Massey-Ferguson Limited v. Her Majesty the Queen, [1974] CTC 671, 74 DTC 6529

Hamid, J:—This is an appeal. by the plaintiff from a reassessment 61 its. 1967 income tax return by the defendant wherein ‘plaintiff's income was revised by including therein the following item:

Deemed interest income (Perkins Eng Inc) $31,956.00.

The plaintiff is a Canadian corporation, described in evidence by its Taxation Director, Mr Hyman Arnold Sherman, as being 85% Canadian owned and Toronto based. The plaintiff is the holding company for the Massey-Ferguson group of world-wide companies, comprising, in total, some 100 different companies. Mr Sherman described the plaintiff as the parent company in the Massey-Ferguson group.

During the whole of the 1967 taxation year the plaintiff owned all of the outstanding shares of Verity Plow Limited (hereafter Verity), an Ontario corporation having its head office at Toronto. The books and records of Verity were kept at the plaintiff's Toronto office.

Since 1957 Verity has been an inactive and non-operating company having as its sole function, the holding of investments in and the making of loans to other Massey-Ferguson subsidiaries to further the interests of the Massey-Ferguson group. The records of Verity establish various loan and investment transactions with other subsidiaries and with the plaintiff during the period 1957 to 1971. Verity had no bank account. It looked to the plaintiff as its banker. At all relevant times the officers and directors of the plaintiff were also the officers and directors of Verity and were remunerated only by the plaintiff. Verity had no employees of its own. Any necessary work performed for Verity was performed by employees of the plaintiff who were also remunerated only by the plaintiff. Verity had no separate office. Its office was in the plaintiff’s offices in Toronto. In transactions involving the plaintiff and Verity, the plaintiff’s employees would make the necessary entries in both sets of books. The books and accounting records of Verity were kept in the plaintiff’s accounting department.

Verity, in turn, throughout the taxation year 1967 held all the outstanding shares of Perkins Engines Inc (hereafter Perkins), a Maryland corporation with head office in Farmington, Michigan, said company being engaged in the business of selling and servicing diesel engines manufactured by Perkins Engines of England, another of the plaintiffs subsidiaries.

In March of 1967 the plaintiff determined that Perkins was in need of additional funds to be used by it as working capital for its day-to-day operations for the purpose of gaining or producing [1] income.’ Perkins received the sum of $1 million (US funds) from the Canadian Imperial Bank of Commerce who were directed by the plaintiff to transfer that sum to it. from the plaintiff’s account in New York. Perkins then used ‘the said sum in its business for the purpose of gaining or producing income.

Verity had acquired, in 1960, shares of Perkins in a transaction. by which those shares were issued to Verity and paid for by the plaintiff on behalf of Verity. The books of account of the plaintiff subsequently showed a loan to Verity and the books of account of Verity showed a loan from the plaintiff and an acquisition of the shares of Perkins.

1967, to its treasurer, Blair, from its assistant treasurer, Wleugel which reads as follows:

Loans to Perkins USA and Perkins Canada

Agrotrac via CIBC is presently lending Perkins Engines Inc, $300,000 at 6% per annum interest. It has been decided to provide Perkins US with an additional loan of $700,000 and Perkins Canada a loan of $250,000—both of medium term character.

As agreed with you and Mr Sherman, we will proceed as follows:

1.) MF Limited will lend Perkins USA, US $1,000,000 via Verity Plow at no interest charge on March 26, 1967.

2.) MF Limited will lend Perkins Canada, Cdn $250,000 on March 26, 1967.

Whether or not interest will be charged to Perkins Canada, will depend upon MF Limited’s and Perkins Canada profit position. Mr Sherman will review this in September. If interest is charged to Perkins Canada, the rate will be 6% per annum.

3.) Perkins Inc will, upon receipt of the loan, repay CIBC’s loan of $300,000 in full (plus accrued interest).

4. ) It is not advisable to make Perkins US a subsidiary of MF Inc, due to the effect of MF Inc’s borrowing capacity and debt tests. (Refer Mr Sherman’s memo to Mr Tiffany of February 22, 1967.) Mr Sherman and I will review the position again in September.

