D
E
Taylor:—These
appeals,
heard
in
Winnipeg,
Manitoba,
on
November
19,
1981,
are
against
income
tax
assessments
for
certain
years
in
which
the
Minister
of
National
Revenue
added
amounts
as
follows
to
the
taxable
income
of
the
appellant:
|
Tax
Year
|
1974
|
1975
|
1976
|
1977
|
|
Reduction
in
Purchases
|
$
7,481.12
|
$
6,022.92
|
$
7,255.81
|
$6,166.60
|
|
Additional
Income
(Rebates)
|
4,598.92
|
4,253.57
|
3,316.93
|
Nil
|
|
Total
|
$12,080,04
|
$10,276.49
|
$10,572.74
|
$6,166.60
|
The
appellant
relied,
inter
alia,
upon
the
provisions
of
section
10,
paragraphs
18(1
)(a)
and
20(1
)(l)
and
(p)
of
the
Income
Tax,
SC
1970-71-72,
c
63,
as
amended,
while
the
respondent
relied,
inter
alia,
upon
sections
2,
3,
4,
9,
12,
18,
20
and
248
of
the
Income
Tax
Act,
as
amended.
The
appellant
is
a
corporation
incorporated
under
the
laws
of
the
Province
of
Manitoba
and
maintains
its
head
office
at
Arborg,
Manitoba,
and
Carries
on
business
as
a
merchant.
During
the
relevant
years,
the
appellant
was
a
Link
Hardware
Company
Ltd
(“Link”)
dealer,
and
had
certain
contractual
arrangements
with
Link.
Contentions
By
the
appellant:
—
The
amounts
at
issue
represented
the
cost
to
the
taxpayer
of
its
inventory
for
the
years
under
appeal.
—
Alternatively,
they
constituted
an
outlay
or
expense
incurred
by
the
taxpayer
for
the
purpose
of
gaining
or
producing
income
from
a
business.
—
Further
and
in
the
alternative,
the
amounts
ought
to
be
deductible
as
a
reserve
for
a
doubtful
debt
and
fully
deductible
as
a
bad
debt.
By
the
respondent:
—
The
appellant
overstated
the
amount
of
its
purchases
by
the
amounts
shown
as
“Reduction
in
Purchases”.
—
The
amounts
by
which
purchases
were
overstated
in
fact
represent
loans
by
the
appellant
to
Link.
These
loans
were
made
pursuant
to
Clause
11
of
an
Agreement
dated
September
25,
1974.
—
The
appellant
failed
to
report
volume
rebates
on
purchases
received
from
Link
in
the
amounts
shown
as
“Additional
Income
(Rebates)”.
—
The
appellant
loaned
the
amount
of
the
volume
rebates
to
Link
in
the
form
of
interest-bearing
promissory
notes.
At
the
start
of
the
hearing,
counsel
for
the
appellant
withdrew
the
second
alternative
argument
above
(re
doubtful
accounts
and
bad
debts)
and
notified
the
Board
that
he
would
concentrate
on
the
other
two
arguments.
Evidence
Mr
Kjartan
Johnson,
director
and
manager
of
the
appellant
company,
testified
regarding
the
arrangement
with
Link
and
the
operations
of
the
appellant
company.
Link
was
founded
by
a
group
of
individual
hardware
merchants
for
the
purpose
of
large
scale
hardware
purchasing,
thereby
in
turn
to
provide
merchandise
at
the
lowest
possible
cost
to
its
members,
one
of
which
was
the
appellant.
A
copy
of
the
agreement
in
effect
during
the
years
in
question
was
filed
as
Exhibit
A-1.
Two
promissory
notes,
one
dated
January
1,
1974
for
$4,598.92
and
one
dated
January
1,
1975
for
$4,253.57
from
Link
to
the
appellant,
were
also
filed
as
Exhibit
A-2,
together
with
a
covering
letter
which
accompanied
them,
dated
January
30,
1975
(Exhibit
A-3).
Under
cross-examination
by
counsel
for
the
respondent,
Mr
Johnson
filed
a
copy
of
a
letter
(Exhibit
R-1)
dated
March
24,
1978
received
from
Link.
All
these
documents
are
vital
to
an
appreciation
of
this
case.
Exhibits
A-1,
A-3
and
R-1
are
reproduced
in
total.
The
Note
dated
January
1,
1974
(part
of
Exhibit
A-2)
is
reproduced
and,
except
for
a
different
amount
and
interest
rate,
it
appears
identical
to
the
similar
note
for
January
1,
1975.
Exhibit
A-1
THIS
AGREEMENT
made
this
25th
day
of
SEPTEMBER,
A.D.
1974
BETWEEN:
LINK
HARDWARE
COMPANY
LTD.,
a
body
corporate,
having
an
office
at
the
City
of
Edmonton,
in
the
Province
of
Alberta,
(hereinafter
called
“the
Company”)
OF
THE
FIRST
PART,
—and—
JOHNSON
AND
SONS
ARBORG
LTD.
of
the
Town
of
Arborg
in
the
Province
of
Manitoba
Hardwareman,
(hereinafter
called
“the
Dealer”)
OF
THE
SECOND
PART.
