The Assistant Chairman:
1 These are the appeals of Kruger Pulp & Paper Limited from income tax assessments in respect of the appellant's 1966, 1967, 1968 and 1969 taxation years, which, for the sake of clarity, were divided by the appellant into two separate issues.
2 The Board feels it necessary, because of the extremely long delay in reaching its decision in these appeals, to apologize to the parties concerned and explain that because of the complexities of the facts it was necessary to request a transcript of the hearings. It took a considerable amount of time to obtain these lengthy documents and more time was expended in reading them, sorting out the facts, and reaching a decision, while also continuing to hear and to adjudicate other cases under appeal. I have taken steps to try to avoid such delays in the future.
3 The first part of these appeals deals with the disallowance by the respondent of certain amounts claimed in each of the taxation years under appeal as deductible expenses in respect of the acquisition of timber cutting rights for the proposed construction of a pulp and paper plant in St Felicien, Quebec.
4 The second part of this appeal concerns the deductibility in the taxation years 1968 and 1969 of certain expenses and the capital cost allowances claimed by the appellant in respect of two pulp and paper plants situated in Italy and allegedly owned by the appellant in the pertinent years.
5 Dealing first with Part I of the appeals: For the 1966 taxation year (Appeal No 73-897)—By Notice of Assessment dated September 30, 1971, and confirmed by the Minister of National Revenue on October 31, 1973, an amount of $84,895 claimed as a deduction in respect of expenses incurred by the appellant in connection with an investigation of the site of the proposed St Felicien plant was disallowed by the Minister on the ground that the amount so claimed constituted expense of a capital nature.
6 Counsel for the appellant in his pleadings admitted that, of the $84,895 so claimed, an amount of $8,696 was a capital payment laid out for options to acquire a site and was no longer in issue. However, in respect of the balance of $76,199 remaining in issue, the appellant contends that $60,000 paid in 1966 to London Paper Box Co Limited for consulting services in connection with the obtaining of a licence and/or wood procurement rights is a normal operating expense and deductible. The balance of $16,199 was paid to Omer Lussier and Associates in 1966 in consideration for the preparation of a logging plan or feasibility study in respect of wood procurement rights that would be adequate to meet the wood requirements for the St Felicien plant, an outlay which the appellant also considers to have been a current deductible expense.
7 Counsel for the respondent, on the other hand, contends that the amounts of $60,000 and $16,199 disallowed were expended in the acquisition of timber limits and that they were capital in nature and not deductible.
8 For the 1967 taxation year (Appeal No 73-898)—By Notice of Reassessment dated October 5, 1973, an amount of $40,174.86 was charged to site investigation and deemed by the Minister to be the cost of acquiring a capital asset, and considered by him to be a non-deductible capital payment.
9 Counsel for the appellant contends that the amount of $40,714.86 is made up of several specific items. $25,000 of that amount represents a second payment made to London Paper Box Co Limited, and, for the reasons already given in respect of the 1966 payment to the said company, was considered by the appellant as a deductible current expense. Also included in the amount of $40,714.86 was an amount of $8,715 paid to the law firm of Cate, Ogilvy and Bishop for negotiations with the provincial government in connection with the issuance of an Order-in-Council granting the appellant a licence to acquire the timber rights.
10 In respect of the St Felicien project, an additional amount of $7,000 paid to the firm of Lamontagne & Lamontagne was at first claimed by the appellant but was withdrawn during the hearing of the appeal.
11 Counsel for the respondent invokes the same argument with regard to the second payment of $25,000 by the appellant to London Paper Box Co Limited in 1967 in justification of its disallowance, and contends that the payment of $8,715 made in 1967 to a law firm for drafting the agreement with the provincial government is an expenditure made to acquire wood cutting rights, an asset which he considers to be depreciable, and concludes that such a capital expenditure is not deductible.
12 It is to be noted that any discrepancy in the total amounts claimed and disallowed in each of the pertinent taxation years and those dealt with by me in Part I of these reasons for judgment is due principally to the fact that some of the amounts claimed in a particular taxation year refer to expenses incurred in relation to the Italian operation which will be dealt with in the second part of these reasons for judgment.
