Lehndorff Realty Developments Limited v. Minister of National Revenue, [1982] CTC 2721, 82 DTC 1742

John B Goetz:—This is an appeal from an income tax assessment for the appellant’s 1974 taxation year. The appellant’s notice of appeal, inter alia, included the following statements of facts and of law:

Introduction

1. By a re-assessment, notice of which is dated September 28, 1977 the Minister of National Revenue added to the taxpayer’s income amounts totalling $5,222,907 described in the Statement of Adjustments attached to the notice of re-assessment as follows:

(1 ) foreign exchange loss claimed in 1974— re: 1973		$ 140,899
	re: 1974	4,918,471	5,059,370
(2)	Interest on foreign exchange loss
	Claimed in 1974— re: 1973	11,272
	re: 1974	152,265	163,537
			$5,222,907

On objection the assessment was confirmed by notificatioin dated January 26, 1979.

It is to the addition of these amounts totalling $5,222,907 that the appellant objects.

Statement of Facts

2. The Appellant is a company incorporated under the laws of Ontario. At the material time it held interests in companies which owned and developed land in Ontario and elsewhere in Canada. All of its issued shares are owned by a German Kommanditgesellschaft (“limited partnership”), Canada Grundstücksentwick- lungen Lehndorff Vermogensverwaltung GmbH & Co (hereinafter referred to as “Canada Grund”).

3. The taxpayer owned a 40% interest in a company, Kashel Developments Limited (hereinafter referred to as “Kashel”) which owned all of the shares of a subsidiary Morenish Land Developments Limited (hereinafter referred to as “Morenish”). Morenish owned 49.9% of the shares of Y & R Properties Limited (hereinafter referred to as “Y & R”) and 73.5% of the shares of Imperial General Properties Limited. Kashel owned .65% of the shares of Y & R. On April 30, 1974, Kashel owned no shares in Y & R but the interest of Morenish in Y & R had increased to 52.37%.

4. In addition to its interest in Kashel, the Appellant owned 90% of the shares of Lehndorff Properties Limited (hereinafter referred to as “Lehndorff”) and 90% of the shares of Amex Development Limited (hereinafter referred to as “Amex”). All of the companies in which the appellant had a direct or indirect interest carried on the business of owning or developing real property.

5. By a letter of agreement dated December 31, 1971, the Appellant agreed to idemnify and save harmless Canada Grund from any currency losses incurred by Canada Grund as a consequence of Canada Grund having advanced loans to corporations of which the Appellant was a substantial shareholder which currency losses were to be repaid from dividend income from those corporations. By an agreement dated January 2, 1973, between the Appellant and Canada Grund, the letter agreement of December 31, 1971, was amended to delete the provision that the indemnity was to be paid out of dividend income. The agreement further provided that Canada Grund, in consideration of the Appellant’s agreement to indemnify it against currency exchange losses, agreed to continue to advance loans to corporations in which the Appellant had substantial interests.

6. As a result of the Appellant’s agreement to pay the currency losses sustained by Canada Grund, Canada Grund continued to make substantial advances to Kashel and Morenish by way of loan and by way of subscription for preferred shares, which advances were used by those companies in their respective businesses.

7. Pursuant to the agreements, the Appellant was obliged in 1974 to indemnify Canada Grund for currency exchange losses sustained by it in the aggregate amount of $5,059,370 in respect of loans to corporations in which the Appellant had a substantial interest, together with interest in the amount of $163,537. In computing its income for the taxation year 1974, the Appellant deducted these amounts, which deductions were disallowed by the Minister in making the reassessment for the 1974 taxation year.

8. In 1974 the Appellant sold its shares in Kashel and realized and reported a Capital gain on the sale. The Minister, in addition to refusing to allow the deduction of the sum of $5,059,370 in computing the Appellant’s income as an outlay or expense on revenue account, also refused even to treat the amount paid as a loss on capital account the amount whereof should be deducted in computing the Appellant’s net capital gain for the 1974 taxation year.

9. The Appellant’s agreement to indemnify Canada Grund for currency losses otherwise sustained by it was made as a matter of commercial necessity and with a view to earning income in the form of dividends from the shares which it owned.

Statutory Provisions Upon Which the Appellant Relies and Reasons Which it Intends to Submit

10. The Appellant relies upon, inter alia, sections 9, 38, 39 and 248 of the Income Tax Act.

11. The Appellant says that the amounts paid to Canada Grund were laid out as a necessary cost of earning income and for the purpose of gaining or producing income as a matter of practical commercial necessity and were not outlays of a capital nature. Accordingly the amounts are fully deductible on revenue account in computing the Appellant’s income.

NOTE: The respondent neither pleaded nor argued that the outlay of expenses were on account of capital.

In reply thereto, the Minister in his reply to notice of appeal maintained his assessment on the following assumptions:

6. In assessing the Appellant for the 1974 taxation year the Respondent relied upon the following assumptions:

(a) the facts hereinbefore admitted;

(b) the amount of $5,220,907 paid by the Appellant to Canada Grund in its 1974 taxation year was not an outlay or expense made or incurred by the Appellant for the purpose of gaining or producing income from property or a business of the Appellant;

(c) the said amount of $5,220,907 was not an outlay or expense made or incurred for the purpose of disposing of the shares of Kashel

Statutory Provisions Upon Which the Respondent Relies and the Reasons Which he Intends to Submit:

7. He relies, inter alia, upon Sections 3, 4 and 9; Paragraph 18(1 )(a) and Subparagraph 40(1 )(a)(i) of the Income Tax Act RSC 1952, c 148.

The Minister also admitted that the documents referred to in the appellant’s material “should speak for themselves”.

Before calling any evidence, counsel for the appellant pointed out to the Board certain portions of the decision in MNR v Pillsbury Holdings Ltd, [1964] CTC 294; 64 DTC 5184, at 302 and 5188 respectively:

The relevance of this pleading appears from the decision of the Supreme Court of Canada in Johnston v MNR, [1948] SCR 486; [1948] CTC 195 per Rand, J, delivering the judgment of the majority, at pp 489, 202:

“Every such fact found or assumed by the assessor or the Minister must then be accepted as it was dealt with by these persons unless questioned by the appellant.”

