Lebern Jewellery Co LTD v. Minister of National Revenue, [1976] CTC 2422, 76 DTC 1313

The Chairman:—This is the appeal of Lebern Jewellery Co Ltd from income tax assessments in respect of the 1971, 1972 and 1973 taxation years.

By notices of assessment dated December 4, 1974 the respondent imposed on the appellant, a Canadian corporation, tax of $936.06 in 1971, $652.21 in 1972, and $910.60 in 1973, plus interest and penalties for failure by the appellant to withhold the said 15% non-resident tax from so-called interest payments in the amounts of $6,240.38, $4,348.05 and $6,070.64 respectively made to its non-resident suppliers in each of the pertinent years pursuant to paragraph 106(1 )(b) and subsections 109(5) and 123(8) of the Income Tax Act, RSC 1952, c 148, as amended, in respect of the 1971 taxation year, and paragraph 212(1 )(b) and subsections 215(6) and 227(8) of the Income Tax Act, SC 1970-71-72, c 63, as amended, in respect of the other two years.

From the evidence adduced, the appellant company is in the business of purchasing watches abroad and selling them, principally, in Canada. It was alleged that, although a a certain quantity of watches were sold outside Canada, the amount involved is minimal and, for purposes of this appeal, the appellant concedes that all overseas purchases of watches may be considered as having been purchased for resale in the Canadian market.

Mr Levy, the president and a substantial shareholder of the appellant company, explained that 20% to 25% of its purchases of watches were made in Canada and, of the 75% to 80% of purchases made abroad, 90% were made in Switzerland. The appellant purchased unassembled watches, ie, movements, cases and dials, and its principal European suppliers were the Waltham Company and the Endura Company of Switzerland.

The movements were usually bought in Switzerland, but the dials and cases could at times be purchased in other countries, and, in assembling the watches, their type, size and shape would be dictated by market requirements either in Switzerland or in Canada. It was also alleged that the appellant did a considerable amount of contract work for Simpsons-Sears, The Robert Simpson Company Ltd and Eaton’s.

The relationship between the appellant and both Waltham and Endura was stated to have been more than simply that of purchaser and vendor. Both the Waltham and the Endura companies, though using their own watch movements, also bought dials and cases from other countries. If the components offered met the appellant company’s requirements, the Swiss companies would purchase more to meet the appellant’s order. If not, the appellant itself would choose and order the required components from other suppliers. However, both Waltham and Endura served as contacts, and even in some cases as purchasing agents, for the appellant in the purchasing of watch components anywhere in the world. When he was in Switzerland, which occurred about five or six times a year, Mr Levy, president of the appellant company, was free to use office facilities of Waltham or Endura to meet with prospective suppliers of watch components.

Officials from both the Swiss companies at times accompanied the appellant company’s president to other countries in search of desired component parts of watches. Some shipments of such purchases were made directly to the appellant and others to Waltham and Endura.

All purchases made from either Waltham or Endura, on whose respective products the appellant company enjoyed exclusive handling rights, were invoiced in Swiss francs and were paid by the appellant in Swiss francs (see Exhibits A-1, A-2 and A-3). Mr Levy, in his testimony, declared that these invoices and payments were typical of all such payments made by the appellant to its Swiss suppliers.

It is alleged that the terms of payment for both Waltham and Endura were normally 60 days net. However, owing to the good relationship between the appellant and its suppliers, and depending on the season, the appellant was sometimes allowed to make payments in 120 to 180 days. However, payments made beyond the 60-day period always included an extra payment to cover the cost of carrying the appellant’s account beyond the normal 60-day term.

In support of this allegation, counsel for the appellant filed as Exhibit A-4 an agreement between Waltham International SA and Lebern Jewellery Co Ltd, the appellant, where, among other things, it states at page 8, paragraph 8:

Waliham shall invoice Lebern at the time of shipment. Lebern will pay net 65 days after receipt of merchandise, with 7.5% interest per annum on late payments.

Counsel for the appellant also attempted to file as an exhibit a letter from Endura SA to the appellant company dated July 19, 1973. Counsel for the respondent objected to the filing of the letter on the ground that he could not cross-examine the sender of the letter and that the witness, Mr Levy, might be able to testify as to his understanding of the document but could not testify as to Endura’s intention in writing the said letter.

The Board took the objection of respondent’s counsel under reservation and allowed the letter to be filed. The Board, not being bound by the strict rules of evidence, considered the impracticality of having a witness brought to Monireal to testify that he had sent the letter and deems the letter to be a valid exhibit. However, since it is true that the sender of the letter could not be cross-examined, the Board accepts as evidence only what is actually stated in the letter without drawing any other conclusion as to its import. The said letter (received as Exhibit A-5) reads as follows:

Mr Jerry Levy

LEBERN JEWELLERY LTD

2705 Bates Road

MONTREAL 251, PQ

Canada

Basel, July 19-th, 1973/t

Dear Mr Levy,

We thank you for your three checks of a total amount of Sw Frs 59’214.10 which we have handed over to our bankers.