13 For the 1968 taxation year—The amount claimed as deductible by the appellant and disallowed was $4,514.23 as shown in the Notice of Reassessment dated October 5, 1973. Of this amount the payments made to Lamontagne & Lamontagne were again dropped by the appellant as were amounts totalling $950 paid to Eric M Lack, Notary, and to the firm of O'Brien, Hall & Nolan. In issue was an amount of $1,964.23 in Canadian currency paid to Hamburger & Green, Counsel lors at Law. (Although Exhibit A-6 shows this expense to have been $2,577.19, counsel for the appellant claimed only $1,964.23 as a deduction from income). Exhibit A- 7 is a bill for $600 from O'Brien, Home, Hall, Nolan, Saunders, O'Brien & Smyth, Barristers & Solicitors, and deducted by the appellant, $200 of which was disallowed because it dealt with the St Felicien project. Exhibit A-8 is a bill in the amount of $300 from Omer Lussier and Associates for copies of the original logging plan, the payment for which was claimed by the appellant as a deduction and disallowed by the Minister.
14 For the 1969 taxation year—A bill for $7,928.36 from O'Brien, Home, Hall, Nolan, Saunders, O'Brien & Smyth was paid by the appellant and claimed as a deductible expense (Ex A-9); a bill of $2,957.46 from Omer Lussier and Associates was paid by the appellant and claimed as a deduction (Ex A-10); a bill from J J Turcotte, Notary, in the amount of $2,650 was paid by the appellant and claimed as a deductible expense (Ex A- 11), as was a bill from Camille Gagné for $8,288.78 for services in respect of technical surveys in relation to the proposed site for the construction of the St Felicien Plant (Ex A-12). The deductibility of all these claims was originally disallowed by the Minister.
15 The Board took note that in argument the respondent agreed to the deductibility of the $60,000 paid to London Paper Box Co Limited in 1966 as an expense incurred in making representations to the Government of the Province of Quebec in the hope of obtaining a licence permitting the cutting of wood in connection with the appellant's business within the meaning of paragraph 11(1)(aa) of the old Income Tax Act. Therefore, for the same reasons, the amount of $25,000 paid to London Paper Box Co Limited in 1967 would also be deductible.
16 Counsel for the respondent further agreed to the deductibility of the $8,288.78 paid to Camille Gagné for topography re the site of the plant to be built at St Felicien.
17 Notwithstanding the complexity of the various claims made by the appellant and disallowed by the Minister, some of which were dropped by the appellant and others subsequently allowed by the respondent, the issue in the first part of these appeals is clear enough and is simply whether the expenses claimed by the appellant are on capital account or whether they are normal operating expenses incurred to produce income.
18 Kruger Pulp & Paper Limited is engaged in the manufacture of newsprint and other wood products. Over the years the company expanded, and in 1966 it was operating plants in Bromptonville, Côte St Paul, Ville LaSalle, Toronto and Montreal. In that year the supply of wood in the Eastern Townships was becoming depleted. The appellant company contemplated the building of a new modern newsprint plant at St Felicien, Quebec, and the appellant company's officers were negotiating with officers of the Department of Lands and Forests of Quebec, as well as with officials in Ottawa, investment brokers and consulting engineers, as a preliminary step to the execution of the project.
19 In this connection the firm of Omer Lussier & Associates, forestry engineers, was employed in 1966 by the appellant to study the location, quality and quantity of wood per acre required and available, and the estimated end cost of acquiring that wood. It was alleged that the logging study was required by the Department of Lands and Forests of the Province of Quebec before a licence for the cutting of the wood could be granted. Such a study was also required by any potential lender of money to finance the project, who would need to know how the current productions would be effected and how much more the proposed plant would produce. The logging plan (Ex A- 2) was therefore published at a cost to the appellant of $16,199.
20 As a result of these negotiations, Order-in-Council No 702 was passed by the Government of the Province of Quebec in which the Department of Lands and Forests was authorized to grant to the appellant, for an initial period of 25 years, cutting rights in the forests of Roberval and Chibougamau in order to supply the wood necessary for the paper plant and for a cellulose pulp plant to be built by the appellant at St Felicien at an estimated cost of $75,000,000. The wood-cutting rights were granted by means of a separate Notarial Act of Agreement between the Department of Lands and Forests and the appellant for each of the two projected plants as appears in Exhibits A-4 and A-5.
21 It is my understanding that, because of a softening of the newsprint market, the difficulty of obtaining the necessary financing and the fact that the federal Government could not assist in the realization of the project, the proposed pulp plants were in fact not proceeded with, and the licences for cutting on the timber limits, though granted, were never used. The licences lapsed and the amounts expended in the process of obtaining them constituted a loss to the appellant.