THIS
AGREEMENT
WITNESSETH
that
for
and
in
consideration
of
the
mutual
covenants
and
agreements
herein
set
forth
and
contained,
the
parties
hereto
covenant
and
agree
as
follows:
1.
The
Company
agrees
to
sell
to
the
Dealer
such
of
the
Dealer’s
requirements
of
hardware
merchandise
as
are
described
in
the
Company’s
then
current
hardware
catalogue
and
are
available
at
the
prices
set
forth
in
such
catalogue
at
the
time
of
the
shipment
of
the
merchandise
to
the
Dealer
for
resale.
2.
The
Dealer
shall
within
fifteen
(15)
days
following
the
date
of
statement
to
him
by
the
Company
of
hardware
merchandise
remit
to
the
Company
the
full
purchase
price
thereof,
to
be
payable
in
Canadian
Funds
at
par
at
the
City
of
Edmonton,
in
the
Province
of
Alberta.
3.
The
Company
reserves
and
shall
have
the
right
at
any
time
to
revoke
any
credit
extended
to
the
Dealer
because
of
the
Dealer’s
failure
to
promptly
pay
for
any
merchandise
when
due
or
for
any
other
reason
deemed
good
and
sufficient
by
the
Company,
and
in
such
event
the
Company
shall
have
the
right
to
require
payment
in
advance
before
accepting
any
further
orders
of,
or
making
any
further
shipments
to,
the
Dealer.
4.
The
Dealer
shall
bear
and
be
responsible
for
all
expenses,
taxes,
licenses,
fees,
tariffs
and
other
charges
incurred
in
the
shipment
and
in
the
resale
of
all
merchandise
purchased
from
the
Company
for
the
Dealer’s
account.
5.
The
Dealer,
in
consideration
of
the
covenants
of
the
Company
herein
contained,
agrees
to
pay
the
Company
a
monthly
service
charge
of
Twenty-Three
($23.00)
Dollars
or
such
other
amount
as
the
Company
may
from
time
to
time
determine,
not,
however,
to
exceed
in
any
one
month
the
sum
of
Fifty
($50.00)
Dollars
without
the
prior
written
consent
of
the
Dealer.
6.
Delivery
at
any
point
in
Canada
or
in
the
continental
United
States
of
merchandise
to
a
common
carrier
or
licensed
trucker
for
the
Dealer’s
account
shall
constitute
delivery
to
the
Dealer
and
all
risks
of
loss
and
damage
in
transit
shall
be
borne
by
the
Dealer.
7.
The
Company
shall
not
be
liable
or
responsible
for
failure
to
deliver
or
delays
occasioned
by
strikes,
lockouts,
fires,
inability
to
obtain
merchandise
or
shipping
space,
breakdowns,
delays
of
carriers
or
suppliers,
governmental
acts
and
regulations
and
other
causes
beyond
the
control
of
the
Company.
8.
It
is
expressly
understood
and
agreed
that
there
are
no
guarantees,
warranties
or
representations,
express
or
implied,
made
by
the
Company
as
to
the
quality,
character
or
condition
of
any
of
the
merchandise
sold
to
the
Dealer
or
the
fitness
of
such
merchandise
for
any
particular
use
or
purpose.
9.
The
Dealer
is
and
will
continue
at
all
times
to
be
an
independent
hardware
merchant
and
is
not
to
be
considered
in
any
way
subject
to
control
by
the
Company.
11.
(a)
As
continuing
and
collateral
security
and
in
good
faith
for
the
performance
of
this
agreement
and
in
compliance
with
the
Company’s
credit
requirements
the
Dealer
hereby
deposits
with
the
Company
the
sum
of
One
Thousand
($1,000)
Dollars
(hereinafter
called
“the
Security
Deposit”)
the
receipt
of
which
the
Company
does
hereby
acknowledge.
(b)
In
respect
of
the
Security
Deposit
the
Dealer
covenants
and
agrees
that:
(i)
If
the
Dealer
fails
to
promptly
pay
the
monthly
service
charge
prescribed
in
Clause
5
hereof
or
for
any
merchandise
when
due,
the
Company
may,
without
his
consent
or
notice
to
him,
apply
all
or
any
part
of
the
Security
Deposit
in
satisfaction
of
the
Dealer’s
indebtedness
to
the
Company
as
aforesaid;
(ii)
Until
the
Company
shall
have
elected
to
realize
on
the
Security
Deposit
pursuant
to
this
Clause,
the
Company
shall
be
entitled
to
the
use
of
same
without
payment
of
interest;
(iii)
The
Company
reserves
and
shall
have
the
right
at
any
time
and
from
time
to
time
to
require
the
Dealer
to
deposit
with
the
Company
such
additional
securities
as
the
Company
may
determine;
provided,
however,
that
the
aggregate
principal
amount
of
all
securities
held
by
the
Company
on
deposit
for
the
credit
of
the
Dealer
shall
not
exceed
at
any
time
the
sum
of
Two
Thousand
($2,000.00)
Dollars,
and
all
such
additional
securities
shall
be
subject
to
the
terms
hereof.
Provided
further
that
nothing
herein
shall
limit
the
Company’s
right
to
demand
of
the
Dealer
a
performance
bond.