Please take note that for the check of Sw Frs 50’000.—, our bankers deducted Sw Frs 325.—for discount charges, therefore we credited your account with Sw Frs 49’675.— only.

Alway with pleasure at your disposal, we remain, dear Mr Levy,

sincerely Yours

ENDURA AG

Enclosure

1 Xerox-copy of Swiss Bank Corp, Bienne

In determining the issue in this appeal, it seems necessary to first establish where the appellant was carrying on its business. The facts, in my opinion, clearly indicate that the appellant company was operating a business of buying watches and components and selling assembled watches. Regardless of where they were acquired, the purchase of watch components and/or watches, although an important facet of the appellant’s business, is not the business itself. The appellant’s operation, in my view, became a business only when the watches were sold and a profit derived therefrom. Notwithstanding the relationship that might have existed between the suppliers and the appellant, the evidence is that the appellant was a Canadian company; that it sold its products almost exclusively on the Canadian market; that its profit was made in Canada; and that taxes on the said profit were paid to the Government of Canada. In the circumstances, it is very- difficult for the Board not to conclude that the appellant was carrying on business in Canada within the meaning of the Income Tax Act, a conclusion which is supported by considerable case law.

One of the questions to be determined is whether the appellant, a Canadian company, was obligated to withhold tax on the charges paid for late payments for invoiced goods in accordance with clause 106(1)(b)(iii)(E) of the Income Tax Act, RSC 1952, c 148, as amended, for the 1971 taxation year and clause 212(1 )(b)(iii)(E) of the Income Tax Act, SC 1970-71-72, c 63, as amended, for the 1972 and 1973 taxation years, which read:

106. (1) Every non-resident person shall pay an income tax of 15% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(b) interest except

(iii) interest payable in a currency other than Canadian currency to a person with whom the payer is dealing at arm’s length, on

(E) any obligation entered into in the course of carrying on a business in a country other than Canada, or

212. (1) Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(b) interest except

(iii) interest payable in a currency other than Canadian currency to a person with whom the payer is dealing at arm’s length, on

(E) any obligation entered into in the course of carrying on a business in a country other than Canada, to the extent that the interest payable on the obligation is deductible in computing the Income of the payer under Part I from a business carried on by him in any such country, or

Notwithstanding counsel for the appellant’s submission that the obligation referred to in clause 106(1 )(b)(iii)(E) for the 1971 taxation year could be interpreted as being the obligation of the Swiss suppliers to accept the appellant’s late payment, I believe that both clause 106(1)(b)(iii)(E) and clause 212(1)(b)(iii)(E) refer to an obligation of the Canadian resident taxpayer to pay certain amounts and, since the appellant, in my opinion, was not carrying on business in a country other than Canada, the exceptions in clause (E) of subparagraph (iii) of paragraphs 106(1)(b) and 212(1)(b) of the respective Acts do not apply to the facts of this appeal.

However, as I see it, the real issue is whether the additional amounts paid by the appellant to its Swiss suppliers because of late payments of its accounts represent interest income earned in Canada by the Swiss suppliers, or whether they are simply the suppliers’ carrying charges for payments made more than 60 days after the invoicing of goods purchased in Switzerland for resale in Canada.

As rightly pointed out by counsel for the appellant, although the appellant company has been assessed under paragraphs 106(1 )(b) and 212(1 )(b) of the Income Tax Act, it is the Swiss suppliers who are really being taxed, and the appellant is being held responsible for the payment of tax which the respondent alleges it should have withheld from the payments before forwarding them to Switzerland.

If the facts are as alleged by the appellant, then in principle it seems to me that, whatever percentage of the invoiced price is received by the suppliers in respect of late payments by the purchaser, this constitutes a part of the agreed selling price of their products. For the appellant, any additional amount paid to the suppliers for late payment is a surcharge agreed upon between the vendor and purchaser, and is therefore included in the cost to the appellant of the goods purchased. This is an ordinary commercial and business practice which is used to facilitate payment in contracts for the purchase and sale of goods required to carry on a business, and, in my opinion, the said amounts are related directly to the costs of doing business for both the vendor and purchaser, and are only incidentally related to the vendor’s income.

Part III of the Income Tax Act, RSC 1952, c 148, as amended, and Part XIII of the Income Tax Act, SC 1970-71-72, c 63, as amended, clearly deal with income by way of interest, and I do not believe that under the above circumstances the Swiss suppliers can be considered to have earned interest within the meaning and intent of those Parts of the respective Income Tax Acts.

Since the surcharges are included in a sale agreement between the appellant and the suppliers for products sold in Switzerland and form part of the negotiated price of those products, they are not, for the vendors, an additional source of income earned in Canada; they are part of the overall cost to the vendor of his products. In my opinion, the receipt of such surcharges cannot be taxed in the hands of the Swiss suppliers as income earned in Canada any more than can the income earned by the Swiss suppliers from the sale of their products to a Canadian customer.