(For the word “appellant” in that quotation, may be substituted “respondent” for the purpose of this appeal.) The respondent could have met the Minister’s pleading that, in assessing the respondent, he assumed the facts set out in paragraph 6 of the Notice of Appeal by:

(a) challenging the Minister’s allegation that he did assume those facts,

(b) assuming the onus of showing that one or more of the assumptions was wrong, or

(c) contending that, even if the assumptions were justified, they do not of themselves support the assessment.

(The Minister could, of course, as an alternative to relying on the facts he found or assumed in assessing the respondent, have alleged by his Notice of Appeal further or other facts that would support or help in supporting the assessment. If he had alleged such further or other facts, the onus would presumably have been on him to establish them. In any event, the Minister did not choose such alternative in this case and relied on the facts that he had assumed at the time of the assessment.)

Counsel therefore contended that the only assumption that he had to deal with, pursuant to the Minister’s reply to notice of appeal, was the Minister’s assumption that the payments involved were not an outlay or an expense made or incurred by the appellant for the purpose of gaining or producing income from property or a business of the appellant.

Numerous documents were filed by the appellant which would appear to substantiate its allegations in its notice of appeal. The Crown’s case rested solely upon the proposition that payment was not an outlay or expense made or incurred for the purpose of gaining or producing income from property or a business of the appellant within the meaning of paragraph 18(1 )(a) of the Act.

Issue

It would appear therefore, that the only issue to be determined by me is whether the payment of $5,520,907 by the appellant to “Canada Grund” was paid out as a necessary cost of earning income for the purpose of gaining or producing income as a matter of practical commercial necessity was not an outlay of a capital nature and, if I should so find, then the amount would be fully deductible on revenue account in computing the appellant’s income.

Facts

The facts as disclosed in the notice of appeal were verified by the documents filed as well as through the evidence of Dr Hans G Abromeit. Donald G H Bowman, Esq, QC, counsel for the appellant, at the outset explained certain terminology and gave some explanations of names of the German companies involved. The appellant is a company incorporated under the Laws of Ontario. All of its issued shares were and still are owned by a German limited partnership known as Canada Grundstücksentwichlungen Lehndorff Vermogensverwaltung GmbH & Co, (hereinafter known as “Canada Grund”). I am quoting directly from the transcript taken at the hearing:

Now, a German word which will appear in the evidence from time to time and which means “limited partnership” is “Kommanditgesellschaft” sometimes abbreviated to “KG”. This is a form of business organization which is very common in Germany. The structure is essentially the same as the structure of a limited partnership under Ontario Law, with one difference that I will come to in a moment. There is a general partner known as “Komplementar” and the limited partner is known as “Kommanditisten”. The general partner which in this case is the corporation has the responsibility of running the affairs of the partnership and is fully liable to the debts, obligations and liabilities of the partnership. To that extent it is similar to our limited partnership. The limited partners contribute capital to the partnership and their liability is limited to the capital which they have subscribed. In this particular partnership and their liability is limited to the capital which they have subscribed. In this particular partnership the general partner is a German limited company known as Lehndorff Vermogenswerwaltung GmbH, the shares of which are owned by Dr and Mrs Hans G Abromeit and Mr Jan Von Haeften.

Dr Abromeit will be my first witness.

Under the partnership agreement which formed the limited partnership a board of individuals is constituted whose function it is essentially to pass on important decisions of the partnership and to protect the interests of the limited partners. Moreover the partnership had its own independent auditor in Germany.

To that extent I would say that there is a difference under the German Law and the Canadian Law in that the limited partners do have a board which acts as sort of a watchdog. We do not have a similar arrangement under Ontario Limited partnerships, or under any of the provincial limited partnerships that I am aware of.

Canada Grund is one of a number of limited partnerships set up in Germany under the Lehndorff name and the purpose of the partnership was to invest in real estate in Canada. At the relevant time there were several hundred limited partners, virtually all of whom were German individuals or companies, German and I suppose other Europeans, but more German than anything else. The partnership interests are and continue to be bought and sold on a regular basis in Germany. All of the shares of the Appellant, Lehndorff Realty Developments Limited, were at the time of the transactions in question, and continue to be owned by Canada Grund. Lehndorff Realty Developments Limited owned a forty per cent (40%) interest in the Kashel Developments Limited, a Canadian company which owned all of the shares of a subsidiary, Morenish Land Developments Limited. Morenish in turn owned forty-nine per cent (49%) of the shares of Y & R Properties Limited, and seventy-three point five per cent (73.5%) of the shares of IGP, all of this is set out in the pleadings, I am just setting it out here again.

The appellant filed a book of documents as Exhibit A-1 and I refer to Tab 1 thereof which shows the corporate connection and interrelationship of Lehndorff Realty Developments Limited, the Canadian corporation. This can be referred to as a chart of Corporate Relationships showing their interrelationship and ownership of shares (see chart attached hereto, p 2825).

1. 5% OWNED BY THE METROPOLITAN TRUST COMPANY WHICH VOTES WITH

LEHNDORFF REALTY PURSUANT TO A VOTING TRUST AGREEMENT.

2. 50% OWNED BY W. B. SULLIVAN CONSTRUCTION COMPANY LIMITED.

3. 2.5% OWNED BY NAVONA INVESTMENTS LIMITED.

2.5% OWNED BY COCO INVESTMENTS LIMITED.

4. 50% OWNED BY DINEEN CONSTRUCTION LIMITED.