(c)
Nothing
in
this
clause
contained
shall
in
any
way
restrict,
prejudice
or
preclude
the
Company
from
making
or
enforcing
any
claim
or
demand
whatsoever
it
may
have
against
the
Dealer
for
or
in
respect
of
any
breach
of
the
terms
of
this
agreement
and/or
for
any
failure
of
the
Dealer
to
promptly
pay
the
Company
for
merchandise
when
due.
11.
(a)
The
Dealer
further
covenants
and
agrees
that
the
Company
shall
be
entitled
to
assess
and
add
to
each
invoice
for
merchandise
rendered
to
the
Dealer
an
amount
equal
to
such
percentage
of
the
gross
amount
of
each
invoice
as
the
Directors
of
the
Company
may
determine
from
time
to
time,
not,
however,
to
exceed
Two
(2%)
per
centum.
(b)
Any
amount
assessed
as
provided
for
in
11(a)
above
shall
be
deemed
to
be
a
loan
(hereinafter
called
“the
Volume
Loan”)
to
the
Company
by
the
Dealer,
which
shall
be
used
to
provide
working
capital
for
the
Company
and
shall
be
repaid
or
secured
to
the
Dealer
as
follows:
(i)
By
the
issuance
to
the
Dealer
of
$10.00
par
value
Redeemable
First
Preference
Shares
of
the
Company
(hereinafter
called
“Preference
Shares”)
until
the
Dealer
shall
have
accumulated
such
number
of
Preference
Shares
as
shall
be
equivalent
in
their
aggregate
par
value
in
any
specific
year
to
not
less
than
Twenty
(20%)
per
cent
of
the
total
value
of
his
previous
year’s
purchases
from
the
Company
(such
accumulation
being
hereinafter
called
“the
Basic
Accumulation”);
(ii)
In
respect
of
any
portion
of
the
Dealer’s
Volume
Loan
in
any
year
not
included
in
or
represented
by
the
Basic
Accumulation
by
the
issuance
to
the
Dealer
of
Subordinated
Promissory
Notes
of
the
Company
as
in
Clause
12
hereof
described
(hereinafter
called
“the
Subordinated
Notes”).
(c)
The
Company
shall
deliver
to
the
Dealer
annually,
not
later
than
one
hundred
and
twenty
(120)
days
after
the
close
of
the
Company’s
fiscal
year,
a
statement
of
the
aggregate
principal
amount
of
the
Volume
Loan
to
his
credit
for
such
year,
together
with
a
statement
of
such
Preference
Shares
and/or
Subordinated
Notes
as
the
Dealer
may
be
entitled
to
at
the
end
of
such
fiscal
year
and
shall
forward
therewith
certificates
for
any
Preference
Shares
and
any
Subordinated
Notes
indicated
thereon.
12.
(a)
The
Subordinated
Promissory
Notes
given
to
secure
payment
of
Volume
Loans
pursuant
to
Clause
11
(b)(ii)
hereof
shall
become
due
and
payable
in
ten
(10)
years
and
shall
bear
interest
at
such
rate
as
may
be
fixed
from
time
to
time
by
the
Board
of
Directors.
(b)
The
indebtedness
evidenced
by
the
Subordinated
Notes,
including
principal
and
interest,
shall
be
subordinate
and
subject
in
right
of
payment
to
all
Senior
Indebtedness.
(c)
The
term
“Senior
Indebtedness”
means
the
principal
of
and
interest
on:
(i)
indebtedness,
other
than
the
Subordinated
Notes,
whether
outstanding
on
the
date
of
this
agreement
or
hereafter
created,
incurred,
assumed
or
guaranteed,
which
is
for
money
borrowed
by
the
Company
or
for
money
borrowed
by
others
for
the
payment
of
which
the
Company
is
responsible
or
liable;
(ii)
indebtedness
created,
incurred,
assumed
or
guaranteed
by
the
Company
in
connection
with
the
acquisition
by
it
or
a
subsidiary
of
any
other
business,
properties
or
other
assets;
and
(iii)
renewals,
extensions
and
refundings
of
any
such
indebtedness;
unless
in
each
case
it
is
provided
by
the
terms
of
the
instrument
creating
or
evidencing
such
indebtedness
that
such
indebtedness
is
not
superior
in
right
of
payment
to
the
Subordinated
Notes.
(d)
All
or
any
part
of
the
Subordinated
Notes
issued
pursuant
to
this
agreement
are
callable
without
notice
or
bonus
prior
to
maturity
at
the
discretion
of
the
Board
of
Directors.
13.
The
Dealer
covenants
and
agrees
that
within
six
(6)
months
from
the
date
hereof
he
will
at
his
own
cost
and
expense
erect
on
his
retail
premises
a
sign
visible
from
the
exterior
of
such
premises
and
of
a
form
or
design
approved
by
the
Company,
bearing
such
insignia
of
the
Company
as
it
may
require.
14.
This
agreement
constitutes
a
personal
contract
and
neither
party
shall
assign
or
transfer
the
same
or
any
part
thereof
without
the
prior
written
consent
of
the
other.
15.
This
agreement
shall
continue
in
force
for
a
period
of
one
(1)
year
from
the
date
hereof,
and
thereafter
from
year
to
year
subject
to
termination
at
any
time
by
sixty
(60)
days’
notice
in
writing
being
given
by
either
party
to
the
other.