It will not be necessary for Limited to borrow in order to obtain the $1,250,000 to be lent and consequently the problem of interest being disallowed for tax purposes does not arise.

be Mr P A Giroux—please arrange for execution accordingly.

By way of an explanation of paragraph 1 of said memorandum, Mr Sherman said that he had met with Messrs Blair and Wleugel and that he had pointed out to them that Perkins was not a subsidiary of the plaintiff and that it was doubtful whether the exempting provisions of subsection 19(3) of the Act would apply to this transaction. He thus recommended that the loan be made “via Verity Plow” since Verity was a subsidiary of the plaintiff. They accepted his advice and paragraph 1 of subject memorandum resulted.

Then there is a letter dated March 2, 1967 from plaintiff’s treasury assistant to Perkins Engines Limited of England which reads as follows:

Thank you for your letter of February 20, 1967. It has now been decided to proceed with the loans to Perkins Engines Inc, and Perkins Engines Canada Limited, and it has been suggested that they be handled in the following manner:

Massey-Ferguson Limited will lend Perkins Engines Inc via Verity Plow Limited, US $1,000,000 at no interest charge, on March 26, 1967. However, upon receipt of this loan, Perkins Engines Inc will repay the Canadian Imperial Bank of Commerce its loan of US $300,000 plus accrued interest.

Massey-Ferguson Limited will lend Perkins Engines Canada Limited, Cdn $250,000 on March 26, 1967. Whether or not interest will be charged will be subject to review in September 1967. If interest is charged, it will be at the rate of 6% per annum.

I understand Mr H A Sherman will be meeting you some time in March, and he will be able to explain the tax implications of the interest charges at that time.

We hope you will find these arrangements to be satisfactory.

Mr Sherman said that the purpose of this letter was to inform Perkins of England (the administrative headquarters of the Perkins Engines group) of the way in which the loan to Perkins was going to be accomplished.

Then there was a letter dated March 23, 1967 from the plaintiff to its bank, the Canadian Imperial Bank of Commerce, Toronto. A postscript at the bottom thereof was typed in on the copies only for the attention of certain employees of the plaintiff. The postscript was, in essence, accounting instructions.. That letter and postscript read as follows:

In accordance with our telephone conversation of today, would you please arrange the transfer of the following funds for value March 29, 1267:

1) $250,000 Canadian from the account of Massey-Ferguson Limited, CIBC, Toronto to Perkins Canada Limited at CIBC, Dixon Road and Martingrove Branch, Rexdale, Ontario.

2) $1,000,000 US in federal funds from the account of Massey-Ferguson Limited, CIBC, New York Agency, to Perkins Engines Inc, at the National Bank of Detroit, Branch #52, Novi Branch, Wixom, Michigan.

In addition, Perkins Engines Inc will repay on March 29, 1967, their loan of $300,000 US plus accrued interest calculated at 6% per annum. Agrotrac SA will be in contact with you regarding the disposition of their deposit of $300,000 US plus accrued interest on March 29, 1967.

Thank you for your co-operation in this matter.

PS. For accounting purposes the $1,000,000 US loan to Perkins Engines Inc should be shown as a short-term advance from Verity Plow Limited at no interest charge. The $250,000 Canadian loan to Perkins Canada Limited should be shown as a short-term advance from MF Limited. Whether or not interest is to be charged on this loan, will be subject to review in September 1967.

There was also a letter dated March 27, 1967 from the plaintiff to Perkins which reads as follows:

This letter will confirm our telephone conversation of March 23, at which time we advised you that Massey-Ferguson Limited will lend Perkins Engines Inc, via Verity Plow Limited, US $1,000,000 on March 29 ,1967, at no interest charge. These funds will be credited to your account at the National Bank of Detroit, Branch #52, Novi Branch, Wixom, Michigan, for value March 29, 1967. For accounting purposes this loan should be recorded as a short-term advance from Verity Plow Limited.

However, upon receipt of this loan, Perkins Engines Inc, should repay the Canadian Imperial Bank of Commerce its loan of $300,000 US plus accrued interest up to March 29, 1967, which amounts to US $7,545.60.