Admittedly, taxing statutes must be interpreted restrictively. However, in principle and in the absence of a clear definition of interest income in the Income Tax Act, applying subsections 106(1) and 212(1) respectively to ordinary business carrying charges (whether or not they are called interest, as is alleged in this appeal) would, in my opinion, distort the purpose of the pertinent sections of the Act by making non-residents taxable on business income earned abroad in the ordinary course of carrying on their business with Canadian companies, which, in my opinion, is not what Part III or XIII of the respective Acts were intended to do, or indeed say.

As I intimated above, I have so far attempted to deal, as I see it, with a principle of law that is pertinent to this appeal. However, one of the points raised by counsel for the respondent with which I have not yet dealt is that the appellant not only has the burden of proving that the amounts paid were not “interest”, but also each one of the amounts of $6,240.38, $4,348.05 and $6,070.64, paid by the appellant in 1971, 1972 and 1973, must be shown not to have been in payment of interest.

In presenting his evidence, counsel for the appellant admitted that what he was attempting to do was merely to establish, among other things, the nature of the arrangement for payment in respect of purchases made by the appellant from its Swiss suppliers. To that effect, he filed invoices from Endura SA dated March 23, 1973 for an amount of 2,894.15 Swiss Francs and a covering cheque from the appellant, dated August 23, for an amount of 2,943.90 Swiss Francs, 49.75 Swiss Francs more than the amount of the invoice (Exhibit A-1).

Exhibit A-2 is an invoice from Endure SA, dated May 30, 1973, for 33,370.05 Swiss Francs and a covering cheque for 33,943.60 Swiss Francs, dated November 12, 1973, 573.55 Swiss Francs more than the invoice total.

Exhibit A-3 is a series of invoices from Waltham International for November 1973, totalling 25,460 Swiss Francs and a covering cheque dated April 10, 1973 for 25,937.37 Swiss Francs, 477.37 Swiss Francs more than the total of the invoices.

Counsel for the appellant alleged that the pattern set out in the filed invoices, in which additional Swiss francs were paid because payments to the vendor were made later than the normal 60-day term, was followed throughout the pertinent years and added up to the amounts in issue in each of the pertinent taxation years.

Counsel for the appellant also filed an agreement between Waltham International and the appellant where interest of 7.5% per annum was charged on late payments (Exhibit A-4). Counsel, however, explained that, by verbal agreement with Waltham International, the rate of charge increased with the increase of bank interest rates.

Exhibit A-5 is the letter from Endura SA dated July 19, 1973, which the Board has accepted as a valid exhibit evidencing only what is evident from the letter, viz, that 325 Swiss Francs were deducted from the appellant’s cheque of 50,000 Swiss Francs as discount charges.

On the basis of the evidence, both written and oral, before me, I am satisfied that, by contract or by oral agreement, certain additional amounts were paid by the appellant to its suppliers for late payment of accounts in the taxation years under review. However, there is no way this Board can determine, on the basis of the figures presented to the Board, what exact amounts were so paid in each of the years 1971, 1972 and 1973. Even though quantum may be an issue, as it has been in many tax cases dealt with by the Board, it is not necessarily so in every case, and I do not believe that quantum is the real issue in this appeal. The issue, as I see it, is simply whether any or all of the amounts specified in the appellant’s assessments for 1971, 1972 and 1973 were interest payments made to a non-resident and should have been subject to withholding tax pursuant to subsection 106(1) of the 1952 Act and subsection 212(1) of the new Act.

As I see it, the appellant’s burden of proof in this appeal is to establish to the satisfaction of the Board that the payment specified in the assessments were not subject to the withholding tax. Having establish to the satisfaction of the Board that the payments specified in general policy agreed upon and followed by the purchaser and the vendors in respect of late payments, I do not believe that it is incumbent on this Board to verify countless invoices covering three years of evidently numerous business transactions, merely in order to check out, as suggested by counsel for the respondent, which one, if any, of the amounts specified in the Minister’s reply to the notice of appeal might contain interest payments on which the withholding tax would apply. That, in my opinion and in that of my predecessors on the Board, is not the role of the Tax Review Board.

For these reasons, the appeal is allowed in part and referred back to the Minister for reconsideration and reassessment so that he may take into account that the Board has held that the payments made by the appellant over and above the amounts stated in the invoices filed as Exhibits A-1, A-2 and A-3 at the hearing, as well as the discount charges referred to in Exhibit A-5, are not subject to the non-resident withholding tax, and so that he may also take into account, in considering all other relevant invoices not filed with the Board as exhibits, that no amounts paid by the appellant to non-residents in the 1971, 1972 and 1973 taxation years as surcharges for late payment of accounts in the ordinary course of purchasing products from foreign suppliers constitute interest income within the meaning and intent of subsections 106{1) and 212(1) of the respective Income Tax Acts.

In all other respects, the appeal is dismissed.

Appeal allowed in part.