Upon
termination
of
this
agreement,
and
provided
the
Dealer
is
not
the
indebted
or
liable
to
the
Company
for
any
breach
of
the
terms
hereof
or
for
any
merchandise
sold
to
the
Dealer,
the
Company
shall
return
to
the
Dealer
the
Security
Deposit
and
any
additional
securities
deposited
pursuant
to
the
terms
hereof.
In
the
event
the
Dealer
is
in
breach
of
this
agreement
or
is
indebted
to
the
Company
at
the
time
of
termination
of
this
agreement,
the
Company
shall
be
entitled
to
retain
the
Security
Deposit
and
any
additional
securities
then
on
deposit
or
such
portions
thereof
as
may
be
necessary
to
fully
pay
and
satisfy
the
Dealer’s
indebtedness
to
the
Company.
16.
Notwithstanding
anything
in
this
or
in
any
previous
agreement
between
the
Company
and
the
Dealer
contained
any
Volume
Loans
to
the
Company
by
the
Dealer
made
or
incurred
during
the
1972
or
any
subsequent
fiscal
year
shall
be
subject
to
the
provisions
of
Clauses
11
and
12
of
this
Contract.
IN
WITNESS
WHEREOF
the
parties
hereto
have
executed
this
agreement
in
duplicate
the
day
and
year
first
above
written.
LINK
HARDWARE
COMPANY
LTD.
(corporate
seal)
Per:
Per:
Johnson
and
Sons
Arborg
Ltd
President
Secretary
Exhibit
A-2
SUBORDINATED
PROMISSORY
NOTE
Edmonton,
Alberta
Date:
Jan.
1,
1974
LINK
HARDWARE
COMPANY
LTD.,
for
value
received,
hereby
promises
to
pay
to
or
to
the
order
of
Johnson
&
Sons
Ltd.,
Arborg
ten
years
after
date,
subject
to
the
conditions
endorsed
hereon,
at
the
office
of
the
Company,
14810
-
131
Avenue,
Edmonton,
Alberta,
the
sum
of
Four
Thousand
Five
Hundred
&
Ninety
Eight
Dollars
&
Ninety
Two
Cents
—
Dollars
($4,598.92)
in
lawful
money
of
Canada
upon
due
presentation
and
surrender
of
this
Subordinated
Promissory
Note.
In
addition
thereto
Link
Hardware
Company
Ltd.
will
pay
interest
at
the
rate
of
Eight
per
cent
(8%)
per
annum
on
the
31st
day
of
December
in
each
year
until
the
maturity
hereof.
LINK
HARDWARE
COMPANY
LTD.
by
by
CONDITIONS
1.
This
Note
is
one
of
an
issue
of
like
notes
of
the
Company
(designated
as
Subordinated
Promissory
Notes
and
herein
sometimes
called
“the
Notes”)
issued
or
to
be
issued
in
sundry
amounts
evidencing
shareholder
loans
made
to
Link
Hardware
Company
Ltd.
(“the
Company”)
pursuant
to
a
certain
“Dealer’s
Contract”
between
the
original
registered
holder
hereof
and
the
Company
and
is
subject
to
all
of
the
terms
thereof.
2.
The
indebtedness
evidenced
by
the
Notes,
including
principal
and
interest,
shall
be
subordinate
and
subject
in
right
of
payment
to
all
Senior
Indebtedness.
3.
The
term
“Senior
Indebtedness”
means
the
principal
of
and
interest
on:
(a)
indebtedness,
other
than
the
Notes,
whether
outstanding
on
the
date
of
this
Subordinated
Promissory
Note
or
hereafter
created,
incurred,
assumed
or
guaranteed,
which
is
for
money
borrowed
by
the
Company
or
for
money
borrowed
by
others
for
the
payment
of
which
the
Company
is
responsible
or
liable;
(b)
indebtedness
created,
incurred,
assumed
or
guaranteed
by
the
Company
in
connection
with
the
acquisition
by
it
or
a
subsidiary
of
any
other
business,
properties
or
other
assets;
and
(c)
renewals,
extensions
and
refundings
of
any
such
indebtedness;
unless
in
each
case
it
is
provided
by
the
terms
of
the
instrument
creating
or
evidencing
such
indebtedness
that
such
indebtedness
is
not
superior
in
right
of
payment
to
the
Subordinated
Promissory
Notes.
4.
This
Subordinated
Promissory
Note
is
callable
without
notice
of
bonus
prior
to
maturity
at
the
discretion
of
the
Company.
5.
A
register
will
be
kept
at
the
Company’s
head
office,
whereon
will
be
entered
the
names
and
addresses
of
the
registered
holders
of
all
of
the
Subordinate
Promissory
Notes
of
the
Company
and
the
particulars
(including
the
maturity
dates)
of
the
Notes
held
by
them
respectively.
6.
As
interest
on
this
Note
matures,
the
Company
(except
in
case
of
payment
at
maturity
or
on
redemption
when
payment
of
interest
will
be
made
on
surrender
of
this
Note)
shall
forward
by
ordinary
post
to
the
registered
address
of
the
registered
holder
of
this
Note,
as
of
the
fifth
day
prior
to
the
date
of
such
payment,
a
cheque
on
the
Company’s
bankers
for
such
interest
(less
any
tax
deducted
as
required)
payable
at
par
in
Edmonton,
Alberta.