22 It seems to me that, in considering the first issue in these appeals, the St Felicien project should not be looked at as a separate entity. In fact it is, in my opinion, but another plant in the overall Kruger Pulp & Paper Limited family engaged in the production of paper products in various forms and whose basic and essential raw materials for earning income are trees. The forests, which are now more than ever before under government supervision and control, are being protected from complete depletion and, as I understand happened in this instance, the wooded areas in and about Bromptonville were nearing the maximum permissible depletion point. Therefore the appellant had to seek new areas in which it might find and make use of the quantity and quality of wood required for the production of its end product so that it might continue its overall production and maintain or increase its past income. In 1966 the appellant company declared an income of $1,654,574 from its overall operations, and in 1971 its sales reached $69,772,856. Looked at in that light, the total amount of the expenses claimed in relation to the St Felicien project would not appear to be unreasonable if they were in fact part of the overall operational expenditures of the Kruger enterprises taken as a whole. Nor, in my opinion would it be illogical to conclude that such amounts were, in the circumstances, normal operating expenditures.
23 For income tax purposes, however, counsel for the respondent holds that the expenses claimed were disallowed by the Minister because they were capital expenditures incurred relative to, or forming part of, the capital cost of acquiring timber limits for the St Felicien project. In support of his argument, counsel refers to paragraph 1100(1)(e) of the Income Tax Regulations in which a capital cost allowance based on “the capital cost to him of a timber limit or a right to cut timber from a limit” is permitted. (The italics are mine.)
24 Counsel's point, no doubt, is that the expenses incurred in acquiring timber limits are looked upon in that section of the Regulations as capital expenditures. I do not believe that, on the facts of these appeals, one can come to that conclusion so easily. I would think that the effective acquisition of enduring depreciable assets as a result of such expenditures would still be an important factor in determining whether the same expenses are of a capital nature. In interpreting section 1100 of the Regulations, I think we must assume that the section refers to depreciable assets which were effectively, as well as legally, acquired and which were, or would eventually be, used in the operations of the taxpayer's enterprise.
25 In this instance, expenditures were made for the legal acquisition of the licence and right to cut timber but there was, apart from the legal formalities, no real, effective or useful acquisition of depreciable assets of an enduring advantage by the appellant because the whole St Felicien project was aborted and, the licence permitting the cutting of timber having since expired, not a single tree was ever cut from the said timber limits. Regardless of the legality in other fields of law of the acquisition of the cutting rights, for income tax purposes how can section 1100 of the Regulations apply in such circumstances? Had the plant been built and operated, the expenses incurred for the obtaining and use of the timber cutting rights would have been included in the overall costs of the assets on which capital cost allowance might have been granted pursuant to Regulation 1100, and the present tax issue might not have arisen. Since the St Felicien plant did not materialize and did not at any time operate, can the expenses already incurred by the appellant as laid down costs of the legal acquisition of timber rights which were never used, be considered as a true capital expenditure? Can such expenditures, in the circumstances, not be viewed as expenses incurred in the appellant's overall operations for the purpose of earning income?
26 In my opinion, the disallowance of the said expenditures would, in the circumstances of these appeals, be an unfair and even unjustified breach of the basic principle of matching gross revenues with the cost of earning income that is generally accepted as a rule of thumb in accounting practices and for income tax purposes, because in this instance there was no revenue derived from the expenditures and no depreciable asset acquired.
27 Although at the hearing several cases were cited dealing with the distinction to be made between capital and current expenditures, the Federal Court decision in Bowater Power Company Limited v Minister of National Revenue, [1971] C.T.C. 818, 71 D.T.C. 5469, appears to me to be the most applicable to the facts of the case at bar.
28 Mr Justice Noël's statement at page 837 [5481], in relation to the issue at bar, in my opinion is particularly significant in determining the present issue, where he said:
It was, I believe, felt in the two above cases, that a business expenditure that is made or incurred for the purpose of gaining or producing income is no less a cost of doing business because it is not attached to depreciable property and the same should apply, I believe, when the business expenditure is made in vain and did not result in the creation of a depreciable asset such as we have here.
I do not indeed feel that merely because the expenditure was made for the purpose of determining whether to bring into existence a capital asset, it should always be considered as a capital expenditure and, therefore, not deductible. In distinguishing between a capital payment and a payment on current account, regard must always be had to the business and commercial realities of the matter.
29 In the case at bar the acquisition of the licence did not effectively create a depreciable asset and no capital cost allowance was ever taken by the appellant on the timber rights. The business and commercial realities of the appellant's acquisition are non-existent.
30 Counsel for the respondent, in commenting on the Bowater case, alleged that Bowater was continually engaged in research for discovery of new sources of energy and this was part of the current operations of the company.
