Canadian Motor Sales Corporation Limited v. Minister of National Revenue, [1977] CTC 2037, 77 DTC 30

The Assistant Chairman:—The above-named company (hereinafter called “Sales”) has appealed to this Board from an assessment for tax for its 1971 taxation year. Another company, Canadian Motor Distributors Limited (hereinafter called “Distributors”), has also appealed to this Board from an assessment for tax for its 1971 taxation year. Both of these companies, as well as other companies including Overseas Motor Corporation Limited (hereinafter called “Overseas”), are subsidiaries of Canadian Motor Industries Holdings Limited (hereinafter called “Holdings”). The Mitsui Company of Canada Limited (hereinafter called “Mitsui Canada”) purchased control of Holdings in 1966 and, by that acquisition, gained control of both Sales and Distributors. Prior to 1966 Toyota motor vehicles were sold by Mitsui Company of Japan (hereinafter called “Mitsui Japan”) to Overseas. Overseas then, in arm’s length transactions, sold the vehicles to Winter Export Ltd, a Bermudian corporation (hereinafter called “Winter”), which company sold the vehicles to the two appellants. This, it was explained in evidence, was the manner in which the two appellants, prior to 1966, acquired their vehicles for sale on the Canadian market. Mr Torrance, who was the solicitor for Mitsui Canada, stated that he knew nothing of Winter, although he did know matters relating to the other companies I have mentioned, as they were, aS mentioned, subsidiaries of Mitsui Canada. The result was that, when Mitsui Canada acquired control of Holdings, it in effect inherited the manner in which Sales and Distributors purchased their Toyota vehicles for resale.

The evidence given by Mr Torrance, together with the evidence given by Mr Yano, who from 1966 for several years was president of Holdings, was that initially Mitsui Canada was concerned with getting Holdings’ business well established in Canada and making it successful, as at that time it was doing poorly. In the first few years things were quite difficult and Mr Yano spent his time endeavouring to get the business on a paying basis. Very little, if any, attention was paid to the paper-work with respect to the importation and acquisition of vehicles. Around 1970, when the business was reasonably well established, Mr Yano directed his attention more to the importation of the vehicles. It was then realized that the vehicles were purchased through companies as previously mentioned, and an invoice was received from Winter for a stated amount. However, it was ascertained that the amount stated in that invoice was less than the amount stated in the invoice which Mitsui Japan issued in connection with the same vehicle. In other words, Sales and Distributors were paying a lesser amount for the vehicles than Mitsui Japan was billing for the same vehicles. As mentioned, in 1970 Mr Yano busied himself with looking into this matter, with the result that, starting some time in 1970, the paper-work followed the vehicles, so that the amount Sales and Distributors paid for the vehicles was the same amount as Mitsui Japan billed.

Some time in 1971 officers of the Customs and Excise Division of the Department of National Revenue investigated the affairs of Sales and Distributors. As a result of that investigation, in the opinion of those officers, Distributors and Sales had not paid the proper customs duty, excise tariff and sales tax inasmuch as the billings of Mitsui Japan were higher than those claimed by Sales and Distributors. Their invoices from Winter were for a lesser amount. In June of 1971 discussions were held by those officers with Mr Torrance, as well as other representatives and officers of Sales and Distributors. On or about July 16, 1971 there was sent to 1291 Bellamy Road North, Scarborough, Ontario, the address of Sales and Distributors as well as the address of the parent company Holdings, a customs document identified as K30 /2. The front of the K30 /2 reads as follows:

Customs Seizure No. 20013/8243

The Director, Customs and Excise Investigations Division having reported on July 8, 1971 that the following facts have been ascertained upon investigation, namely:

that within the past three years you imported into Canada certain goods as listed on the attached statement, Schedules A, B, C and D.

valued at $ more or less; and the following charges for infractions of the Customs Laws having been made against you, namely:

that the said goods were entered at Customs on untrue invoices at an undervaluation and payment was thereby avoided of duty and excise taxes lawfully payable.

Wherefore take notice that if such seizure or charges be maintained, the Said goods or moneys, if accepted on deposit in respect thereof, become liable to forfeiture, and each party concerned in such infraction of the law subject to penalties under the provisions thereof.

I have also to notify you that any evidence you may present within thirty days from the date hereof, by affidavit or affirmation, to be sworn to or affirmed before any Justice of the Peace, Collector of Customs, Commissioner for taking affidavits in any Court or Notary Public, in rebuttal of the said charge so preferred against you, will be duly considered; and at the end of said thirty days, or sooner if you so desire, I will, as required by section 162 of the Customs Act report to the Minister upon the merits of the case, and the evidence (if any) so furnished, for his decision or for such other action as he may determine, and his decision, thereupon rendered will be final, unless within thirty days after being notified thereof, you give him notice in writing that such decision will not be accepted, as provided by section 164, of the said Act.

