Panelling Unlimited of London Incorporated v. Minister of National Revenue, [1982] CTC 2178

John B Goetz:—This is an appeal by the appellant with respect to its 1977 taxation year. At the outset of the hearing, by agreement between counsel, it was agreed that the issues involved would apply as well to the 1978 taxation year. This was done at the suggestion of W L Whittingham, of the Appeals Division of Revenue Canada in a letter addressed to Mr H S Muroff and dated August 21, 1981. The letter reads as follows:

Revenue Canada

Taxation

Our file

August 21, 1981 W L Whittingham

Appeals Division

Mr H S Muroff

c/o Muroff Forest Products Limited

P O Box 518,

WINDSOR, Ontario

N9A 6N1

Dear Sir:

Re: Panelling Unlimited of London Inc.,

1977 Appeal to Tax Review Board

This letter will confirm the verbal advice given by Mr R Davey, Chief of Appeals, that if the company is successful in its appeal of the 1977 year to the Tax Review Board, the Department will carry the resultant loss forward to the year 1978 as Originally filed.

To protect yourself from the situation where the 1978 year might go statute-barred, it is recommended that you request the Tax Review Board decision to include the application of any 1977 loss to the year 1978 if applicable.

I acceded to the above request, but on reflection, I consider that I had no jurisdiction to do so because the only material before me related to the 1977 taxation year. Consequently, this judgment relates only to the 1977 taxation year.

This appeal relates to the disallowance of a bad debt expense of $128,002 claimed by the appellant which was disallowed in the 1977 taxation year. The respondent contends that the so-called bad debt was in fact an advance of capital to two related companies and relies, inter alia, upon section 3, subsection 9(1), paragraphs 12(1)(a), (b), 18(1)(a), 20(1)(p), subparagraph 40(2)(g)(ii) and section 251 of the Income Tax Act, SC 1970-71-72, 63, as amended.

Henry Muroff gave evidence on behalf of the appellant. He indicated that he had many years of experience in the lumber business and that the appellant had a large business in the sale of general lumber, both retail and wholesale, to contractors or to the trade.

The appellant as well as Panelling Unlimited of Ontario Inc and Panelling Unlimited of Kent Inc (hereinafter referred to as “Ontario Inc” and “Kent Inc” respectively) were incorporated on May 19, 1971. The three companies could properly be termed as a family enterprise as the appellant company shareholders were the husbands of the wives of Ontario Inc and their chil- dren were shareholders of Kent Inc. Control, of course, flowed from the appellant which did business in the London area. Kent Inc did business in Sarnia and Ontario Inc did business on the east side of London. They were all separate stores and, of course, three separate legal entities.

The method of operation was as follows: the appellant made all purchases of materials and supplied inventory to the two related companies at cost. It was responsible for payment for purchases from suppliers. Kent Inc and Ontario Inc each paid into the appellant’s bank account on a weekly basis, proceeds of sales of the inventory supplied to them by the appellant. The related companies deposited money daily into their local bank and then each week the money was transferred to the appellant’s account in Windsor at the main branch of the Canadian Imperial Bank of Commerce. All goods were transferred at cost. At the end of each year the sales of the three stores were calculated and each charged with the cost of goods sold. All the books of records were kept by the appellant.

The reason given by the appellant for this arrangement was that it felt it would enable the appellant to get a reduction in the purchase price by virtue of volume purchases which would be to its benefit as well as to the related companies. The evidence in this regard, I am afraid, was very nebulous and the accountant who gave evidence on behalf of the appellant could not, with any certitude, state what savings, if any, were made by the so-called volume purchases. In light of this, I do not accept the volume purchase proposition set forth by the appellant.