Such
cheque
shall
be
payable
to
the
order
of
such
registered
holder,
or,
in
the
case
of
joint
holders,
to
the
order
of
all
such
joint
holders
(failing
written
instructions
from
them
to
the
contrary)
and
shall
be
sent
to
the
registered
address
of
that
one
of
such
joint
holders
whose
name
stands
first
on
the
register
as
one
of
such
joint
holders
and
the
payment
by
the
Company’s
bankers
of
such
cheque,
if
purporting
to
be
duly
endorsed,
shall
be
an
effective
discharge
to
the
Company
to
the
extent
of
the
sum
represented
thereby
plus
the
amount
of
any
tax
deducted
as
required.
Exhibit
A-3
LINK
HARDWARE
COMPANY
LTD.
January
30,
1975.
Dear
Sirs:
We
are
very
pleased
to
enclose
our
January
1st.,
1973
and
January
1st,
1974
Promissory
Notes
covering
the
Rebate
for
the
years
1972
and
1973.
Yours
very
truly,
LINK
HARDWARE
COMPANY
LIMITED
A.M.
De
La
Plante
President
and
General
Manager
encs.
Exhibit
R-1
LINK
HARDWARE
COMPANY
LTD.
March
24,
1978
Johnson
&
Sons
Arborg
Ltd.
Arborg,
Manitoba
ROC
0A0
Dear
Sirs:
Our
1977
year
end
has
now
been
completed.
We
submit
herewith
an
analysis
of
your
investments
in
Link
Hardware
Company
Ltd.
Equities
as
of
December
31,
1977:
|
Common
shares
(200)
|
|
$
|
750.00
|
|
Security
deposit
|
|
1,000.00
|
|
Trust
fund,
1970-1971,
bearing
annual
interest
at
3%
|
|
1,540.79
|
|
Volume
loan
(arising
from
finance
charge)
|
|
|
1972
non-interest
bearing
|
|
3,573.39
|
|
1973
|
|
2,692.53
|
|
1974
|
|
7,481.12
|
|
1975
|
|
6,022.92
|
|
1976
|
|
7,255.81
|
|
1977
|
|
6,166.60
|
|
Promissory
notes
(arising
from
volume
rebates)
|
|
|
1972
bearing
annual
interest
@
|
7%
|
|
2,335.46
|
|
1973
|
@
|
8%
|
|
4,598.92
|
|
1974
|
@
|
7%
|
|
4,253.57
|
|
1975
|
@7-3/4%
|
|
3,316.93
|
|
Total
equity
|
$50,988.04
|
Should
you
desire
any
further
information,
please
contact
Mr.
Len
Kondro.
Yours
truly,
R.D.
Dalmer
AN
ASSOCIATE
MEMBER
OF
UNITED
WHOLESALERS
LTD.
Comptroller
It
appeared
from
the
testimony
of
Mr
Johnson
that
in
addition
to
the
Agreement
A-1,
there
had
been
at
least
the
hope
on
the
part
of
the
participating
hardware
dealers
such
as
the
appellant,
that
if
Link
were
profitable,
dividends,
rebates
or
discounts
of
some
kind
other
than
those
reflected
in
Exhibit
A-1
might
have
been
expected
by
the
dealers.
None
of
those
advantages
were
forthcoming,
but
that
prospect
and
the
indefinite
wording
of
certain
documents
may
have
caused
the
mathematical
confusion
which
will
be
referenced
later
in
this
decision.
It
was
Mr
Johnson’s
view
that
however
phrased,
Exhibit
R-1
referred
to
the
accumulated
2%
surcharge
that
was
mentioned
in
the
Agreement
(Exhibit
A-1).
Simply,
it
was
recorded
on
the
invoices
in
that
way
and
paid.
Link
was
to
operate
basically
on
the
discounts
it
received
from
suppliers
(by
buying
in
large
quantities),
but
the
2%
surcharge
was
to
provide
additional
operating
funds
to
the
degree
that
the
above
discounts
were
not
adequate
for
the
operation
of
Link.
Now,
Link
has
been
amalgamated
with
Home
Hardware
Ltd.
Mr
Gutman,
CA,
auditor
of
the
appellant
company
for
many
years,
testified
regarding
the
accounting
treatment
accorded
the
“2%”
amounts
referenced
in
the
Agreement
(Ex.
A-1).
In
essence,
2%
was
separately
added
to
each
invoice
from
Link,
the
total
of
the
invoice
(including
the
2%)
was
paid
to
Link,
and
that
entire
amount
inclusive
of
the
2%
was
charged
as
an
expense
of
cost
of
goods
sold.
It
was
treated
in
the
same
manner
as
one
would
treat
freight
—
as
a
part
of
the
laid-down
cost
of
goods.
It
had
been
the
considered
opinion
of
the
management
of
the
appellant,
and
supported
by
Mr
Gutman,
that
the
promissory
notes
and/or
preference
shares
were
valueless,
in
view
of
the
known
poor
financial
condition
of
Link.
If
indeed
any
of
these
amounts
had
ever
been
received
from
Link,
in
the
future
they
would
have
been
treated
as
income.
In
effect,
the
amounts
in
question
(if
they
could
be
considered
“income”
at
all)
were
only
“contingent
income”.