In 1969 and 1970 the appellant entered into a relationship with a gentleman by the name of Prusac. Canada Grund wholly owned the appellant, which company was set up to deal in real estate and land development. Having no expertise in that field, Dr Abromeit, who was the moving force behind all of the corporations, had the appellant enter into an agreement on March 16, 1970 with the firm known as W B Sullivan Construction Limited (“Sullivan”). This agreement was filed under Tab 6 of Exhibit A-1 and the parties involved were:

W B Sullivan Construction Limited hereinafter called “Sullivan”

OF THE FIRST PART

Lehndorff Realty Developments Limited hereinafter called “Lehndorff Realty”

OF THE SECOND PART

The Metropolitan Trust Company hereinafter called “Metro”

OF THE THIRD PART

— and —

Lehndorff Vermôgensverwaltung GmbH hereafter called “Lehndorff GmbH”

OF THE FOURTH PART

Prusac had the real estate expertise and the appellant had the financial backing of Canada Grund. As a result, they incorporated a company known as Kashel Developments Limited whose purpose of incorporation was to develop certain lands. A clause in that agreement provides as follows:

16. All income generated by the Company shall be applied as follows:

(d) To the prepayment of the principal sum from time to time outstanding pursuant to the Metro Mortgage, which prepayment shall be made:

Lehndorff Realty	as to 80%
Sullivan	as to 20%

(e) The balance of the income of the Company, if any, shall, unless the directors

otherwise agree, be paid to the parties in the following proportions:

Sullivan	50%
Lehndorff Realty	40%
Lehndorff GmbH	5%
Metro	5%

The appellant became very successful in its relationship with Prusac and then became associated with persons of like expertise in the major centres from coast to coast in Canada, ending up with approximately $155,000 in assets.

Respondent’s Position

The respondent submitted that Canada Grund was a German corporation and could only act through the appellant. Counsel for the appellant says that it is an erroneous technicality and that it was the obligation of the appellant to provide financing to Canadian land developers. Counsel for the respondent argued that all the presumptions go against the appellant’s case and submitted that the payments made by the appellant were not made for the purpose of gaining or producing income and therefore the appellant comes within the prohibition of paragraph 18(1)(a) of the Act. Originally, the appellant was to pay back Canada Grund through dividends as a result of the real estate activities of Kashel and Morenish. This was subsequently changed whereby the appellant, in order to obtain any further funds from Canada Grund, accepted a complete and full obligation to repay any advances made to it through Canada Grund, who in turn obtained its funds from its numerous limited partners in Europe in this joint corporation business venture.

Counsel for the respondent cited the following list of authorities:

Canada Safeway Limited v MNR, [1957] CTC 335; 57 DTC 1239;

The Queen v H Griffiths Company Limited, [1976] CTC 454; 76 DTC 6261;

L Berman & Co Ltd v MNR, [1961] CTC 237; 61 DTC 1150;

MNR v George H Steer, [1966] CTC 731; 66 DTC 5481;

Algoma Central Railway v MNR, [1967] CTC 130; 67 DTC 5091;

D W S Corporation v MNR, [1968] CTC 65; 68 DTC 5045;

Stewart & Morrison Limited v MNR, [1972] CTC 73; 72 DTC 6049;

Donald P McLaws v MNR, [1972] CTC 165; 72 DTC 6149;

Her Majesty The Queen v F H Jones Tobacco Sales Co Ltd, [1973] CTC 784; 73 DTC 5577;

Neonex International Ltd v Her Majesty The Queen, [1977] CTC 472; 77 DTC 5321.

Counsel for the respondent argued that the business of the subsidiary is not the business of the parent. The exchange losses vis-a-vis the Canadian dollar and the German mark became a problem and it was for this reason that the appellant had to enter into an absolute obligation of repaying any moneys advanced plus any loss of exchange. Mr Gill, counsel for the respondent, stated:

I submit that whatever benefits the appellant was the gain from the results that were to be achieved by entering into the agreement with Canada Grund to repay the exchange losses, even if there were some gains to be made, they were too remote.

I certainly acknowledge the fact that the business of a subsidiary is not necessarily that of its parent company. I do not accept the respondent’s contention that the interposition of the appellant which entered into all agreements with Canadian developers whereby it, the appellant, provided the majority of the financing and the developer provided the expertise, does categorize what Mr Gill says:

. . . the Appellant did not lend the money to its subsidiary, the Appellant in those transactions had no direct connection, it was merely a loan from Canada Grund to Morenish and Kashel.

Mr Gill says that the F H Jones Tobacco Sales Co Ltd case (supra) does not apply to the case at bar because the appellant does not meet the “sole purpose test”.

Appellant’s Submissions

I think that because of the succinctness with which Mr Bowman can express himself, I cannot improve on the written submission filed by him at the conclusion of the evidence and I quote same in toto:

Submissions Made on Behalf of the Appellant

Mr Chairman, the issue in this case boils down to a very simple single point. “Was the sum of $5,222,907 paid by the Appellant to Canada Grund an outlay or expense made or incurred by it for the purpose of gaining or producing income from property or business of the Appellant?” This is the only issue raised by the Minister and the only basis advanced for disallowance. I come back to the submission I made in my opening statement, that is that the only onus which lies upon the Appellant in this case is to show that that assumption by the Minister is wrong. There is only one assumption that is put against me and on the authority of the Pillsbury case it is the only one with which I was called upon to deal. There is no suggestion by the Minister that the payment was on capital obligation or that it was something other than what it purported to be. I propose therefore to examine in some detail the facts that have been proved and it will be my submission that the Appellant has established overwhelmingly that the payment was made for the purpose of gaining or producing income from its business or property and that in the circumstances there was no other manner in which the particular problem with which Lehndorff Realty was faced with could be overcome.

I propose, therefore, to ask that the Board consider the issue in light of the principle laid down by the Supreme Court of Canada in MNR v Algoma Central Railway [1968] CTC 161 where it quoted with approval the following passage in B P Australia v Commissioner of Taxation, [1966] AC 224:

“The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.”

The same principle was stated by Mr Justice Dickson in the High Court of Australia in Hallstroms Pty Limited v FCT (1946), 72 CLR 634 at 648 where he stated that the solution . . .