It is important that your bank be made aware of these impending transactions so that they may be carried out without delay on March 29, 1967.

Then on March 29, 1967 the Canadian Imperial Bank of Commerce, New York agency sent the following advice to the plaintiff:

We DEBIT your account as follows:

Refer our Toronto Branch telegram of 27th instant—

T/T National Bank of Detroit, Novi Branch #52, Novi Michigan for credit Perkins Engines Inc.

$1 ,000,000.00

Plaintiff’s treasury employees contemporaneously prepared the necessary accounting records covering this transaction. The financial statements of Verity, for the year ending October 31, 1967, approved by its directors and shareholders early in 1968, also reflect Subject loan as being an account payable by Verity to the plaintiff. On September 23, 1969 Verity, by letter, assigned said loan to the plaintiff and transferred all of the Perkins shares to plaintiff.

The applicable sections of the Income Tax Act, RSC 1952, c 148, prior to the amendments effected by section 1 of SC 1970-71 are subsections 19(1) and 19(3) which read as follows:

19. (1) Where a corporation resident in Canada has loaned money to a non-resident person and the loan has remained outstanding for one year or longer without interest at a reasonable rate having been included in computing the lender’s income, interest thereon, computed at 5% per annum for the taxation year or part of the year during which the loan was outstanding, shall, for the purpose of computing the lender’s income, be deemed to have been received by the lender on the last day of each taxation year during all or part of which the loan has been outstanding.

(3) Subsection (1) does not apply if the loan was made to a subsidiary controlled corporation and it is established that the money that was loaned was used in the subsidiary corporation’s business for the purpose of gaining or producing income.

The term “subsidiary controlled corporation” used in subsection 19(3) above quoted is defined in paragraph 139(1)(aq) of the Act which reads as follows:

(aq) “subsidiary wholly-owned corporation” means a corporation, all the issued share capital of which (except directors’ qualifying shares) belongs to the corporation to which it is subsidiary and “subsidiary controlled corporation” means a corporation more than 50% of the issued share capital of which, (having full voting rights under all circumstances) belongs to the corporation to which it is subsidiary;

It is admitted that subject $1 million loan was, in fact, outstanding for one year or longer. It is also admitted that the plaintiff is a “corporation resident in Canada”. It is also admitted that Perkins is a “non-resident person”. The plaintiff, however, submits that subsection 19(1) does not apply on the facts here established.

The plaintiff submits that the evidence has established its intention at all material times to lend subject $1 million in US funds to Verity and to cause Verity to lend said sum to Perkins which intention was carried out as evidenced by the books of account of all three companies and the audited financial statements of Verity and Perkins. The main thrust of the plaintiff’s argument is that subsection 19(1) applies only where a corporation has loaned money to a non-resident person and since this loan was made to Verity, a Canadian corporation, subsection 19(1) does not apply.

With respect, -l do not agree that the evidence adduced has established plaintiff’s intention to lend subject $1 million to Verity.

The memorandum of February 27, 1967 deals with two loans, one to Perkins Canada, the other to Perkins Inc, the American subsidiary. The context of this memorandum satisfies me that the plaintiff was the lender in each case and that the ‘via Perkins” was inserted in the case of the loan to the American subsidiary, on the advice of plaintiff’s tax expert, Mr Sherman, in an attempt to get this transaction outside the provisions of subsection 19(1). of the Act. Furthermore, in the plaintiff’s letter of March 2, 1967 to Perkins of England, it is stated:

It has now been decided to proceed with the loans to Perkins Engines Inc and Perkins Engines Canada Limited .

This again is a clear indication that both of subject loans were from the plaintiff to the two Perkins subsidiaries. Then, there is the instructing letter of March 23, 1967 from the plaintiff to its bank wherein the funds were transferred directly from the plaintiff to Perkins. The postscript to the letter of March 23, 1967 is significant. It reads:

For accounting purposes the $1,000,000 US loan to Perkins Engine Inc should be shown as a short-term advance from Verity Plow Limited at no interest charge. (Underlining mine)

Then again, the letter from plaintiff to Perkins of March 27, 1967 which reads, inter alia:

Massey-Ferguson Limited will lend Perkins Engines Inc, via Verity Plow Limited US $1,000,000 on March 29, 1967 at no interest charge.