31 It was stated but not contested at the hearing that new timber sites were being carefully looked into at St Felicien because of the forest depletion in the Eastern Townships which forced the appellant to search for a new source of raw material, and I do not believe this to be an unusual situation in the pulp and paper industry. Whether or not, as claimed by counsel for the respondent, a wood cutting right or licence can be exploited almost indefinitely once it has been granted, is, in my view, immaterial to the issue in these appeals, because those cutting rights were never exploited at all. Respondent's counsel further contends that the timber cutting rights that the appellant obtained were exclusively for the St Felicien plant. That, of course, may be so, but I still continue to believe that the St Felicien project would have been but one of the plants through which the Kruger Pulp & Paper Limited operated its pulp and paper business, and the proposed plant at St Felicien had been contemplated only in order to produce additional income for the appellant.
32 On the facts of these appeals, I hold that all expenses claimed by the appellant in the course of the hearing that are clearly and directly related to, and concerned with, the acquisition of timber cutting rights at St Felicien are current expenses incurred in the appellant's operation of its pulp and paper business for the purpose of earning income within the meaning of the exception contained in paragraph 12(1)(a) of the Income Tax Act, RSC 1952, c 148 as amended, and are deductible.
Part II
33 The basic issue in the second segment of these appeals is: Who, for income tax purposes, legally owned the two Italian tissue plants in Italy? The decision on that issue will determine whether the expenses and capital cost allowance claimed by the appellant in respect of these two off-shore plants are deductible or not.
34 Kruger Pulp & Paper Limited had borrowed $15,000,000 through the intermediary of three insurance companies by means of a mortgage bond and a deed of trust and mortgage with the Royal Trust Company dated September 15, 1965 (Ex A-13). This deed of trust and mortgage contained, among other things, a restrictive clause (clause 21 of section 4) which in effect prohibited the appellant company from investing in excess of $250,000 in the shares of any subsidiary company that was not a restricted subsidiary. Having already invested $25,000 in a non-restricted subsidiary, an investment of $225,000 pursuant to the Trust Deed was available for investment by Kruger Pulp & Paper Limited in non-restricted subsidiaries.
35 Prior to 1965, Gene and Bill Kruger were interested in, and contemplated operating, a paper mill in Italy, and investigations were carried out in Italy to that end. An Italian corporation called ISVEIMER, which would be comparable to the Canadian Department of Regional Economic Expansion, invited the Kruger brothers to consider the construction of a mill in an economically depressed area of Southern Italy. For good and valid business reasons, the Kruger brothers, Gene and Bill, who were the beneficial owners of the appellant corporation, decided to build a tissue mill in Benevento at an estimated cost of $7,000,000. A company called “Soavex SpA” was incorporated for the purpose of constructing and operating the Benevento mill, and in March of 1967 an agreement between Soavex and ISVEIMER was entered into by which ISVEIMER was to advance to Soavex 64.5% of the total cost of the construction (Ex A-14 and Ex A-15). In fact ISVEIMER in the pertinent years advanced Soavex between $3,000,000 and $4,000,000 for the construction of the Benevento mill.
36 After considerable questioning by the respondent, it was finally established that the two Kruger brothers, who were also the beneficial owners of all the Kruger Pulp & Paper Limited family of enterprises, owned between them 100% of the shares of Soavex.
37 At about that time ISVEIMER had financed the construction of a similar type of paper tissue mill in Scafati and, the original borrowers having been unsuccessful in their operations, ISVEIMER approached Soavex through the Kruger brothers and asked that Soavex take over and operate the Scafati mill. On July 28, 1965, Soavex purchased the Scafati mill by assuming a debt of $850,000 owed to ISVEIMER on the Scafati mill (Ex R-1). Soavex therefore acquired legal title to both the Benevento and Scafati mills.
38 The construction of the Benevento mill and the reinstallation of the Scafati plant was supervised by engineers, financiers and other administrative personnel who were employees of Kruger Pulp & Paper Limited and who set up their head office in Rome and commuted on a more or less regular basis between that city and Montreal. The alleged expenditure for such supervision was $16,765.
39 Once the construction of the Benevento plant was all but completed and the necessary machinery installed, the river on which Soavex relied for its necessary water supply dried up. Efforts to find new sources of water proved futile, and the Benevento plant never really got off the ground.
40 The Scafati mill was put into operation after certain necessary technical readjustments and, though it operated at a loss for the two first years, it began to operate profitably in 1970 and has since been realizing increasing profits. In 1971 Soavex went into bankruptcy. The trustees in bankruptcy seized the machinery and whatever assets were available in the Benevento mill but, for some reason not clearly explained, permitted the Scafati mill to continue its operations.
41 On December 12, 1968, an agreement was entered into between Kruger Pulp & Paper Limited and Soavex whereby the latter sold all its rights, titles and interests in the two mills to Kruger Pulp & Paper Limited for $5,530,400 (Ex A-16 and Ex A-17).
