . There are three basic areas into which you could break down the costs I feel. Those three areas are essentially the area of the artists’ fees and scriptwriters’ fees, the transportation and related costs, that includes brokerage commissions, customs and excise taxes paid for the material to enter Canada and the like and the third area would be the principal hard costs which are the print and lab costs for the reproduction of videotapes and films.

With respect to the first of those the Appellant takes the position of artists’ and scriptwriters’ fees are costs of production and that they must be paid to make the copies and that particularly with respect to the scriptwriters’ fees they are protected under copyright provisions in Section 3 of Article 11 of the Canada — UK Tax Convention.

With respect to the transportation costs and taxes it is our position that these give no rights in or to the film but only get the physical product to Canada. They arise before or after or incidental to the showings of the films and they have no bearing or relationship to a royalty. The only basis of calculation is the invoice price for the transportation or the print cost or whatever which has no relationship to use or ownership or the length of time it is going to be paid in Canada. It is a one-shot payment in other words.

Counsel for the appellant also argued that the respondent, in taxing the form rather than the substance of the contract, wants to tax the costs like a royalty simply because they are associated with a contract that gives rise to royalties.

Counsel for the appellant referred the Court to the following cases:

(1) Peliculas Sari SA v MNR, [1980] CTC 2864; 80 DTC 1766 in this case, it was decided that there was no withholding of taxes when a film was sold to a resident by a non-resident.

(2) MNR v Paris Canada Films Limited, [1962] CTC 538; 62 DTC 1338, and The Queen v Saint John Shipbuilding & Dry Dock Co Ltd, [1979] CTC 380; 79 DTC 5297; in those last two cases, the Court dealt with royalties and rents.

Then, he gave the exemple of buying a “Picasso” painting which does not give the right to make copies therefrom. He concluded this first issue by saying because the off-shore disbursements are effectuated by the English company as agent for the appellant, they are not subject to withholding tax.

On the other issue, he said that there was no failure nor attempt to evade the payment of tax. He referred the Court to Regina v The City of Sault Ste-Marie — 85 DLR (3d) 161 and The Queen v Kurt Merkle, [1979] CTC 519; 80 DTC 6027, to show the existence of two kinds of offences, one which involves “mens rea” or guilty mind and the other which is the existence of a middle ground called “strict liability” to conclude that while one has done something wrong but had been reasonable in doing it, he violates the words but not the spirit of the Act and should not be liable for the offence.

On the other hand, counsel for the respondent argued that the words of subsection 212(5) of the Income Tax Act under the heading “Motion picture films” are clear and wide enought to tax the non-rent costs paid to the nonresident. Even if the intention of the taxpayer was to minimize taxes by drafting an agreement, the non-rent costs are still taxable under the said section because:

(1) They are still amounts paid for the use of a facility in England, and

(2) had the cost been paid by the UK firm without reimbursement, the rent would have been 70% of the net profit instead of 50%.

He also argued that the UK company was, at all times, the owner of the materials and the appellant company had no other right than to arrange for a limited distribution of the films. Also, once the films were used, they had to be returned to the UK company or destroyed. One should not say that certain costs do not fall within the meaning of a section of the Act just because of the existence of a written agreement which does not even appear to relate to what the appellant company did. He also mentioned that most of the cases cited by the appellant dealt with ownership and royalties and the only question to be decided in the case at bar was whether the legal agreement was a rental or a sale agreement.

As to the penalty section he says that once tax exists then the penalty and interest simply follow. There is a distinction to be made between criminal and civil proceedings, and in the case at bar, we are dealing with an assessment being raised in a civil manner and consequently there is no question of “mens rea” or reasonableness. As to the various cases cited by the appellant, they are all criminal cases and consequently not applicable in the present case.

The case at bar is simple. There is no doubt that the payment by the appellant company of various costs incurred by the UK company was a condition “sine qua none" to allow the various material, exclusive property of the latter, to be used in Canada by third parties, and the amounts of money whether royalties, hard costs, artists’ and scriptwriters’ fees, costs of transportation, etc were paid within the meaning of subsection 212(5) of the Income Tax Act which reads as follows:

(5) Motion picture films. (Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of, payment for a right in or to the use of

(a) a motion picture film, or

(b) a film or video tape for use in connection with television

that has been or is to be used or reproduced in Canada

(the italics are mine).

As may be seen, the above section does not mention royalties or cost but says “Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays” so there is no need herein to make any distinction between royalties and costs as long as they were amounts paid for the use of the films and videotapes.

Furthermore, the cases which were allowed with respect to subsection 212(5) of the Act, dealt with an amount paid for the sale of the material. Consequently, the amount paid was not for the use of, but for the ownership or the “us in re".

As to the second issue, it is obvious that once tax exists the penalty and interest follow, because herein we are dealing with an assessment being raised in a civil manner and therefore there is no question of “mens rea” or reasonableness.

For these reasons, the appeal is dismissed.

Appeal dismissed.