Capital Garment Co Inc v. Minister of National Revenue, [1974] CTC 2199, 74 DTC 1164

Judge Flanigan (orally: June 28, 1974):—This is an appeal by Capital Garment Co Inc, a Quebec Corporation, against a direction of the Minister of National Revenue, in which the Minister exercised his discretion under subsection 138A(2) of the Income Tax Act as it applied to the years 1968, 1969 and 1970. In exercising his discretion, the Minister deemed the appellant company in this case to be associated with a company known as Lou-Ann Limited.

The Board and the Federal Court is specifically limited by subsection 138A(3) in its ability to allow the appeal. It must find that none of the main reasons for the separate existence of these companies was to reduce the amount of tax that would otherwise be payable under the Act.

This is not the usual type of case that one meets under this section —if there is a usual type of income tax case—but the most prevalent type of case under this section is where the company has become very successful and there is a splitting-off of a part of the business for the obvious reasons contemplated by section 138A. Also, there are cases where two companies may be incorporated at the outset, and clearly for the purpose of reducing taxes.

I recently had a case in Calgary, Jack Carter Ltd, where the majority shareholder had carried on for some 15 or 20 years with two separate companies. He was in the car dealership business, one company owning the land and buildings, the other being the dealership; and after 15 or 20 years, when both companies were making money, the Department invoked subsection 138A(2).

The answer in this case, as I perceive it, is so simple that I feel that I may have missed something in the course of the hearing and, for this reason, should the matter go further, I will try to set out briefly the facts as I recall them.

Capital Garment Co Inc, the appellant, is really Joseph Cymbalista, who retired last July at the age of 71 after spending all of his working life as a tailor. He was born in a portion of Poland that was under Russian control and he worked from an early age until he left that region after the First World War and settled in Belgium. He was uprooted again in the Second World War and ended up finally in Canada and in Montreal. All the years that he worked, he worked as a tailor. He had a business of his own in Belgium which was liquidated along with some other assets after the war. He eventually found, through reading the newspapers as I recall, that there was a small garment business for sale in Montreal and it was in the same line of business that he was familiar with, namely, the making of ladies’ coats and raincoats. He purchased the business and, as he said, he did not know very much about the ways of business in Canada and he bought everything, including the employees that would stay with the business.

Mr Kwiat, who is a chartered accountant and gave evidence, said he has been auditor of the appellant company since it was incorporated, and certainly before Mr Cymbalista purchased it. He also said that Mr Cymbalista acquired a bookkeeper with the business. He built the business up by keeping control of the production end himself and leaving the administration end to his son-in-law, his son Armand, and his bookkeeper—he had two children, obviously a boy and a girl.

In the material years in question, the evidence indicates that, although Mr Cymbalista Sr kept his finger on all aspects of the business, he was mainly concerned with production and left the administration to the others I have mentioned.

A look at the financial statements for the years 1966 to 1970 of this appellant shows that it had built up a steady business. It was not growing by leaps and bounds but was maintaining sales of around a million dollars, which was sufficient to satisfy Mr Cymbalista Sr. The son, however, as the evidence indicates, was much more ambitious, and felt that other avenues of revenue should be sought so that the revenues of the appellant company would increase and the son’s earnings would thereby increase also.

He was approached by someone representing a company that had the exclusive rights for distribution in Canada of all goods exported from Hungary. This group offered to Armand the exclusive right to distribute in Canada leather and suede coats made in Hungary. At that time, the son had a close association with Mr Kwiat because, as l have said, he was on the administration side of the business. He spoke to Mr Kwiat and they discussed the matter. They even went so far as to project a pro forma balance sheet, which satisfied them that there was money to be made in this import business. It was an import business even though there was a middleman because, for all intents and purposes, they would be selling only imported coats from Hungary in Lou-Ann Limited. They approached the father with a view to persuad- ing him to take on this extra line but he would have no part of it. He has given several reasons. The one that permeates all his evidence is that he was satisfied with the business that he was generating, and that he would not invest $150,000, or any sum, in goods that he had not seen. He had had a bad experience with zippers imported for his own business which turned out to be unusable, and he felt concerned about the effect on the good name of the appellant company should delivery not be made and the appellant’s customers be left without the line of leather coats to sell that they had anticipated.