42 In the 1968 taxation year Kruger Pulp & Paper Limited claimed an amount of $1,136,361 as a capital cost allowance. It is my understanding that an amount of $16,765 was also claimed in 1968 as current expenditures made by the appellant in relation to the Italian mills. In the 1969 taxation year, the appellant claimed a capital cost allowance of $968,017 on the Italian plants, all of which was disallowed by the respondent on the ground that the appellant, for tax purposes, did not own the Italian plants. The appellant objected to this ruling and appealed the assessments. This is a very brief, but I believe necessary, resumé of the sequence of events in a rather complicated set of circumstances.
43 I listened very attentively to the eloquent arguments of counsel for the appellant and I had the opportunity to review them in the transcript, and although I found them both interesting and instructive, I do not necessarily agree with much that was said. Nor can I refrain from expressing a very strong view that the Board cannot, must not, and in this case did not, take any account of the fact that either the appellant or the respondent argued the reverse side of a similar issue in another case with other facts and under other circumstances with which the Board is not seized. However, I was considerably surprised and disturbed to hear counsel for the appellant state before the Board:
Now, Mr Chairman, a first point that I want to make is whether the Department really wants in its own best interest to win this case. I represent a single taxpayer each time, I don't represent the body of all taxpayers, I must defend the interests of a particular client. In this particular case there are momentary advantages to the recognition of the beneficial ownership of the assets in Kruger Pulp & Paper. My Learned Friend says a million dollars ($1,000,000.00) is involved. I don't know which way. Last year we had to pay taxes on our Italian operations. This year we estimate a million dollars ($1,000,000.00) of profit or near that, on which we are going to have to pay taxes, as we understand the matter. My Learned Friend is saying in this case you don't have to pay taxes. Naturally I said to my clients: “Do you want to win or lose the case”, because they may be making a great mistake in trying to win the case, in the long run they will undoubtedly pay more taxes if they win the case than if they lose the case, and really from a practical viewpoint the only reason that we have any interest in fighting this case is interest and if it was not for the interest factor we would be better off to lose the case than to win. But I put it in the opposite context for the Department.
44 Unless I do not understand the role of this Board, the financial advantages or disadvantages to either party in litigation in the winning or losing of an appeal can in no way be a matter of concern to the Board in rendering its decision in an appeal.
45 Whether the Department of National Revenue loses income as a result of winning an appeal and whether appellant's counsel is not sure whether it would be more advantageous financially to his client to lose his case, is of no interest whatever to the Board. It was the appellant's decision to appeal the assessment and, once seized with the appeal, the Board must adjudicate the case on the basis of the pertinent sections of the Income Tax Act and their application to the facts as presented in the pleadings of both parties, and not on the basis of the financial advantage to either party in litigation.
46 I find it most unusual, and indeed somehow unethical, for the appellant's counsel to refer at considerable length in his argument to possible financial advantage which would be contrary to the very arguments the appellant is presenting to the Board in its appeal. With all due respect to a very learned, expert and experienced counsel, for whom I have great esteem, I nevertheless feel very strongly that it is not only unnecessary, but also improper, to make such remarks before any tribunal.
47 I do, however, agree with many of the other arguments advanced by counsel for the appellant, particularly when he states that the main issue in the second part of these appeals boils down to the determination of whether Kruger Pulp & Paper Limited is, for tax purposes, the legal owner of the Italian operations, and that the onus of establishing its contention to the satisfaction of the Board rests with the appellant.
48 Counsel for the respondent holds that, in order to be eligible for the deduction of capital cost allowances, more than the legal title to depreciable property is required. The respondent cites paragraph 1102(1)(c) of the Income Tax Regulations, which reads:
1102. (1) The classes of property described in this Part and in Schedule B shall be deemed not to include property
49 Counsel for the respondent contends that title to the property can be acquired for reasons other than to produce income, and suggests that, in the circumstances of these appeals, title to the Italian operations was acquired by the appellant in order to benefit from the capital cost allowances permitted by the Income Tax Act and was not acquired for the purpose of producing income. Counsel referred also to stipulations of the Income Tax Act that the transactions whereby property is transferred from one owner to another must not be a sham if capital cost allowance on the transferred property is to be allowed, and that such capital cost allowance on a property must not be an artificial or unreasonable reduction of income.
50 One of the problems that arises in the consideration of the Italian operations under Soavex is not only the involvement of Gene and Bill Kruger, who are also the beneficial shareholders of the Kruger Pulp & Paper Limited family of enterprises, but also the participation of other Kruger enterprises, apart from Kruger Pulp & Paper Limited in the Italian operations.