Certain
financial
information
and
shareholdings
records
from
Link
were
filed
by
the
appellant,
but
counsel
for
the
respondent
noted
that
no
witness
was
provided
to
identify
them
or
give
acceptable
evidence
thereon.
Under
questioning,
Mr
Gutman
agreed
that
no
specific
identifying
reference
had
been
made
to
the
amounts
(the
2%
payments)
in
the
accounts
of
the
appellant,
and
that
there
might
be
a
slight
difference
between
“freight”
as
a
laid-down
cost
and
these
payments
since
the
appellant
had
no
similar
agreement
with
its
freight
handlers
for
the
acquisition
of
stock
or
notes
in
those
companies.
Mr
Gutman
was
not
aware
of
anything
which
would
provide
the
Minister
with
the
view
that
the
items
referred
to
on
Exhibit
R-1
as
“arising
from
volume
rebates”
were
different
in
any
way
from
the
promissory
notes
referenced
in
the
Agreement
with
Link.
The
so-called
“investments”
in
that
letter,
other
than
the
first
three
therein,
arose
strictly
from
the
accumulated
2%
noted
earlier.
No
effort
had
been
made
to
correlate
the
details
on
Exhibit
R-1
with
the
invoices
from
Link,
or
the
books
and
records
of
the
appellant,
by
Mr
Gutman.
Mr
Homeniuk,
an
officer
of
Revenue
Canada,
testified
that
the
Minister’s
assessments
had
been
based
for
all
practical
purposes
on
Exhibit
R-1
—
that
the
amounts
in
question
if
founded
in
Exhibit
A-1,
might
apply
to
the
previous
fiscal
years,
and
that
no
effort
had
been
made
by
Revenue
Canada
to
correlate
the
amounts
on
R-1
to
the
income
of
Link,
or
the
books
and
records
of
the
appellant.
Argument
In
essence,
counsel
for
the
appellant
suggested
that
the
actual
form
and
import
of
the
transactions
with
Link
should
be
examined
and
accepted
as
cost
of
goods.
The
appellant
was
not
making
investments
and
except
for
the
two
promissory
notes
(Exhibit
A-2),
nothing
else
—
notes
or
preferred
shares
—
had
ever
been
issued
by
Link.
Even
in
Exhibit
A-2,
payment
was
not
due
for
10
years
and
there
was
no
possibility
that
Link
could
pay
then.
Cases
cited
by
counsel
included:
Algoma
Central
Railway
v
MNR,
[1967]
CTC
130;
67
DTC
5091;
MNR
v
Algoma
Central
Railway,
[1968]
CTC
161;
68
DTC
5096;
Associated
Investors
of
Canada
Limited
v
MNR,
[1967]
CTC
138;
67
DTC
5096;
The
Queen
v
F
H
Jones
Tobacco
Sales
Co
Ltd,
[1973]
CTC
784;
73
DTC
5577;
Paco
Corporation
v
The
Queen,
[1980]
CTC
409;
80
DTC
6215.
Counsel
for
the
respondent
noted
that
the
Agreement
itself
was
important.
No
effort
had
been
made
by
the
appellant
to
enforce
issue
by
Link
and
receipt
by
the
appellant
of
the
promissory
notes
or
the
preferred
shares,
and
there
remained
a
strong
doubt
in
the
mind
of
counsel
about
the
precise
nature
of
the
“volume
rebate”
amounts
referenced
on
Exhibit
R-1.
According
to
the
Minister,
they
could
be
additional
rebates
credited
to
the
appellant
by
Link,
outside
of
the
terms
of
the
Agreement
(Ex.
A-1).
At
the
very
least,
they
were
part
of
Agreement
(A-1)
and
were
still
taxable
on
the
same
basis
as
the
other
amounts
noted
on
that
exhibit,
having
arisen
by
virtue
of
the
2%
surcharge
in
cost
of
goods
annually
recorded
by
the
appellant.
Counsel
agreed
there
might
be
some
technical
argument
regarding
the
proper
fiscal
year
for
taxation
of
the
amounts,
depending
on
their
origin,
but
nothing
had
been
provided
by
the
appellant
to
give
better
identification
for
the
amounts
than
that
ascribed
to
them
by
the
Minister.
The
argument
of
counsel
for
the
appellant
seemed
to
have
two
thrusts
—
one
that
the
amount
in
question
is
a
proper
charge
to
inventory
and
should
only
be
thought
of
in
that
way.
According
to
counsel,
it
was
just
part
of
the
Agreement
by
which
the
appellant
obtained
its
merchandise.
The
appellant
had
no
choice
except
to
pay
it,
recognizing
even
while
paying
it
that
there
was
no
merit
whatsoever
in
the
clauses
of
the
Agreement
relating
to
securities,
possible
return
of
these
funds,
revenue
from
them
as
investments,
etc.
The
second
thrust
of
his
argument
appeared
to
be
that
even
if
they
were
“investments”
in
the
technical
sense
of
the
word,
the
case
law
cited
supported
his
proposition
that
even
though
they
might
appear
to
be
capital
in
nature,
they
were
nevertheless
legitimate
deductions
for
the
purpose
of
gaining
or
producing
income.