“depends upon what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

Now admittedly, Mr Justice Dickson and the Supreme Court in the passages which are quoted above were dealing with whether an expenditure was on revenue or on capital account and that is not an issue that I have to meet here. The principle, in my submission, is equally applicable to the type of case that we are dealing with today.

I would like therefore to review the facts with you. They are these: Canada Grund is a large German limited partnership known as a Kommanditgesellchaft with many limited partners most of whom live in Germany and a general partner. The general partner, Lehndorff Vermogensverwaltung GmbH has the general obligation and authority to administer the affairs of the partnership. It is however subject to the overriding scrutiny of the board of Canada Grund. What must be borne in mind in this relationship is that the limited partners themselves are a large unrelated group of persons dealing at arm’s length among themselves. Accordingly, the function of the board is to ensure that their interests are protected. We are not dealing here with a traditional parent-subsidiary relationship as between Lehndorff and Canada Grund. We are dealing with a limited partnership consisting of a large number of people who have given to the general partner a certain authority to conduct the affairs of the partnership in Canada but who nonetheless (s/c) have a degree of authority themselves through their board over what the general partner does. At that time Canada Grund raised money for the Canadian operations by selling interests of the partnership in Germany and presumably in other parts of Europe. The purpose of the partnership was to invest in real estate in Canada and this it has done in a substantial way over the years. For this purpose, the Appellant company, Lehndorff Realty Developments Limited, was incorporated and you can see from its objects which are under Tab 5 in the book of documents that it had as its purpose real estate investment and development.

At this time, that is back in the late 1960s, Lehndorff was just getting started in Canada and it was therefore necessary that it go into a joint venture with an experienced Canadian developer who in this case was Mr Prusac who controlled W B Sullivan Construction Limited. Lehndorff Realty had no expertise in development at that time and so the “partership” or “joint venture” between Lehndorff Realty and Mr Prusac began as an arrangement under which Mr Prusac provided the land and the development expertise and Lehndorff Realty Developments Limited was to provide the financing. That is the arrangement that was contemplated in the agreement of March 16, 1970 which appears at Tab 6. I would draw your attention specifically to paragraph 6 which contemplated an 80% — 20% responsibility with respect to funds for legal fees, land transfer tax and so forth. Also in clause 4 the cash of $1,427,750 which had to be paid by Kashel on closing was to come as to $1,142,200 from Lehndorff and $285,000 from Sullivan.

Kashel was essentially the vehicle chosen by Lehndorff Realty and Mr Prusac to effect their joint venture in these lands. Dr Abromeit explained the manner in which this was done. It was quite a common method of doing business where some other developer was involved.

Another provision of the contract which shows what the parties had in mind is in paragraph 16 which sets out detailed rules as to what was to be done with the income generated by Kashel and in clause (d), the prepayment of the principal sum outstanding under the Metro mortgage was to be made as to 80% to Lehndorff Realty and 20% to Sullivan. In paragraph (e) it is provided that the balance of the income was to be paid to the parties in proportion to their respective shareholdings, Sullivan 50%, Lehndorff Realty 40%, Lehndorff GmbH 5% and Metro 5%.

Dr Abromeit also testified that as Kashel became involved in further activities, such as the acquisition of Morenish which in turn brought with it a controlling interest in Y & R Properties and Imperial General, the financing arrangement between Prusac and Lehndorff Realty was extended so that basically Lehndorff Realty maintained the role of financing partner and Prusac continued to be the managing or development partner. This is set out as well in Mr Prusac’s affidavit under Tab 9, paragraph 31 where he said:

“Kashel originated as a corporate partnership between myself and Dr H G Abromeit for the acquisition and development of the Fairdale Northlands. Dr H G Abromeit arranging the financing and I providing the operational management. That it was a success in the beginning was attributable I believe to the very close rapport which Dr H G Abromeit and I were able to establish between Ourselves as individuals. The original limited purposes of our partnership were rapidly expanded by the subsequent success by acquisitions of Morenish and of subsidiary Y & R and Imperial General and of the McLennan lands. In less than four years we have been able to build the partnership’s assets to over $150,000,000.

My purpose in outlining in some detail the business relationships between Lehndorff Realty Developments Limited and Prusac is to show that we had here a genuine business relationship and that in arranging the financing Lehndorff was properly carrying on its business by fulfilling its original and continuing financing role and that its purpose in doing this was to earn dividend income. Indeed, paragraph 16(e) of the agreement with Sullivan of March 16, 1970 was very specific on this point.

It might be appropriate at this stage in the argument to refer the Board to a decision of the Supreme Court of Canada in MNR v Consolidated Mogul Mines Limited [1968] CTC 429. That case is no doubt different from our situation to some extent. The issue there was whether the principal business of Consolidated Mogul Mines Limited was mining or exploring for minerals. In that case the company had a substantial investment portfolio in other mining companies to which it provided management and technical services and it arranged for the financing of those companies. The Minister of National Revenue took the view that the companies principal business was not mining or exploring for minerals but the Supreme Court of Canada disagreed with this. Mr Justice Spence speaking for the Court stated at page 433:

“As the learned member of the Tax Appeal board remarked:

So, it would appear to be reasonable to assume that the multiplicity of arrangements which exist between mining companies and the constant juggling of shareholdings for various necessary purposes is just part and parcel of the mining business. In my view, it shows lack of understanding of the mining business to point to the financing arrangements of a mining company as a separate business activity to that of mining. Obviously, the financing function of a mining company is an integral part of its business.

For these reasons I would dismiss the appeal with costs.”