You will find printed on the back hereof sections 160 to 167 of the said Customs Act, to which your attention is called.

To that printed form was attached an 11-page schedule. The first 9 pages indicate the goods involved which, in the view of the customs officers, had not had the proper sales tax, excise tax and/or duty paid when they were imported to Canada by Sales and Distributors. Page 10 is a summary of the previous pages. Page 11, which indicated a basis for the deposit, reads as follows:

SCHEDULE A —

DOUBLE DUTY SHORT PAID	$316,670.36x2 $633,340.72
PLUS SALES TAX SHORT PAID		288,131.68
			921,472.40
SCHEDULE B —
DOUBLE DUTY SHORT PAID	$2254.35 x 2	4,508.70
PLUS SALES TAX SHORT PAID		2,074.02
			6,582.72
SCHEDULE C —
DOUBLE SALES TAX SHORT PAID	$2222.19 x 2		4,444.38
SCHEDULE D —
DOUBLE DUTY SHORT PAID	$6919.04 x 2	13,838.08
PLUS SALES TAX SHORT PAID		6,011.85
PLUS EXCISE TAX SHORT PAID		2,766.30	22,616.23
	TOTAL		955,115.73

Following receipt of the document, the appellant, through its officers and solicitor, had two meetings in Ottawa with the then Deputy Minister of Customs and Excise and other officers of the Department. What transpired at those meetings will be mentioned later. After those meetings, Mr Torrance received a letter dated October 14, 1971 from an officer of Customs and Excise who attended those meetings, which letter reads as follows:

Apropos the meeting held today in the above matter, this is to confirm that the settlement figure agreed upon is $768,385.81. This will also confirm that duty, sales tax and excise tax exigible on importations within the three year period prior to July 16, 1971 (the date of our Notice) amounts to $618,385.81, as follows:—

Duty	$321,098.65
Sales Tax	294,520.86
Excise Tax	2,/66.30
	$618,385.81

This is achieved by deleting lines 1-22 inclusive of Schedule A by reason of which duty short paid is reduced by $4,745.10 and sales tax by $3,918.88, for a total of $8,663.98.

The last paragraph of that letter refers to the first 22 items on page 1 of the schedule which was attached to the form K30 /2.

Sales and Distributors, between the two of them, duly paid the amount shown in that letter of October 14, namely, $768,385.81. The total amount was shared between the two of them in proportion to the goods imported. Both companies, when they filed their income tax returns for their 1971 taxation year, claimed their share of the $768,385.81 as a business expense in computing their profit for the year. It is to be noted from that letter that it would appear the duty, sales tax and excise tax totalled $618,385.81 and the difference between the two figures was $150,000. Of the $150,000, Distributors and Sales claimed as an expense, in computing their income, the sums of $44,350 and $105,650 respectively. Taxation Canada was of the view that the $150,000 was a penalty imposed pursuant to the Customs Act and that that penalty was not a deductible expense in computing one’s income, and so disallowed the claim by each company of the amount Taxation Canada believed to be the penalty. It is from this disallowance that Sales and Distributors have appealed to this Board. The hearing, in effect, proceeded on the assumption that the dispute was with respect to the $150,000.

According to the evidence submitted at the hearing, on or about June 14, 1971, as mentioned, there was a meeting between Mr Torrance and others on behalf of Sales and Distributors with Mr West, an investigator of Customs and Excise who had worked on the question of Sales’ and Distributors’ customs duty. According to Mr West—and Mr Torrance, if I recall correctly, did not disagree—the schedule attached to the K30% was fully discussed, especially the portion relating to double duty. In so far as Mr West was concerned, there was no doubt that it was made clear that Sales and Distributors were being penalized, but my recollection is that it was never stated under what section the penalty was being levied. As indicated by Exhibit R-1, in August Mr Torrance wrote a 4-page letter to the Deputy Minister of Customs and Excise in connection with the matter, and in that letter indicated that, while his clients wished to negotiate a settlement, the real point ‘‘at issue is the penalties claimed amounting to $328,065.94”. The letter continued that it was their submission that no penalties should be charged. The letter continued and offered to settle the matter on paying the short-paid duty, sales tax and excise tax totalling $627,049.79. As mentioned, Mr Torrance and other officers, in the fall of 1971, had two meetings with the then Deputy Minister and other officers of Customs and Excise. Mr Torrance stated that settlement would be on the basis that there was no penalty. He stated that the Deputy Minister, on behalf of Customs and Excise, agreed with this. His statements in this respect were confirmed by Mr Yano and Mr McArthur, a senior vice-president of Holdings who was also at the meeting. Mr Torrance, after the agreement as to quantum was reached, asked for a letter with respect to the settlement, and it was for this reason that the letter of Ocober 14 was written. At the meeting of October 14 there was discussion as to penalty on behalf of the two companies and it was contended that there was no basis for penalty and nothing had been done which would give rise to penalty. Sales and Distributors, in a private meeting on October 14 while in Ottawa after having seen the Customs and Excise officials, through their officer Mr Yano decided to settle the matter, even though their counsel advised that there was no basis for any penalty. If I recall, Mr Yano stated that for practical business reasons he wanted to get along with the Canadian government, as he would have to deal with it in the future. It was for this reason they accepted the amount of $768,385.81.