To
the
second
of
these
arguments,
counsel
for
the
Minister
responded
that
while
the
case
law
cited
could
give
some
comfort
to
the
appellant
(that
“capital”
items
could
be
deducted),
nevertheless
that
same
case
law
dealt
only
with
the
point
in
time
when
such
“capital”
items
became
losses
by
way
of
uncollectibility
or
as
bad
debts.
Such
amounts
were
found
in
certain
selected
case
law
to
have
resulted
from
loans,
advances
or
guarantees
incurred
in
the
pursuit
of
gaining
or
producing
income,
and
were
judged
deductible.
Findings
As
I
see
it,
this
is
really
a
factual
issue
—
whether
or
not
the
accounting
treatment
accorded
the
2%
surcharge
amounts
(as
an
item
of
current
expenses)
is
appropriate,
or
whether
the
amounts
at
issue
represent
capital
amounts
and
are
therefore
not
properly
classified
as
part
of
cost
of
goods
sold.
We
are
going
to
refer
to
the
total
amount
at
issue
as
simply
“X”
since
another
facet
of
this
dealing
with
quantum
remains
to
be
addressed
after
the
above
major
issue
is
put
to
rest.
“X”
is
that
which
the
appellant
paid
to
Link
during
the
years
in
question
over
and
above
the
regular
invoiced
price
for
the
goods
alone,
and
calculated
according
to
the
Agreement
at
2%
of
the
regular
amounts.
“X”
at
present
has
been
deducted
by
the
appellant
as
a
cost
of
merchandise
purchased
—
a
direct
cost
of
doing
business
(argument
#1
above).
On
that
point,
there
is
only
one
thing
that
counts
—
the
Agreement
Exhibit
A-1,
and
it
is
explicit.
When
taken
in
the
context
of
the
testimony
of
Mr
Johnson
(that
“X”
was
used
to
provide
operating
funds
for
Link),
the
viability
of
the
“cost
of
goods”
treatment
accorded
to
“X”
disintegrates.
A
straight
reading
of
the
Agreement
leads
to
only
one
possible
conclusion
—
that
after
a
period
of
time
Link
would
have
established
itself
as
an
independent
and
stable
organization,
that
the
dealers’
investments
in
redeemable
preferred
shares
could
be
redeemed
(if
desirable)
and
that
the
promissory
notes
could
be
paid
off.
That
would
leave
the
common
shareholders
(of
which
the
appellant
was
one)
owning
the
company
Link,
and
able
to
to
continue
buying
merchandise
at
low
cost
from
an
organization
which
in
itself
was
earning
a
profit
for
them.
This
did
not
apparently
come
about,
but
that
is
the
result,
not
the
intention
of
the
Agreement.
The
Agreement
could
have
just
as
easily
called
for
a
simple
2%
(or
any
other
figure)
surcharge
on
invoiced
merchandise,
for
which
the
dealer
was
neither
promised,
nor
received
or
expected
anything
in
return.
That
would
have
had
the
same
effect
as
far
as
the
operation
of
Link
would
be
concerned,
but
it
would
not
have
provided
for
any
possible
investment
build-up
by
the
participants.
I
also
note
with
some
interest
that
the
opportunity
existed
in
the
Agreement
for
the
appellant
to
terminate
it
on
60
days’
notice.
That
opportunity
was
not
taken
up
by
the
appellant,
and
the
unilateral
decision
on
the
part
of
the
appellant
to
treat
its
2%
contribution
as
added
cost
of
goods
sold
rather
than
the
investment
agreed
upon
is
without
effect
against
the
Minister
of
National
Revenue.
The
Minister
is
a
disinterested
third
party,
as
regards
the
Agreement,
and
the
income
tax
liability
inherent
in
the
Agreement
cannot
be
prejudiced
by
the
unwarranted
interpretation
placed
on
it
by
the
appellant
through
accounting
procedures,
no
matter
how
sound
and
reasonable
a
business
decision
it
might
have
appeared
under
the
circumstances
to
record
it
in
that
way.
“X”
does
not
represent
a
part
of
the
cost
of
goods
sold,
nor
does
it
have
any
relationship
to
the
inventory
of
the
appellant.
On
the
second
point
raised
by
counsel
for
the
appellant
(for
the
purpose
of
gaining
or
producing
income),
it
is
my
view
that
to
make
it
effective,
counsel
must
first
accept
that
“X”
is
a
capital
item,
at
least
not
a
normal
revenue
item.
In
raising
this
point
as
an
argument,
counsel
has
implicitly
changed
direction
and
accepted
that.
He
is
entitled
to
do
so,
but
it
is
now
his
responsibility
to
establish
that
“X”
was
uncollectible,
and
indeed
when,
how
and
under
what
circumstances
it
became
uncollectible,
as
referenced
by
counsel
for
the
respondent.
The
only
two
physical
indications
of
“X”
are
in
Exhibit
A-2,
and
that
is
a
difficult
task
to
prove
when
the
maturity
date
is
ten
(10)
years,
and
of
course
it
has
not
yet
elapsed.
The
fact
that
for
whatever
reason
physical
documents
representing
the
balance
of
“X”
have
not
been
issued
according
to
the
Agreement,
is
an
indication
of
a
lack
of
attention
to
its
own
legitimate
business
interests
by
the
appellant,
not
proof
of
uncollectibility
from
Link.