The case of course differs somewhat from this one, but it does illustrate the extent to which the Courts will recognize the multiplicity of functions required to carry on a business. Clearly one of these functions is financing. This was an integral part of Lehndorff Realty’s business arrangements. It was to arrange the fianc- ing of the development and its revenues were to come from dividends resulting from the operation. The funds had been raised in German marks in Germany and from the point of view of the German investors a substantial exchange loss was becoming apparent. Lehndorff Realty needed more money for the development of the properties in Canada. The ability of Lehndorff Realty to meet its financing obligations in the relationship with Prusac depended upon Canada Grund’s ability to raise money in Germany by selling further interests. Unless Canada Grund’s investors were protected against this possible loss due to the fluctuations in foreign exchange the German auditors would not give an unqualified opinion and therefore, the board would not have approved any more loans to the Canadian operations. However, the question is even more fundamental than whether the board would approve loans. There would have been nothing to loan because without an unqualified opinion by the German auditors Dr Abromeit considered it impossible to sell interests in the partnership which, as a practical matter, was the only available source of funds. Lehndorff at this stage had not yet established a Suitable line of credit with Canadian institutions. Lehndorff Realty knew that financing was its obligation. Dr Abromeit also knew that as a practical matter there was no way that he could expect Prusac to agree to having Kashel bear the risk of exchange loss. Therefore, Lehndorff Realty had no alternative but to sign the agreement of December 31, 1971.

As I stated in opening by the end of 1971 three things had become extremely Clear. First the existing loans and investments in preferred shares in Canada Grund had made to Kashel and Morenish, if paid off in Canadian dollars, would result in a substantial exchange loss to Canada Grund because the Canadian dollar had declined vis-à-vis the German mark. Secondly, Canada Grund could not advance further monies to Kashel and Morenish unless it could be protected against the exchange losses that had accrued at that time and that might accrue in the future as it continued to advance money to those companies. Without an unqualified opinion from the German auditors which, as Dr Abromeit testified, could not be obtained without exchange loss protection, Canada Grund could not have raised the funds needed to finance the subsidiaries of Lehndorff Realty and Lehndorff Realty was of course obliged under its arrangements with Prusac to arrange the financing. Without further funds Kashel and Morenish could not carry on their land development business and, therefore, no money would have been earned by these companies and no dividends would have been received by Lehndorff Realty.

I might mention that possibly some point will be made by Counsel for the Minister that no dividends were in fact received by Lehndorff Realty Developments Limited. that is quite true. I will come in a moment to the events in 1974 culminating in the settlement with Prusac but had those events not supervened it was projected that substantial profits would have been realized and in fact the agreement of 1971 contemplated that the exchange losses be paid out of dividends earned by Lehndorff Realty. In that event it is not a requirement of the Income Tax Act that income actually be received. The test is not actual receipt of income. It is whether the purpose of an expenditure was to earn income and if there is one thing that is abundantly clear it is that these arrangements that Lehndorff Realty entered into were clearly for the purpose of earning income of Lehndorff Realty. That was what the entire arrangement contemplated.

The principle that the deductibility of an amount does not depend on whether income is in fact produced by that expenditure is very clear from the decision of Consolidated Textiles Limited v MNR, [1947] CTC 63. The same principle is stated in Royal Trust Company v MNR, [1957] CTC 32 at page 43 to 44 and in L Berman & Co v MNR, [1961] CTC 237 at 249.

It is, therefore, important that we consider what the agreement of December 31, 1971 did. It provided first of all that Lehndorff Realty, Dr Abromeit and Jan von Haeften would use their voting rights in Kashel as well as the voting rights of Metropolitan Trust (which had agreed to vote with the Lehndorff interests) towards the passage of a resolution of Kashel that the mortgage receivables and nonvoting preferred shares be repaid with a bonus which had to be adjusted so that it would compensate for any possible revaluation loss of Canada Grund out of its own dividend income. I emphasize that provision because it again underlines the fact that Lehndorff Realty Developments Limited was looking to dividend income from Kashel. Paragraph 3(d) of that agreement provided that Lehndorff Verrno- gensverwaltung GmbH which is the general partner of Canada Grund guaranteed the obligations of Lehndorff Realty.

Dr Abromeit was aware, however, that Prusac would not agree to the resolution contemplated by the agreement of December 31, 1971 and for several reasons. In the first place, he felt that it would be unfair to ask Prusac to do so. Secondly, it would have been futile because Prusac looked to Lehndorff Realty Developments Limited to arrange the financing. It was no part of Prusac’s obligation to ensure that Canada Grund did not sustain exchange losses. Prusac looked to Lehndorff Realty to arrange the financing and that was what Lehndorff Realty was doing in entering into this agreement.

Between December 31, 1971 and January 2, 1973 a number of events occurred which precipitated the second agreement between Canada Grund and Lehndorff Realty Developments Limited. In the first place, foreign exchange losses continued to accrue at a rather more accelerated rate and by January 3, 1973 losses had actually been sustained in the amount of $140,899. Again Lehndorff Realty needed to raise money for the Canadian operations and once again the German auditors refused to give an unqualified opinion which would clearly have inhibited Lehndorff Realty’s ability to arrange the financing as was its obligation. Accordingly, the 1971 was no longer acceptable to Canada Grund and as a condition of its further financing of the Canadian operations Canada Grund insisted on the 1973 agreement. A significant difference between these two agreements is that under the latter agreement, the obligatioin became an absolute one on the part of Lehndorff Realty Developments Limited, rather than one that depended on the receipt of dividend income, the purpose of this agreement was to ensure that Lehndorff Realty would be able to meet its obligation to provide further financing to the development activities of Morenish, Kashel and Amex.

The next event of significance was the creation of Lehndorff Corporation in 1973. This was a public company controlled by Canadian residents. The reason for the creation of this company was the Foreign Investment Review Act and the Ontario Land Transfer Tax Act. The latter Act at that time imposed a substantial additional tax on the registration of lands purchased by companies not controlled by Canadian interests. These two statutes had the effect of limiting severely, if not completely frustrating, any further land acquisition by the companies in which Lehndorff Realty had a substantial interest. Dr Abromeit therefore contemplated a restructuring of the arrangements so that these activities would be in subsidiaries owned by Lehndorff Corporation. Mr Prusac, however, objected strenously to this as you can see from his Affidavit which is at Tab 9 and went so far as to issue a writ claiming an injunction against any dealings in the shares of any of these companies and claiming damages of $50,000,000. The matter came before the Supreme Court for an interim injunction and the judge suggested that the parties should try to settle their differences. This settlement came about in due course and the result was that Prusac bought Lehndorff Realty’s interest in the shares of Kashel.