51 It is on record that in 1965 the Kruger brothers' intention was to operate the Italian plants through Soavex, which was a separate legal entity owned beneficially by Bill and Gene Kruger. On March 23, 1967, ISVEIMER entered into an agreement with Soavex, the original contract being signed by Gene Kruger, by which an amount of some $3,000,000 to $4,000,000 was effectively loaned to Soavex by ISVEIMER, principally for the construction of the Benevento mill. The loan made by ISVEIMER was secured by a first mortgage, collateral liens, and a deposit with ISVEIMER of 51% of Soavex's stock. Moreover, this agreement contained a restrictive clause which, at page 8 of Ex A-15, reads:
Upon the said certificates of shares placed on deposit as well as on the remaining certificates of shares representing the other 49% of the company capital of the borrowing company and on the stockholders' book there must be entered the following binding clause:
“This certificate of shares may not be alienated or put up as a security, without prior consent of ISVEIMER in writing.”
52 Mr Fournier, vice president of Kruger Pulp & Paper Limited, testified that, in the peripheral financing of services in relation to the Italian operations, which presumably includes the engineering and administrative services provided by Kruger Pulp & Paper Limited, some $450,000 was spent in the years 1967 and 1968. These Soavex expenses were paid, not by the Kruger brothers, who together owned 100% of the Soavex shares, nor by Kruger Pulp & Paper Limited, but by another corporate member of the Kruger enterprises called “Kruger Organization”. It would appear from the evidence that the total amount invested in Soavex reached $908,000, but in 1971, after the Soavex bankruptcy (at a time when another company called Valcarta had surreptitiously entered the picture), Kruger Pulp & Paper Limited, notwithstanding the restrictive Clause 21 of Section 4 of the Trust Deed (Ex A-13), allegedly paid the balance of the cost of financing Soavex in the amount of some $450,000, even though it was prohibited by that clause from investing more than $225,000 in a non-restricted subsidiary. So that, up to December 21, 1968, we have Soavex, owned by the Kruger brothers, benefiting from the services of personnel employed by Kruger Pulp & Paper Limited and from the peripheral financing services paid for by Kruger Organization.
53 On December 12, 1968, Soavex sold, transferred and assigned to Kruger Pulp & Paper Limited all its rights, title and interest in Soavex for an amount alleged to be $5,530,400 plus special guarantees to Soavex creditors (Ex A-16). The evidence is to the effect that at no time did Soavex ever request or obtain prior consent in writing from ISVEIMER for the alienation of its shares to Kruger Pulp & Paper Limited, a requirement specifically set forth in the agreement between ISVEIMER and Soavex on March 23, 1967 (Ex A-15). Counsel for the appellant also admitted that the sale of the Soavex assets to the appellant was never registered. Although an amount of $5,500,000 was entered in the financial statements of Kruger Pulp & Paper Limited, there is no indication in the minutes of the company that the amount was used for the acquisition of the assets of Soavex.
54 However, on the same date, December 12, 1968, another agreement was entered into between Soavex and Kruger Pulp & Paper Limited (Ex A-17) which determined the manner in which the amount of $5,530,400 of the purchase price was to be paid to Soavex and which consisted of the payment to Soavex of 50% of the net profits of the Italian operations. Paragraph 2 of that agreement (Ex A-17) contained a right of redemption on the part of Soavex at any time, within the terms of the law of the Province of Quebec and particularly of section 1546 of the Civil Code.
55 As I have said, in 1971 Soavex went into bankruptcy. The Benevento mill which was partially constructed and in which paper-making equipment had been installed, was seized by the trustees and, as I understand it, was sold in favour of the creditors. However, Scafati mill, which was also included in the Soavex bankruptcy, escaped seizure and was allowed to continue its operations. Although evidence in respect of the bankruptcy and the reasons for permitting the continued operation of the Scafati mill are non-existent, the financial statements of Kruger Pulp & Paper Limited and the testimony of Mr Fournier indicate that the remaining assets of Soavex, and particularly the Scafati mill, were transferred to another Italian company called Valcarta. No documents were produced to confirm that these assets allegedly owned by Kruger Pulp & Paper Limited were ever formally assigned to Valcarta and there are no documents to indicate that the assets were ever returned to Kruger Pulp & Paper Limited by Valcarta.
56 To add to what is already sufficiently confusing evidence, sales of Scafati mill products were made, as late as 1972, not in the name of Kruger Pulp & Paper Limited, nor even in the name of Valcarta, to whom, from the evidence given, Soavex's assets had been transferred, but in the name of the supposedly-bankrupt Soavex SpA. Nor is there any evidence that Soavex was the trade name of the products of any particular company.
