Woodbine Forest Products Limited v. Minister of National Revenue, [1977] CTC 2408, 77 DTC 267

The Assistant Chairman:—Six individuals who were employees of Weldwood of Canada Limited (hereinafter referred to as “Weldwood”) decided among themselves in 1970 to cause a company to be incorporated to sell plywood to the retail lumber trade. As a result, Woodbine Forest Products Limited (hereinafter referred to as “Woodbine”) was incorporated. Each of those six persons invested $10,000 in the common shares of Woodbine. Mr Wilson, one of those persons, had been in the lumber business for some 35 years. He was the president of Woodbine. He, as well as the other five shareholders, had contacts in the retail lumber trade due to their previous connection with Weldwood as well as because of their connections with other companies with which they had worked prior to working for Weldwood. These men appreciated the difficulties which confronted Woodbine and they knew who the competition would be. In their opinion, the greatest obstacle in the path of Woodbine’s success was the assurance of a good and continuous source of supply of softwood plywood. Their concern was not that of being able to sell the plywood, but rather of being able to acquire it as, in their opinion, they were confident Woodbine would have no difficulty in disposing of any plywood it could acquire.

One of the sources of supply of plywood in 1970 was Evans Forest Products Limited (hereinafter referred to as “Evans”). Apparently at that time, two gentlemen by the names of Black and Martinello were employees of Evans. They were interested in setting up a company in the area of North Bay, Ontario to make plywood and they were in touch with Mr Frank E McConnell who was an investment dealer and president of McConnell & Company Limited. It appears that Martinello and Black approached McConnell about the prospects of starting a company to manufacture plywood and the marketing of its product. McConnell was confident that, through his company, he could arrange the proposed company’s financing. While they themselves were somewhat experienced in the plywood business, Martinello and Black wanted, should we say, help from experts in the field. Martinello suggested that McConnell approach Woodbine to ascertain whether or not it wished to invest in a company to be formed. To appreciate McConnell’s position, it should be mentioned that he had been in the same business since 1964 and, in his modesty, considered himself in 1970 to be a reasonably successful and competent professional man. He, considering all the things mentioned to him by Black and Martinello, felt that that which they proposed was reasonable; there was a good wood supply as well as skilled labour in the area, both at Rainy River and North Bay where they proposed to get their material, and all other factors being considered, the prospects of the company they suggested were good.

After the appellant was created, which was at about the same time as McConnell got in touch with the shareholders of the appellant, things began to happen. Apparently after McConnell saw one of the officers of the appellant to whom he sent reports as to the prospects of the Black and Martinello company (later incorporated as Champlain Forest Products Limited—hereinafter called “Champlain”), Woodbine decided, should we say, “to get into” Champlain. All the witnesses called, as well as Exhibit A-1, Tab F, indicate that the negotiations between McConnell on behalf of Champlain and one of the directors of Woodbine (who was also a director of Champlain) were on the basis that, if Woodbine does something, Champlain will do something in return. The result was an agreement between the parties (Exhibit A-1, Tab F). The agreement made Woodbine the sole designated distributor in a defined and quite large area of Ontario for five years with an automatic renewal for successive one-year terms unless a notice of 120 days was given before the end of the current term. Woodbine was to obtain “not less than” 45% of Champlain’s production at a stated cost. Nowhere in Tab F of Exhibit A-1 is there any requirement for Woodbine to buy debentures or shares, be they preferred or common, of Champlain before it could obtain the benefits of the contract (Exhibit A-1, Tab F) with Champlain.

Mr Wilson clearly stated that to get a share of Champlain’s production of plywood, Woodbine had to put money into Champlain. Reference was made by him to Tab F of Exhibit A-1, but as I read that exhibit, the only requirement was:

1. DISTRIBUTOR

Woodbine is hereby designated and appointed the sole distributor of Champlain’s softwood plywood in the territory as defined below, so long as Woodbine purchases the quantity of plywood made available to it by Champlain on normal price and credit terms.

I see no requirement to do anything to obtain plywood except that which I have referred to above. The consideration shown in the agreement is as follows:

NOW THEREFORE THIS AGREEMENT witnesseth that in consideration of the premises and the mutual promises, agreements and covenants herein and other good and valuable consideration (the receipt of which is hereby acknowledged by each of the parties hereto), the parties hereto agree as follows.

Mr McConnell, who was called as a witness for the respondent, stated that the officers of Woodbine agreed if it had distribution rights it would have to make some investment, be it shares or debentures, as a prerequisite. McConnell believed that Champlain had a promising future as he relied on the information he had, although that information may not have been correct. He and his family had a share interest in Champlain. Nowhere do I see a contracted obligation to buy debentures or shares, be they common or preferred.

There is no doubt in my mind, based on Tabs B, C and D of Exhibit A-1, that the appellant received from Champlain, on or about

(a) April 12, 1971, a debenture of $34,000;

(b) November 26, 1971, 5,100 common shares NPV; and

(c) November 26, 1971, 1,700 par value $10 preferred shares.