Specifically what happened to trigger the obligation of Lehndorff Realty to pay the exchange losses was as follows: two loans for $500,000 each owing by Kashel to Canada Grund were assigned to Prusac giving rise to an exchange loss of DM 290,577. The preference shares of Kashel which Canada Grund owned were sold to Prusac giving rise to an exchange loss of DM 3,342,855. The mortgage owing by Morenish to Canada Grund of $8,300,000 was, as well as three other mortgages, totalling $7,000,000 were paid off partly in cash and partly by giving a new mortgage for $8,200,000. This total loss came to DM 12,800,012 as set out as an attachment to the letter dated February 15, 1974 to Lehndorff Realty. (Tab 13) In addi- tioin interest was paid as well as the sum of $140,899 which had accrued up to December 31, 1972. This was the amount the Appellant agreed to pay under the agreement of January 2, 1973. A further loss of DM 386,250 ($154,800) was sustained when Canada Grund sold its preference shares of Amex to Lehndorff Corporation. I doubt that it is necessary for me to take you in great detail to the complexities of this settlement. They are set out under Tabs 10, 11 and 12 of the book of documents. There were basically two parts to the settlement. There was the sale of the shares of Kashel which is described in the letter from Strauss Associates dated September 25, 1974 under Tab 10 and the restructuring of the loan arrangements with Morenish set out in a letter of the same date under Tab 11. There is however one point which I should draw to your attention and that is that the interest rate under the new mortgage from Morenish to Canada Grund was set at 19% rather than 13% which presumably was the prevailing rate at the time. The additional 6% was paid immediately and was intended to protect Canada Grund against any further risk of currency loss.

I believe that that sufficiently summarizes the facts for the purpose of this case. There are certain specific findings of fact which I invite the Board to make. In my submission they have been overwhelmingly established and they are these:

1. Lehndorff Realty Developments Limited was the financing “partner” or “joint venturer” in the arrangement with Prusac. It was clearly Lehndorff Realty’s obligation to arrange the financing.

2. It was intended that from its participation in the arrangements Lehndorff Realty Developments Limited would earn dividend income. This is clear both from the agreement of December 31, 1971 and from the agreement of March 16, 1970 and from Dr Abromeit’s testimony.

3. The agreements of December 31, 1971 and January 2, 1973 were entered into for valid commercial reasons having to do with the business of Lehndorff Realty Developments Limited.

4. Had the agreements not been entered into Canada Grund would not have advanced the funds to the companies and there would have been no prospect of Lehndorff Realty earning income or, for that matter, of continuing to carry on its business as it related to Mr Prusac.

Clearly the purpose of these agreements was the earning of income by Lehndorff Realty Developments Limited and it matters not whether one regards that income as being income from a business or income from property. Either purpose is sufficient to meet the test under the Income Tax Act. In my submission there is no other conclusion possible. There was a clear obligation to make the payments and equally a clear commercial necessity which gave rise to the obligation. This is not a case of one company voluntarily assuming an obligation of another company. The exchange loss was never the obligation of Kashel, Morenish or Amex. It was solely the obligation of Lehndorff Realty Developments Limited.

In considering a question of this sort it is my submission that the Court must consider the matter as a practical businessman would and ask the question “Was this payment made for good business reasons? Did it have a commercial purpose? Was it part of the taxpayer’s income earning process?” This principle has been established in many cases under the Income Tax Act, possibly one of the best known of these cases is the Royal Trust Company v MNR, [1957] CTC 32. In that case Mr Justice Thorson, the President of the Exchequer Court, set out the statutory provision involved in that case which was paragraph 12(1 )(a) which reads the same as paragraph 18(1)(a) under the present statute. It states that in computing income no deduction shall be made in respect of:

“(a) An outlay or expense to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer.”

He pointed out that this section replaced section 6(a) of the Income War Tax Act which had provided that in computing the amount of the profits or gains to be assessed deductions shall not be allowed in respect of:

“(a) disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income (Italics added)

Mr Justice Thorson went on to say:

“It is clear that the range of deductibility of an outlay or expense under the Income Tax Act is greater than that of disbursements or expenses under the Income War Tax Act.”

The same observation was made by Mr Justice Abbott in the case of British Columbia Electric Railway Company Limited v MNR, [1958] CTC 21, where Mr Justice Abbott said, in commenting on the distinction between the former Act and the present one,

“The less stringent provisions of the new section should I think be borne in mind in considering judicial opinions based upon the former sections.

He went on to say:

“Since the main purpose of every business undertaking is presumably to make a profit any expenditure made “for the purpose of gaining or producing income” comes within the terms of section 12(1 )(a) whether it be classified as an income expense or a Capital outlay.”

Since I am not faced with any suggestion that this payment is a capital expenditure I need not take the time of the Board in referring to cases that deal with capital payments. My only concern is to establish that the payment was laid out for the purposes of gaining or producing income from property or a business of the taxpayer.

Before I come to the cases upon which I rely I should deal with a case upon which I expect counsel for the Minister may place some reliance. That is the case of Canada Safeway v MNR, [1957] CTC 335. That was a decision of the Supreme Court of Canada where the appellant company issued debentures for the sum of $3,000,000 and preferred stock for $2,000,000. Out of the proceeds of these issues $3,500,000 was paid over by the appellant as the purchase price for the outstanding capital stock of another company. The balance of the funds was set up on the books as due to the parent company and was later transferred to it. The appellant claimed a deduction from its income on the interest paid on the debentures. These were disallowed by the Minister of National Revenue. The Supreme Court of Canada dismissed the taxpayer’s appeal and Mr Chief Justice Kerwin, Mr Justice Taschereau and Mr Justice Cartwright did so on the basis that the payments of interest on the debentures were expenses incurred to earn non-taxable income. Mr Justice Rand with whom Mr Justice Cartwright concurred held that the interest on the debentures was not paid on borrowed capital used in the business of the borrower nor on borrowed money used for the purpose of earning income by the exploitation of property.