57 Page 2 of an insurance policy issued by La Fondiaria Fire Insurance Company Limited (Exhibit R-2) contains the following paragraph:
It is further hereby understood and agreed that effective 12th October 1969, Clause A of endorsement 4 of the above policy is deleted and replaced by the following:
“Loss, if any, payable to Industrie Soavex SpA and/or their Contractors and/or sub-contractors, a, ima.”
58 This policy was extended from January 12, 1970 to October 12, 1971 (Ex R- 2, page 1).
59 If all the assets of Soavex were in fact assigned to Kruger Pulp & Paper Limited in December of 1968, why should the insurance company pay any potential losses to Soavex in any year after 1968?
60 One of the crucial questions asked by counsel for the respondent of both Mr Fournier, the vice president in charge of finance of Kruger Pulp & Paper Limited, and Mr B Kruger, one of the beneficial owners of Soavex as well as of Kruger Pulp & Paper Limited, was why Kruger Pulp & Paper Limited bought the Soavex assets in 1968 if it were the declared intention of the Kruger brothers in 1967 to operate the Italian mills through the Italian Corporation Soavex, SpA. Strangely enough, and it is to be found in the record, neither of these important and knowledgeable witnesses was able to answer adequately this very pertinent question.
61 It is because of the confusion of facts and the incomplete evidence given at the hearing that counsel for the respondent contends that the transfer of assets from Soavex to Kruger Pulp & Paper Limited in 1968 was a sham, that the property so acquired was not acquired for the purpose of producing income, but rather in order that Kruger Pulp & Paper Limited might benefit from the generous Canadian capital cost allowances provided for in the Income Tax Act, and that such a deduction of capital cost allowance on the Italian plants would, in the circumstances, be an artificial and an undue reduction of the appellant's income.
62 Counsel for the respondent in his rebuttal claimed, and rightly so, that Messrs Gene and Bill Kruger established a plant in Italy for the purpose of earning income from the production of paper tissue. For that purpose they incorporated Soavex and held all the Soavex shares between them. In my view, regardless of what the relationship between the other mills of the Kruger enterprises might be, Soavex was a separate legal entity incorporated and established in Italy for the purpose of earning income. The issue, however, in this second part of the appeals does not arise from the existence and the operations of Soavex or the imposing corporate existence of Kruger Pulp & Paper Limited, but rather it stems from the incomplete evidence on the fundamental reasons as to why Soavex assigned its rights and assets to Kruger Pulp & Paper Limited in 1968. Why did Soavex not abide by the restrictive and binding clause of its agreement with ISVEIMER not to alienate any of Soavex's shares without written consent? Why was the sale of Soavex shares to Kruger Pulp & Paper Limited not registered, and why was the acquisition of Soavex never entered in the appellant's minute book? Why was it necessary to include a right of redemption in the sale contract of Soavex's assets? Why did not the appellant assume the debt of the Soavex bankruptcy in 1971, if it owned the Soavex company as alleged? Why did the appellant find it necessary to assign the Soavex assets to Valcarta without any documentary evidence to that effect? Why was it not considered necessary to transfer these assets back to the appellant? And why were the Scafati mill products sold under the name of Soavex SpA? These very pertinent questions and other puzzling facts have, in my view, not been satisfactorily answered or explained.
63 Counsel for the appellant, in objecting to the respondent's use of the term “sham”, seems to consider that the term was applied in connection with the Kruger brothers cooperation with Soavex or with the fact that money was invested in the Italian operations. Counsel for the respondent did not claim that either Soavex or Kruger Pulp & Paper Limited in themselves were shams, nor is the fact that the Kruger brothers personally invested money one way or another in the Italian operations a sham. But what, in my opinion, is a sham, based on the facts of these appeals, is the transaction for the assignment of the shares of Soavex to Kruger Pulp & Paper Limited in 1968.
64 The manner and circumstances in which the assignment of Soavex's assets to Kruger Pulp & Paper Limited was made and all the facts pertaining to the Italian operations were aimed at creating a dual concept of the nature and service of the company carrying out the Italian operations and making sales under the name of Soavex. The confusion and ambiguity created as to whether Soavex was an independent company incorporated and based in Italy, or whether it was a wholly-owned Canadian subsidiary was in my opinion deliberate so that the appellant would be able, on the one hand, to benefit from whatever financial advantages might accrue from the Government of Italy to independent Italian corporations and, on the other hand, to take advantage, among other things, of the capital cost allowances permitted by the Canadian Income Tax Act, which are sizeable in the first few years of operation of a plant, and particularly attractive at the point of time in 1968 when the Benevenuto plant was being discontinued and the Scafati plant was operating at a loss. Although this may have been a very shrewd business tactic, the non-arm's length assignment of Soavex's assets to Kruger was, in my opinion, not a bona fide business transaction, but a sham or simulacrum within the meaning and intent of the Income Tax Act. To deduct capital cost allowances under the circumstances was, in my opinion, artificially and unduly reducing the appellant's income.