Turning
now
to
the
subsidiary
question
—
the
quantum
of
“X”,
I
am
in
agreement
with
counsel
for
the
appellant
and
his
witnesses.
“X”
is
only
that
represented
by
the
accumulated
2%
surcharge
amounts
over
the
years
in
question.
The
Minister’s
assertions
with
regard
to
some
subsidiary
form
of
volume
rebate
(based
on
Exhibit
R-1)
is
without
merit,
according
to
the
testimony
and
evidence
available
to
the
Board.
The
Minister
has
added
the
specific
amounts
noted
earlier
(1974
—
$12,080.04;
1975
—
$10,276.49;
1976
—
$10,572.74;
1977
—
$6,166.60)
to
the
taxable
income
of
the
appellant
rather
than
accepting
the
accounting
treatment
accorded
“X”
in
the
books
of
the
company.
I
agreed
earlier
in
this
decision
that
the
accounting
treatment
could
not
be
supported,
and
did
not
warrant
the
deduction
of
“X”.
At
the
same
time,
I
am
not
impressed
with
the
fact
that
neither
the
Minister,
nor
the
appellant,
made
any
effort
to
determine
the
precise
amount
of
“X”.
The
Minister
simply
took
the
amounts
to
be
added
and
assessed
from
Exhibit
R-1,
without
assurance
that
they
were
the
proper
amounts
or
even
for
the
proper
years;
and
the
appellant
simply
argued
that
the
deductibilty
of
“X”
was
correct,
again
without
regard
for
the
quantum
of
“X”.
I
am
prepared
to
concede
that
the
Minister’s
assessments
in
question
hardly
stand
as
models
of
factual
review
and
precision,
at
least
as
I
can
understand
them.
However,
the
critical
fact
is
that
the
appellant
corporation
has
been
additionally
assessed
on
certain
amounts
in
specific
years,
and
no
evidence
has
been
brought
forward
by
the
appellant
to
show
that
these
amounts
assessed
were
greater
than
amounts
which
should
properly
have
been
added,
and
that
consequently
the
company
is
being
over-taxed.
Merchandise
purchases
by
the
appellant
in
each
of
the
taxation
years
approximated
one
million
dollars,
and
the
Board
has
no
evidence
regarding
which
portion
(perhaps
all)
of
this
was
acquired
from
Link.
Two
per
cent
of
$1,000,000
is
$20,000,
so
there
is
at
least
a
reasonable
prospect
that
the
amount
improperly
included
as
“cost
of
goods
sold”
and
charged
off
as
an
expense
in
each
year
was
$20,000.
It
was
the
responsibility
of
the
appellant
to
show
that
the
amounts
assessed
were
too
great,
and
for
what
reason.
In
the
attempt
to
do
that,
the
appellant
directed
its
efforts
to
showing
that
the
proper
additional
amount
should
have
been
“nil”.
The
company
was
unable
to
support
this
primary
contention
(and
indeed
it
is
an
erroneous
contention),
and
the
Board
has
no
basis
upon
which
to
alter
the
amounts
assessed.
Summary
Whether
the
security
documents
in
question
have
been
issued,
or
whether
the
appellant
can
look
to
realization
on
the
securities,
are
not
the
critical
factors
at
issue
in
this
appeal.
The
payments
made
as
surcharges
to
purchase
invoices
were
for
the
purpose
of
acquiring
investments
—
a
capital
cost
—
and
investments
they
remain
at
this
stage
of
the
process.
They
were
not
for
the
acquisition
of
inventory
and,
irrespective
of
the
fact
that
counsel
for
the
appellant
withdrew
the
“bad
debt”
argument,
no
evidence
was
adduced
which
would
support
a
conclusion
at
this
time
that
as
investments
they
are
worthless.
Further
consideration
of
that
aspect
of
the
matter
could
require
a
review
of
the
case
law
in
George
Sher
v
MNR,
[1978]
CTC
2486;
78
DTC
1356,
(upheld
on
appeal
to
the
Federal
Court
and
reported
at
[1980]
CTC
168;
80
DTC
6095;
Johnson
&
Kredentser
v
MNR,
[1980]
CTC
2471;
80
DTC
1418,
and
Marvin
C
Holland
v
MNR,
[1980]
CTC
2487;
80
DTC
1452.
Out
of
fairness
to
the
appellant,
I
have
also
reviewed
the
case
of
Aluminum
Company
of
Canada
v
The
Queen,
[1974]
CTC
471;
74
DTC
6408,
which
raised
as
one
argument
the
question
of
preserving
a
supply
of
raw
materials.
The
difference
in
that
case
is
that
the
learned
Justice
therein,
in
allowing
the
appeal,
determined
that
the
amount
in
question
represented
a
payment
on
revenue
account,
not
on
capital
account.
That
is
the
opposite
to
my
decision
in
this
matter,
and
the
problem
remains
the
same
for
the
appellant
—
to
establish
how
and
under
what
circumstances
any
part,
or
all
of
that
capital
amount
represents
an
outlay
for
the
purpose
of
gaining
or
producing
income,
under
applicable
sections
of
the
Act.
Decision
The
appeals
are
dismissed.
Appeals
dismissed.
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