The case is readily distinguishable. In the first place the majority judgment proceeds on the basis that the expenditures were laid out to earn exempt income. At that time dividends on shares owned by a Canadian company were exempt from income tax. They were regarded as “exempt income” which was a specific exclusion under the interest deductibility section of the Act. The present Act is different in that it specifically states in section 248:

“Exempt income means money or property received or acquired by a person in such circumstances that it is, by reason of any provision in Part I, not included in computing his income, but for greater certainty does not include a dividend on a share except that for the purposes of paragraph 247(1 )(c) exempt income includes a dividend received by him the amount of which may be deducted by him from his income by virtue of subsection 112(1)” (Italics added).

Therefore, the entire basis of the majority judgment in Canada Safeway has no further application. Secondly, at that time section 6(1 )(a) of the Act disallowed deductions in respect of “disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income”. As was pointed out by Mr Justice Abbott in the BC Electric Railway case (supra) and Mr Justice Thorson in the Royal Trust case (supra) the less stringent provisions of the present act must be borne in mind in considering older cases such as Canada Safeway.

Thirdly, the facts in this case are altogether different. In Canada Safeway the Appellant purchased shares. In this case, Lehndorff Realty Developments Limited was engaged through Kashel Developments in a joint venture with Prusac and its obligations under the two agreements with Canada Grund arose from the commercial necessity of providing financing which was its obligation.

A leading case in this area of the law is Her Majesty the Queen v F H Jones Tobacco Sales Company Limited, [1973] CTC 784, a decision of Mr Justice Noel the associate Chief Justice of the Federal Court. In that case the taxpayer corporation was in the business of growing and selling tobacco. A cigarette distributor acquired control of a cigarette manufacturer with the aid of a $200,000 loan which the taxpayer’s controlling shareholder endorsed in return for the privilege of having the taxpayer corporation henceforth supply tobacco to the manufacturer. The manufacturer distributor became insolvent and the taxpayer corporation paid the balance of $115,000 outstanding the loan. The loss was disallowed by the Minister of National Revenue. Mr Justice Noël held that the obligation assumed in respect of the note was assumed on behalf of the corporation. The expenditure was undoubtedly made for the purpose of gaining and producing income for the corporation’s business. In giving judgment in favour of the taxpayer, Mr Justice Noël stated :

“The Court must consider the situation from a businessman’s point of view and not dwell on technicalities which may be relevant in other types of proceedings in which for instance the company challenged the existence of the obligation which have no relevance here. The payment of the amount of $115,369.55 by the Jones company was undoubtedly made for commercial reasons in accordance with ordinary business principles. On this see L Berman & Co Ltd v MNR, [1961] CTC 237, 61 DTC 1150, per Thorson, P at page 247 (1156):

There is no doubt in my mind that the appellant made the payments in question as a business person intending to continue in business would reasonably do and that consequently, they were made in accordance with the ordinary principles of commercial trading or well accepted principles of business practice and I am unable to find any ground in section 12(1 )(a) for their exclusion.

Even if the appellant had not been legally bound to make the payments that did not prevent them from having been made in accordance with the Ordinary principles of commercial trading. There is strong authority for this statement in Usher’s Wiltshire Brewery, Limited v Bruce, [1915] AC 433. In that case the tenants of the appellants’ tied houses were by agreement bound to repair their houses and pay certain rates and taxes. They failed to do so. The appellants, though in no way legally or morally bound to do so, paid for these repairs and paid these rates and taxes. They did so, not as a matter of charity, but of commercial expediency, in order to avoid the loss of their tenants, and, consequently, the loss of the market for their beer, which they had acquired these houses for the purpose of affording. It was held that, although they were not legally or morally bound to make these payments, yet they were, in estimating the balance of the profits and gains of their business for the purposes of assessment of income tax, entitled to deduct all the sums so paid by them as expenses necessarily incurred for the purposes of their business.”

At page 790 Mr Justice Noël went on to say:

“For some years, however, our courts have been inclined to accept certain expenses or losses as deductible, considering not so much the legal aspect of the transaction, but rather the practical and commercial aspects.”

In my submission if one looks at this as a practical business matter there can be no question that if Lehndorff Realty wished to continue to carry on the business activities which it started with Prusac in 1970, it had no commercial alternative but to enter into the two agreements with Canada Grund. When the events triggered Lehndorff Realty’s obligation to make that payment it had no option but to do so.

There is another aspect of this case that I submit requires some attention. Dr Abromeit is obviously an experienced and intelligent businessmen. He made a business judgment to proceed in a particular way and it is not really the place of the Minister of National Revenue to say that he should have gone about it in a different way. As stated by Mr Boisvert in the Tax Appeal Board in S Holtzman v MNR, 62 DTC 388 at 391:

“Dealing with this second point, it may be said that the officers of the National Revenue Department are not called upon to determine what a taxpayer should do, what he should purchase and where he should purchase the requirements of his business. It would look strange if a taxpayer, whether a corporation or an individual were compelled, in the carrying on of a business, to seek the advice of the Minister as to what to do, where to go and how much to pay for assets he wished to acquire.”

It is quite obvious that Dr Abromeit’s business judgment was sound. If one reviews the evidence of Dr Abromeit it is apparent that he was successful in raising the money, and that he was able to meet all of the obligations that Lehndorff Realty Developments Limited assumed.

In addition to the F H Jones Tobacco decision (supra), there is a series of cases following the Berman decision in which it has been held that a payment made by a taxpayer for the purpose of continuing in business is a legitimate deductible expense. I will mention these only briefly. They are Heap & Partners (Nfld) Ltd v MNR, 66 DTC 772 and Frappier v Her Majesty the Queen, 76 DTC 6066.