65 Though the Kruger brothers' investment in Soavex was no doubt made for the purpose of earning income, the acquisition of those assets by Kruger Pulp & Paper Limited was not for the purpose of earning income and, pursuant to paragraph 1102(1)(c) of the Regulations, no capital cost allowance is permitted on such property.
66 There is another important point of law which, to my surprise, was not strongly argued by the respondent and which, in my opinion, could have shortened the hearings considerably.
67 Counsel for the appellant spent considerable time explaining the common practice of registering in the name of another person something of which one is the beneficial owner, spelling out the legal and practical differences between a registered owner and a beneficial owner. No one, of course, could seriously disagree with counsel's exposé as far as it went. However, I feel that whatever may have been the issues and the facts in the numerous examples he gave, he failed, in my opinion, to answer the simple and direct question with which we are here concerned, and that is whether the contract assigning the Soavex assets to Kruger is binding ... on third parties. My understanding is that counsel for the respondent was not arguing that the December 12, 1968 agreement between Soavex and Kruger Pulp & Paper Limited or that the contract was not binding on both the parties to the agreement. The question, as I see it, is whether the contract transferring the Soavex assets to Kruger was binding on third parties, principally on the Department of National Revenue and on ISVEIMER.
68 It was agreed between the parties that the law of Quebec was to apply in these transactions, and it seems to me that one of the basic tenets of the Quebec Civil Code on contracts as well as in common law is that an agreement or consent between parties containing all the elements of a formal contract can convey property and the contract so made is binding on both parties, but in the case of any contract in which third parties have an interest, such a contract is binding on such third parties only if it is properly and publicly registered. The reason for this basic rule of law is self-evident and very pertinent to the facts of this case. Not only did ISVEIMER have a 51% interest in Soavex but there was, in the agreement of 1967 between ISVEIMER and Soavex, a clause prohibiting the alienation of any of Soavex's shares without the written consent of ISVEIMER, a clause which Soavex did not respect. Regardless of what ISVEIMER may have chosen to do or not to do in respect of the unregistered agreement assigning Soavex shares to Kruger Pulp & Paper Limited, this does not alter in any way the existence and the applicability of the elementary rule that unregistered contracts are not binding on interested third parties. The Department of National Revenue also had an interest in the said transaction and agreement in that some $2,000,000 in capital cost allowance was claimed by the appellant in 1968 and 1969 as a result of it. In my opinion, the respondent is not bound by the unregistered 1968 agreement between Soavex and Kruger Pulp & Paper Limited. From the Department's point of view it is as though the assignment of Soavex's assets to Kruger Pulp & Paper Limited had never taken place and therefore Kruger Pulp & Paper Limited is not, for tax purposes, the legal owner of the Italian operations.
69 It is indeed very difficult for me to understand how such a simple, well-known, and yet essential, Canadian legal requirement could have been overlooked in so important a transaction if the appellant had seriously intended to effectively and legally acquire the Soavex assets so that Kruger Pulp & Paper Limited might earn income from its Italian operations, claim capital cost allowances, and pay income tax to Canada.
70 This point and the other factual anomalies which appear in the evidence on these appeals forces me to conclude that the appellant has not succeeded in proving to the satisfaction of the Board that the appellant, for purposes of the Income Tax Act, the Civil Code and common law, was the owner of the Italian plants and operations.
71 For these reasons, therefore, these appeals are allowed in part and the matter referred back to the Minister of National Revenue for reconsideration and reassessment so that he may take into account the claims which were withdrawn by the appellant and also those expenditures that the respondent consented to allow as business deductions during the course of the hearing of these appeals.
72 Further, I hold that the expenses in respect of the logging plan, as well as those legal fees and other expenditures claimed by the appellant in the course of the hearings which are directly related to the acquisition of a licence for cutting timber for the aborted St Felicien paper mill project on lands owned by the Province of Quebec be allowed.
73 With respect to Part II of these appeals, I hold that the appellant, for reasons stated above, was not for tax purposes the legal owner of the Italian operations and did not acquire the Soavex assets for the purpose of producing income. Therefore the deductions of the current expenses and capital cost allowances claimed in 1968 and 1969 in respect of the two Italian mills were properly disallowed by the Minister and should not be varied.
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