It is well established that, in considering whether a particular transaction brings a party within the terms of the Income Tax Act its substance rather than its form is to be regarded, and also that the intention with which a transaction is entered into is an important matter under the Act and the whole sum of the relevant circumstances must be taken into account.* [1]

On the whole of the relevant circumstances here present, I am satisfied that it was clearly the plaintiff’s intention to lend the $1 million directly to Perkins. Verity played very little part in the transaction except in a nominal way. There was no legitimate business purpose for involving Verity. The only reason, and Mr Sherman was quite frank in admitting this, was in an attempt to keep the transaction outside subsection 19(1). I have thus concluded that the substance of subject transaction, notwithstanding the form thereof, was a loan from the plaintiff to Perkins, a non-resident corporation, so as to make applicable the provisions of subsection 19(1) of the Act.

The plaintiff also submitted that, if I concluded that the documentation of March 1967 described above was not sufficient to establish that the loan was actually from the plaintiff to Verity, by virtue of the audited financial statement and the approval thereof by the directors and shareholders of Verity early in 1968, the plaintiff was legally entitled thereafter to look to Verity for payment who in turn was entitled to look to Perkins, thus making the loan, at that time, if not before, a loan from the plaintiff to Verity. I am not able to accept this argument. In my opinion, the intervention of Verity in this transaction was a sham and what happened in. furtherance of the sham or to complete the sham, such as the approval of the financial state- ments, cannot in any way change the true nature and substance of the transaction which was, at all times, a loan from the plaintiff to Perkins.

The plaintiff’s next argument was, that if I concluded, as is the case, that subsection 19(1) applies, then the facts in this case have established that Perkins was really “a subsidiary controlled corporation” of the plaintiff so as to bring into play the provisions of subsection 19(3) and thus exempt this transaction from the provisions of subsection 19(1). The gist of this argument centres around the meaning of the word “belongs” as the same is used in paragraph 139(1)(aq). The plaintiff concedes that the legal ownership of Perkins shares was at the material time vested in Verity. However, plaintiff's counsel urges me to give to the word “belongs” a wider or more extended meaning. Since plaintiff owned all the shares of Verity and Verity owned all the shares of Perkins, the submission is that the shares of Perkins can thus be said to ‘belong” to the plaintiff. l am not able to accept this argument. It is a well established rule that the exemption provisions of a taxing Act must be construed strictly.* [2] Furthermore The Encyclopaedia Dictionary, Volume 1, Special Edition, page 491 defines “belong” in so far as it relates to things as follows: “To be the property of”. In the High Court of Australia, in the case of Myerson v Collard (1918), 25 CLR 154 at 164, it was held:

When we speak of physical objects as belonging to a person, without any qualifying expressions, the primary natural meaning is that they are his own absolute property, and not that he has, instead of the objects themselves, a mere option which he may never exercise or a mere contractual right to own them on conditions which he may yet elect not to undertake.

Plaintiff’s counsel relied on the decision in Vineland Quarries and Crushed Stone Ltd v MNR, [1966] Ex CR 417; [1966] CTC 69; 66 DTC 5092. However, the word there being considered was the word “controlled” as used in paragraph 39(4)(b) of the Act. I would have no hesitation, on the facts in this case, in concluding that the plaintiff controlled Perkins. However, the word used in paragraph 139(1)(aq) is “belongs” and in my view the primary natural meaning of that word connotes ownership. There can be no doubt on the facts here that all of the Perkins shares were owned by Verity, and thus belonged to Verity and not to the plaintiff. There is no doubt, that because of its control of Verity, the plaintiff was in a position to acquire the shares of Perkins. However, it did not choose to do so and on the basis of the plain and unambiguous meaning of the words used in paragraph 139(1 )(aq) of the Act I have concluded that, at all relevant times, Perkins was not a “subsidiary controlled corporation” of the plaintiff and has thus nor brought itself within the excepting provisions of subsection 19(3) of the Act.

It follows that the plaintiff’s appeal and action must be dismissed with costs.