A further aspect of this case with which I wish to deal is the fact that Lehndorff Realty Developments Limited entered into a commercial transaction with its shareholder Canada Grund. The Minister may try to place some significance on the fact that Canada Grund is a shareholder of the company but I submit that that contention is answered by Pillsbury Holdings Limited v MNR, [1964] CTC 294. In that case Mr Justice Cattanach stated at page 300:

“By way of contrast, in my view, there can be no conferring of a benefit or advantage within the meaning of paragraph (c) where a corporation enters into a bona fide transaction with a shareholder. For example, Parliament could never have intended to tax the benefit or advantage that accrues to a customer of a corporation, merely because the particular customer happens to be a shareholder of the corporation, if that benefit or advantage is the benefit or advantage accruing to the shareholder in his capacity as a customer of the corporation. It could not be intended that the Court go behind a bona fide business transaction between a corporation and a customer who happens to be a shareholder and try to evaluate the benefit or advantage accruing from the transaction to the customer.”

I appreciate that the Pillsbury Holdings case dealt with a benefit or advantage conferred upon a shareholder but the principle stated by Mr Justice Cattanach in my submission is equally applicable here. I appreciate that counsel for the Minister has not suggested in his pleadings that the payment to Canada Grund was in any way a benefit to it of the type that would be taxable under section 15 of the Act. Indeed it would be difficult to make such a suggestion bearing in mind that the agreements between Canada Grund and Lehndorff Realty Developments Limited were precipitated by the requirements of the German auditors and the limited partners. Moreover, the agreement was mutually beneficial. It was highly beneficial to Lehndorff Realty that Lehndorff Realty was able to continue in its business and raise the money which it needed to fulfil its obligations in the relationship which it had with Prusac.

No doubt it will be contended by counsel for the Minister that agreement with Canada Grund was somehow beneficial to Kashel or Morenish. That in my submission is not relevant to the point that I have to meet. The Crown says that my client did not make this payment for the purpose of earning income from its business or property and I submit that it clearly did. A case that in my submission is of assistance in this regard is Pigott Investments Limited v Her Majesty the Queen, [1973] CTC 693 where Mr Justice Noël held that payments made by the taxpayer relating to a proposed new development project in downtown Hamilton by a subsidiary of the taxpayer were deductible expenses. He stated at page 699:

“The evidence indeed disclosed that Pigott paid the expenses and most of the accounts were submitted to Pigott who never considered them to be First Wentworth’s expenses. Counsel for Pigott suggests that the latter regard itself as liable both as a simple matter of commercial morality and as a matter of legal obligation in right of its guarantee to the City and I must agree with this submission. It seems to me that whether or not they could be described on one view of the matter as First Wentworth’s expenses should not make them any the less expenses laid out by Pigott if, for valid business reasons, such expenses were incurred and paid by the latter. It does not appear to me that these expenses should be held non-deductible merely because someone else might also have a legal obligation to pay them.”

In fact Lehndorff Realty’s case is stronger than the Pigott case in that Kashel and Morenish were never under any obligation to pay Canada Grund for the exchange losses. Indeed, it was clear from Dr Abromeit’s evidence that he could or would not have prevailed upon Prusac to have Kashel or Morenish assume this obligation. Therefore, as a practical business matter Lehndorff Realty had no alternative and could not force Prusac to reimburse Canada Grund. It could not have obtained the financing from Canada Grund if it had not entered into the agreements to reimburse the exchange losses.

In the Pigott case Mr Justice Noël again cited the passage which I cited above from the Algoma Central case and the Hallstroms case. At page 701 he said:

“The treatment by Pigott of the expenses paid by it is properly deductible in computing its profits and loss for the years involved herein is in my view consistent with sound business common sense and in line with the recent decision of the Supreme Court of Canada by its Chief Justice in MNR v Algoma Central Railway [1968] CTC 161; 68 DTC 5096 when he quoted with approval the following passage to be found in B P Australia Limited v Commissioner of Taxation (supra) at page 264:

“The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

In Hallstroms Pty Ltd v FCT [1946] 72 CLR 634, Dixon, J (as he then was) of the High Court of Australia stated that the answer to whether an expenditure is on revenue or capital accounts

*. . . depends on what the expenditure is calculated to effect from practical and business point of view rather than upon the juristic classification of the legal rights if any, secured, employed or exhausted in the process.

The conclusion here in the light of the business or commercial realities disclosed by the evidence is therefore that the benefit sought by the payments made was sought by Pigott and for Pigott was not of a capital nature but rather of a revenue nature to Pigott’s construction business and, therefore, these expenses are deductible.”

In my submission the same considerations apply where we are dealing with a question whether an amount is laid out for the purpose of gaining or producing income.

In my respectful submission the evidence overwhelmingly leads to the conclusion that the payments were made pursuant to the legal obligation entered into for good commercial reasons and for the benefit of Lehndorff Realty Developments Limited. Their object was the earning of income from the business or property of Lehndorff Realty Developments Limited and had the dispute with Prusac not arisen unquestionably dividend income would have been earned and Lehndorff Realty would probably still own the shares of Kashel. As it turns out the lawsuit by Prusac and its subsequent settlement precipitated a capital gain on the sale of the shares.

The only assumption which I am called on to meet is that the payments are not made for the purpose of gaining or producing income from a business or property of the taxpayer and in my submission that onus has been fully met. Moreover, I submit that the authorities to which I referred are clear that expenditures of this type are deductible.

Findings

Although the documentation was prolix and complicated, Mr Bowman has clearly established what he has claimed in his notice of appeal. I was impressed with the witness Dr Hans G Abromeit. He was a Doctor of Economics and he obviously was a brilliant and astute man, realizing that joint ventures with local real estate developers in major centres across Canada were the surest and best way for the appellant to earn income from the business of real estate and land development. There is nothing in the written submissions of Mr Bowman that goes counter to any of the evidence adduced at the trial. I concur with his reasoning and allow the appeal and refer the matter back to the respondent for reconsideration and reassessment.

Appeal allowed.