At the meeting of October 14, after the settlement was reached, Mr Torrance inquired as to the form of the notification of the Minister pursuant to section 163 of the Customs Act. He was advised by letter of October 15 that a form K29 would be used and a specimen copy uncompleted was sent to him. The specimen reads as follows:

TO:

Re: Customs Seizure No.

Under the provisions of section 163 of the Customs Act decision has now been rendered in this matter as follows:

Presumably such a document was sent. Looking at sections 160 to 167 inclusive of the Customs Act, it would appear that, pursuant to section 164, if in 30 days after being notified of the Minister’s decision the owner of the goods does not give the Minister notice in writing that his decision will not be accepted, then the decision is final. No suggestion was made that the owner advised the Minister that he would not accept the decision of the Minister and, I presume, the Minister’s decision became final.

As mentioned, the issue is whether or not, between Sales and Distributors, this amount of $150,000 is deductible. There is no dispute as to the deductibility of the other amount of $618,385.81. Taxation Canada takes the position that the $150,000 which Sales and Distributors paid in addition to the duty, sales tax and excise tax, is penalty and, as such, it is a non-deductible expense. As I recall the submissions by counsel for Sales and Distributors, if the $150,000 were a penalty imposed against those two companies, the quantum of the penalty would not be deductible. However, counsel for the appellant first of all submitted that the $150,000 is not a penalty as there was no basis in the Customs Act upon which a penalty could be based. In this respect he submitted that the invoices which both Sales and Distributors paid were invoices which they received in arm’s length transactions. It must be recalled that the contention was that Winter was a corporation with whom Sales and Distributors dealt at arm’s length. Consequently, pursuant to paragraph 192(1)(b) of the Customs Act, there was no false or fraudulent invoice involved in this case.

Section 164 of the said Customs Act reads as follows:

164. If the owner or claimant of the thing seized or detained, or the person alleged to have incurred the penalty, does not, within thirty days after being notified of the Minister’s decision, give him notice in writing that such decision will not be accepted, the decision is final.

It is clear that penalty was referred to in the meeting in June 1971. It is clear penalty was referred to in Mr Torrance’s letter to the Deputy Minister of August 1971. Since the amount of duty, sales tax and excise tax was clear (see letter of October 14, 1971), the only thing the $150,000 can be is penalty. The decision of the Minister pursuant to section 164 “is final” unless notice is given that such decision will not be accepted, and so the duty, sales tax and excise tax figures are correct. If that decision were not acceptable, the steps provided in section 165 et seq should have been followed. I therefore find that the $150,000 was a penalty.

Even if the sum of $150,000 were not a penalty, then it appears to me that it is incumbent upon both companies to satisfy me that the payment of $150,000 was ‘‘an outlay or expense . . . made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property”.

Counsel for the appellant relied mainly on two cases to show that the amount of $150,000 was a deductible expense. The first case was Olympia Floor & Wall Tile (Quebec) Ltd v MNR, [1970] Ex CR 274; [1970] CTC 99; 70 DTC 6085. This is a decision of Jackett, P of the Exchequer Court. In summary fashion, this case pertained to the deductibility as expenses, pursuant to paragraph 12(1)(a) of the Income Tax Act, of amounts which qualified as gifts to charitable Organizations under paragraph 27(1 )(a) of the Income Tax Act. The learned President in his decision held, in the circumstances of the case, that those amounts were deductible pursuant to paragraph 12(1)(a) in computing the income of that appellant. On the facts of the case the President pointed out as follows [p 100, 6086]:

In each of the two years in question, the appellant had sales, in the course of its business, of over one million dollars. In the view of the appellant’s sales manager, between 25 per cent and 30 per cent of these sales were attributable to gifts that, while they qualified as “gifts” to “charitable organizations” within the meaning of those words in Section 27(1)(a) of the Income Tax Act, were made to charitable organizations that were headed up by men who, in their ordinary business lives, were in a position to cause purchases to be made of the appellant’s goods and who, as a consequence of the appellant’s gifts to their charitable organizations, did, in the ordinary course of events as things were done in the particular part of the Montreal community that was involved, cause substantial purchases to be made of the appellant’s goods that would not otherwise have been made. This view was not seriously challenged on cross-examination of the appellant’s sales manager and was supported by other evidence including the evidence of a person who swore that he obtained contributions to a school in which he was interested, from such business people as a plumber and an electrician, as well as from the appellant, by promising that he would use his business position to cause business to go to them and that, when he obtained contributions for that “charitable organization” in that way, he carried out his promise in a substantial way. I accept this evidence and I find that contributions to charitable organizations so made were expenditures laid out by the appellant in the years in question largely, if not entirely, for the purpose of increasing its sales and only subsidiarily, if at all, for charitable or benevolent reasons.

In the same case the learned President, at page 278 [101, 6087], making reference to Riedle Brewery Limited v MNR, [1939] SCR 253; [1938-39] CTC 312; 1 DTC 499-29, also stated as follows:

I am of opinion that the amounts in question (after eliminating those that were not over $100), if one puts aside the fact that they were gifts to charitable organizations, fall clearly within the authority of Riedle Brewery Limited v MNR, [1939] SCR 253; [1938-39] CTC 312 [1 DTC 499-29], where amounts were held to be deductible when they were spent by breweries in following a practice of “treating” potential customers because it was found that, if the practice was followed consistently, their sales would either be maintained or increased “whereas when the practice was discontinued, their sales would materially decrease”.

It can readily be seen that the instant appeal is in no way similar to the Olympia Floor & Wall Tile (Quebec) Ltd case. The $150,000 was not paid so that the companies could get business from the Government of Canada. There was no evidence whatsoever that the Government of Canada had bought any goods from either Sales or Distributors.

In a similar fashion, reference was made to the case Aluminum Company of Canada Ltd v The Queen, [1974] 1 FC 387; [1974] CTC 471; 74 DTC 6408. The appellant in that case had entered into a contract with a Jamaican corporation, which in the report was called “Aljam”, whereby under certain terms and conditions Aljam would supply alumina to that appellant. When the contract was entered into, Aljam was not a subsidiary of the appellant, but in later years it became a subsidiary. The appellant therein, at a later date, entered into an arm’s length agreement with another company for the sale of alumina to it on a barter basis. The latter contract provided that, should the agreement be cancelled, certain payments would be made. The latter contract was cancelled and there was paid to the appellant the sum of $3,600,000. The Jamaican government was of the view that some portion of that payment should be included in the income of Aljam and the Jamaican government entered into discussions with Aljam in that respect. The Jamaican government took the position that the price Aljam received for its alumina was really not a fair price when one looked at the contract which the appellant had with the third company. Officials of the appellant looked at the matter and, after discussing it and considering it, decided to acquiesce in the claim of the Jamaican government and it was settled by paying approximately $1,500,000 to Aljam. Officers of that company contended that that decision was made to preserve a source of raw materials and, if they had not done so, it could jeopardize their position in Jamaica. From a sound business judgment approach, it was a good settlement. The appellant in that case charged the sum it paid to Aljam as an expense in determining its profit for the year. The Minister, in that case, disallowed the claim. Mr Justice Heald, in allowing the appeal of the appellant, stated at page 396 [476-77, 6413]:

... I am satisfied that subject expenditure was incurred in the process of operating a profit-making organization and, as such, was an expenditure on revenue account. Plaintiff is an integrated aluminum company extensively involved in aluminum production from the beginning where the raw ore (bauxite) is mined to the final stages where the finished product, aluminum, is produced, marketed and sold. Its Jamaican subsidiary was faced with demands from the Jamaican Government which result in an upward adjustment of the price of raw product required by the plaintiff for the satisfactory operation of its entire profit-making organization. Thus, the plaintiff-and its subsidiary, Aljam, made a business decision to acquiesce in said upward price adjustment in the cost of its raw material.

This case, as I view it, is different from the instant appeal. In that case, in effect, the company purchased alumina at a price which, at a later date possibly from pressure from the government, was increased retroactively. It was still the cost of the alumina, and was a cost of doing business. In the instant case, as I view the matter, the amount paid had nothing to do with the cost of doing business, nor was it part of a duty, a sales tax or an excise tax. I am of the view that the appellant has not established that the expenditure comes within the ambit of paragraph 12(1)(a) of the Income Tax Act and, even if it were not a penalty, it is not a deductible expense. Consequently, I dismiss the appeal.

Appeal dismissed.