As Mr Kwiat said, Mr Cymbalista never conceded more than to say to Armand and his son-in-law that they could go ahead if they wished to but not to count on him. There is no question whatsoever on the evidence, and I find it as a fact, that there is, or was, no way that Joseph Cymbalista was going to allow the appellant company to actively participate in this importing venture. As he said, his son was headstrong and they did not always agree and, having reached that Stage, the son and the son-in-law approached Mr Kwiat again and they decided to incorporate Lou-Ann Limited and to go ahead with the project.

The financial statements all show that a favourable market had been correctly anticipated because up until 1970—the company was incorporated in May of 1966 and its first shipment was received in November, I think it was, of 1966—they showed a steady increase and the half million dollar mark in sales was reached. However, the supplier then went out of business and I think again the inference is clear that the supplier “went broke” and Lou-Ann Limited has steadily gone downhill to the point where it is insignificant at the moment, or at least it was in 1970.

The evidence is that once it became clear and beyond doubt to Mr Kwiat that the father was not going to take part in this venture, he then set his mind to incorporating a company to secure the best possible advantage, taxwise, for the son and son-in-law in Lou-Ann Limited. His evidence was quite clear that after the father was eliminated, he (Kwiat) then set his mind to the proper advice that he should give to the incorporators of the Lou-Ann company. He said to do otherwise would have almost amounted to malpractice on his part, and so he set up a company as part of the estate planning of the son and the son-in-law. To do this, it was necessary for Mrs Cymbalista, the mother of Armand and the wife of Joseph, who held a qualifying share in the appellant company, to divest herself of that share, as she was going to be the shareholder—I think she was referred to as the trustee for the children who were to hold the shares—in the new company. There is no question whatsoever that Mrs Cymbalista held her qualifying share in trust for her husband and that she had no beneficial interest in it save and except what she might have received from the company in the event of the death of her husband.

There is also the classic situation where once the business was set up, Lou-Ann Limited was operated out of the premises of Capital Garment Co Inc. They used the same employees, they had only one employee of their own, who was a shipper and did the unpacking, the packing, and the addressing and distribution of the coats when they arrived and, as the father said, what was the point of them having a large staff, or any staff, because all they needed was someone there to handle the goods when they arrived.

I have said in many cases that I do not think that it is necessary for someone to incur unnecessary expenses with a view to establishing evidence to satisfy the Minister, if a direction such as was issued in this case should come about, where such expense is not necessary for the carrying-on of the business. To me it would make no sense businesswise, nor would it make any difference to me in a particular case if a company had separate premises and separate employees whether they were needed or not, if in fact the true purpose of the existence of the company was the reduction of taxes. So I place no importance whatsoever on what was done by Mr Kwiat with respect to Lou-Ann Limited because the whole issue, in my mind, in this case, turns on the fact that Joseph Cymbalisia would not, and never did, take part in this business of Lou-Ann. There is no way, in my view, that the two companies could be deemed to be associated. It is true that he loaned money to Lou-Ann rather than have Lou-Ann Limited set up a line of credit at the bank and, when questioned about it, he said in effect: “What do you do? They were my children. I had the funds. I helped them.” Mr Kwiat said the same thing and there is no evidence that this led to any loss to the appellant company. I think the whole case stops and falls apart the minute that Mr Cymbalista indicated with great clarity that he would have no part of the importing business, and I have no hesitation in finding that none of the main reasons for the existence of Lou-Ann Limited was the reduction of tax that might otherwise be paid by the appellant under this Act. The appeal will therefore be allowed and referred back to the Minister for reassessment accordingly.

Appeal allowed.