Later, on a date I do not know, the appellant acquired a further 1,020 shares (presumably preferred). The advance alleged was $10,200 so that the total with respect to Champlain was now $66,300. It was also pointed out that the share interest (common) of the appellant in Champlain was about 5%. There was no suggestion, except by me until I was corrected, that the appellant ever had control of Champlain. It never did in so far as this appeal is concerned. Officers of Woodbine hoped to buy about $1,500,000 to $2,000,000 of plywood from Champlain in the first year and increase the quantity of purchases as time went on. The expected mark-up on resale would be about 8%.

Champlain started into business but things did not go too well. It had problems and Woodbine purchased another 1,020 shares with a payment of $10,200 to keep the mill running. The building of the machinery was in due course completed, but there were production problems: the machinery was not correct, there were problems in logging, and there was not enough high-class veneer to make plywood. By the summer of 1973 Champlain was just producing anything—it was not quality plywood. Later that summer, Champlain ceased production. Richmond Plywood Limited, another plywood producer, looked at Champlain’s operation and took over its business. In June of 1973 Woodbine signed a subordination agreement in favour of the Bank of Montreal with respect to all claims it had against Champlain. A 1974 estimated financial statement of Champlain showed an indicated book deficiency of about $2,000,000. Since Woodbine’s fiscal year-end was September 30, as counsel put it, Woodbine wrote down its “inventory” in Champlain by 50%. This write-down was in the amount of $33,150, being one-half of the amount spent by the appellant on Woodbine’s [sic] shares and debentures. This is the amount in dispute in this appeal. The appellant, when computing its income for its 1973 fiscal year, charged the amount of $33,150 as an expense. The respondent was of the opinion apparently that the appellant had not suffered a business loss, but rather a capital or investment loss and so disallowed that claim when he computed the appellant’s income—hence the appeal. It should be mentioned that at the end of its 1973 fiscal year, the appellant still owned all the shares which had been issued to it by Champlain and it likewise owned the debentures which had cost $34,000. It was pointed out that the officers of the appellant who gave evidence expressed the view that they looked differently upon their own purchase of shares in the appellant than on the purchase of Champlain shares by Woodbine. It was also stressed that Woodbine was not investing in Champlain to make money as it was paying greater interest than was to be paid by Champlain to Woodbine, be it as interest or preferred dividends.

The position of counsel for the appellant was that the write-off or write-down of the amount by the appellant was an inventory loss; it was, in effect, an expense of the year 1973. It clearly was not an investment as one does not, in an investment sense, borrow money at a high interest rate to loan “for investment purposes” at a lesser rate. There would be no gain in this. In addition, one cannot ignore the franchise given of south-western Ontario and the right to get 45% of Champlain’s plywood. These things being considered and the cases he mentioned (D J MacDonald Sales Limited v MNR, 16 Tax ABC 49; 56 DTC 481; Her Majesty the Queen v F H Jones Tobacco Sales Co Ltd, [1973] FC 825; [1973] CTC 784; 73 DTC 5577; and Algoma Central Railway v MNR, [1967] 2 Ex CR 88; [1967] CTC 130; 67 DTC 5091; [1968] SCR 447; [1968] CTC 161; 68 DTC 5096), counsel submitted the appeal should be allowed and the matter referred back to the respondent to reassess on the basis that the amount claimed was properly deductible in computing the appellant’s income for its 1973 taxation year.

Counsel for the respondent supported the assessment on two bases: the outlay at the beginning was a capital outlay inasmuch as the appellant acquired a lasting benefit by its “investment”; and in addition, since it, at the end of its 1973 taxation year, still owned the shares and debentures, it had not suffered any loss. When the appellant signed the agreement with Champlain, it acquired an enduring benefit. The agreement was for five years with automatic renewals of one year unless certain notice was given. There was a further enduring benefit—45% of Champlain’s production—and he stressed the agreement which gave these rights to the appellant did not require the appellant to buy any shares or debentures. While saying possibly the investment went down in value, those assets in that investment were still owned by the appellant at the end of its year and there was no evidence the appellant was a trader in shares and debentures and that those shares and debentures were inventory.

No one puts money into a business, whether it be by way of shares or debentures or even capital in his own business, without hoping and expecting to make a profit. At least a loss is not intended. If a person did, as the appellant did in this case, have a business closely related to the business of the company in which it ultimately put some of its money, undoubtedly the officers of the first company hoped and possibly even expected that the company into which the money was put would do business with it. Does this hope alone make the outlay a business expense? Would not the franchise be a capital expense and, if there were a reason for putting money in Champlain, the franchise and it alone could well have been the reason.

As I view the matter, the appellant did not make the outlay in this case for the purpose of gaining or producing income from a business or property, but rather the outlay was a capital investment. Of course when the appellant made that investment it hoped it would help its business, aS would every businessman with every transaction related even remotely to his business. However, that remote relationship will not change a capital investment into a business expense. Prima facie the property the appellant acquired as a result of its transaction with Champlain is that which is normally classified, except to a trader, as a capital investment. I cannot see that, if it is not a “business expense” or at least an expense on account of business in the year when the outlay is made, it becomes such an outlay or expense a few years later when a loss is suffered, which loss is not in the year the outlay was made but in a subsequent year.

The result is I would dismiss this appeal.

Appeal dismissed.