The appellant was aware each week of how much material had been sent to Kent Inc and Ontario Inc and how much money had been received from these companies. From day one the two related companies, Kent Inc and Ontario Inc, lost money. On the financial statements filed at the hearing, the first balance sheet produced was as of June 1973, showing:

Accounts receivable

Trade	$ 9,556
Other	114,056
The 1974 balance sheet showed:
Accounts receivable
Trade	$ 18,479
Other	135,502

Both Kent Inc and Ontario Inc went bankrupt in 1974, their doors being closed by the appellant in that they were a failure from day one. This so-called account receivable designated as “Other” in the amount of $135,502 represented money owing to the appellant from Kent Inc and from Ontario Inc and was carried on the balance sheet until 1977 when the accountants transferred it to the statement of operations for the year ended June 30, 1977 and therein showed:

A banker perusing their financial statements in the intervening years between 1974 and 1977 would get a completely different picture of the appellant’s business if, in fact, they had placed the sum of $135,502 in the profit and loss statement at least commencing in 1974, and I am sure that, prior to that period, the lack of sales on the part of the related companies would have been more truly reflected, had they been placed in the profit and loss statements.

The reason given by the appellant for placing the sum of $135,502 in its balance sheet in the accounts receivable was that it “hoped” that some day they would reopen the stores or perhaps two other outlets. The disallowed item was not in truth a genuine trade debt but rather an inventory advance to Kent Inc and Ontario Inc and did not compose an integral part of the business of the appellant.

Kent Inc and Ontario Inc received operating capital in the form of inventories supplied at cost and certainly were not trade receivables but rather, in my view, were capital loans. The figure of $135,502, for some reason or other, was changed by the parties to the appeal to $128,002 and that is the figure with which I shall deal.

The transfers of inventory to the two related companies, and I hold them so pursuant to the provisions of section 251 of the Act, were not effected for the purpose of gaining or producing income from the appellant’s business and therefore were not transferred in the course of the appellant’s business. As a result, the transfers are not allowable to a deduction pursuant to the provisions of paragraph 18(1)(a) of the Income Tax Act which reads as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

Furthermore, the said transfers could not be considered a bad debt within the meaning of paragraph 20(1 )(p) of the Act which reads as follows:

20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to the source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(p) the aggregate of debts owing to the taxpayer

(i) that are established by him to have become bad debts in the year, and

(ii) that have (except in the case of debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money) been included in computing his income for the year or a previous year;

From all the evidence before me, I hold that the debt owed to the appellant by the related companies arose from an advance of capital to them and that such loans, or shall I say the supplying of capital by way of inventory, by the appellant, was not made for the purpose of gaining or producing income from a business or property and, in consequence thereof, the loss arising from the related companies which failed to pay the appellant for the transfers of inventory is deemed to be nil by virtue of subparagraph 40(2)(g)(ii) which reads:

40. (2) Notwithstanding subsection (1),

(g) a taxpayer’s loss, if any, from the disposition of a property, to the extent that it is

(ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm’s length,

See North West Tent & Awning Co Ltd v MNR, [1976] CTC 2332; 76 DTC 1227.

The advances made were not an integral part of the profit-making process of the appellant and this is vital to the appellant’s appeal. Counsel for the appellant placed great emphasis on the decision of my learned colleague Roland St-Onge, Esq, QC, in Mosport Park Limited v MNR, [1977] CTC 2397; 77 DTC 264, but that case can be clearly differentiated on the facts. In that case the appellant was in the business of promoting racing events and advanced money to associated companies to prepare and publish an elaborate racing program filled with advertisements and racing articles. At 2399 and 265 respectively, it is stated:

The appellant was not skilled in the printing and publishing field and the work of the said companies would give three definite advantages to the appellant company, that is;

1. no additional cost to obtain the deadline of printing and delivery;

2. a great saving of money regarding the paper stock which was bought in larger quantity;

3. consistency of the product which was necessary to please the customers.

This method of operating then was an integral part of the appellant’s business and it made substantial profits from the sale of the programs. The appellant had advanced money to the associated companies which advances at the end of the appellant’s fiscal year became unrecoverable or, in other words, “bad debts”. Under the circumstances Mr St-Onge found that the advances were an integral part of the appellant’s business and the loss was incurred in its purpose of gaining income.

The case at bar is clearly different and for the above reasons I dismiss the appeal.

Appeal dismissed.