The Assistant Chairman:
1 This appeal of Charter Industries Limited is from income tax assessments in respect of the 1969, 1970 and 1971 taxation years and was heard in Montreal on September 16, 1975.
2 The issue in this appeal is whether amounts of $315,000 advanced to subsidiary companies in 1969 and of $135,000 in 1970 and which the appellant sought to deduct as business expenses in those years, can be written off as uncollectable advances and included in the business losses carried forward by the appellant in its 1970 and 1971 income tax returns. By notices of reassessment dated October 30, 1973, the respondent has imposed a tax in respect of the appellant's corporate income for its 1970 and 1971 taxation years by reason of his disallowance of the said amounts as part of the business losses carried forward from previous years.
3 The appellant company was incorporated on October 28, 1968 and, from the facts adduced, the purpose of its incorporation, though more fully set out in its charter (Exhibit A-1), can, in my opinion, be summarized as “to carry on the business of an investment, management and holding company”.
4 Charter Credit Corporation, a company which existed prior to the appellant's incorporation, was a company which lent money on mortgages, chattel mortgages and commercial pledges and was the first company to become a wholly-owned subsidiary of the appellant. Mr Elliot Godel, president of both the appellant company and Charter Credit Corporation, testified that it was his intention to diversify the activities of the appellant company after its incorporation, and therefore, in 1968, the appellant company proceeded to buy Lightstone Sales Co Inc (subsequently renamed Warwick Bros Ltd) and also bought Fanco Products Inc. In 1969 Warwick Bros & Rutter Co Ltd, Karr's Inc, Mutual Wholesale Stationery Limited, Viscount Plastics (Canada) Limited and Bedisco Inc were also purchased, and I believe the appellant company caused another company, Bel-Air Stationers Ltd, to be incorporated.
5 In general, through its wholly-owned subsidiaries, the appellant company dealt in stationery for schools and offices, and in general business supplies, and each of the companies acquired either specialized in a certain type of stationery, or had a name favourably well known in that field of business not only locally but in other parts of the country.
6 In 1969 the appellant became a listed public company. According to the testimony of Mr Godel, it was the policy of the appellant company to advance money to any of its wholly-owned subsidiaries that might need it, rather than have them borrow it from a bank. The principal source of the appellant's lending capital was the sale of the appellant's own stock on the market, and it is my understanding that only one amount of $150,000 was actually borrowed from a bank and that was completely repaid within a period of only a few months. (See ledger sheets filed as Exhibit A-2.)
7 It is also on record that Charter Credit Corporation, the appellant's first wholly-owned subsidiary, made some advances to Lightstone Sales Co Inc and to Fanco Products Inc.
8 The appellant charged the current rate of bank interest on loans made by it to its subsidiaries and also charged management fees for its services, although it had no staff. Mr Godel, in his own testimony, admitted that he personally made most of the important decisions in respect of the subsidiaries, with the help of another director, a Mr Usheroff, who was president of Lightstone Sales Co Inc.
9 From 1968 to April of 1970 the appellant made some 35 loans to its subsidiaries which were stated to be in the total amount of about $2,791,000 (see Exhibit A-3). Generally these loans were repaid to the appellant by the borrowing subsidiary, the moneys being held by the appellant company and recirculated within the group of its subsidiaries in the form of advances, as and when necessary.
10 It was established that the management fees of the appellant for 1969 totalled $21,000 and for 1970, $24,000 (Exhibit A-2). In a statement of the earnings of the appellant for the year ended December 31, 1969 provided by respondent's counsel during argument as it also contained the comparative figures for 1968, the interest income of the appellant, which had been $1,625 in 1968, was shown to be $27,189 in 1969. This statement was part of the auditors' report to the directors of the appellant company by Peat, Marwick, Mitchell & Co, Chartered Accountants, dated May 21, 1970, and was presented in slightly different form from the annual report to the shareholders filed as part of Exhibit A-3.
11 Fanco Products Inc was a manufacturer of brief-cases, attaché cases, binders and schoolbags. The appellant purchased Fanco Products Inc on November 22, 1968 for $350,000, of which $200,000 was paid in cash plus 16,666 shares of Charter Industries Limited valued at $150,000.
12 In 1969, between February 12 and December 11, a series of advances was made to Fanco by the appellant in the total amount of $565,000, some of which were paid back to the appellant. However, as of December 31, 1969, a balance of $315,000 was still outstanding and had not been reimbursed. Therefore, at the end of its 1969 taxation year, which terminated on December 31, the appellant claimed that this amount of $315,000 had become uncollectable. Evidence given by Mr Godel indicates that Charter Credit Corporation had also made a loan of $75,000 to Fanco in 1969. In spite of having declared advances in the amount of $315,000 uncollectable in 1969, the appellant advanced Fanco an additional amount of $135,000 in 1970 which was not reimbursed, and Charter Credit Corporation is also said to have advanced a further $100,000 to Fanco.
13 Early in 1969 the appellant had charged Fanco interest at the current bank rate for the loans or advances made to it but, later in that year, interest was no longer charged on loans made to Fanco, nor was any interest charged on the $135,000 advanced to Fanco by the appellant in 1970.
14 Counsel for the appellant suggested—and, in my view, rightly so—that it is the entire business operation of a company that should be examined, and that it is what a company actually does that must be weighed and considered rather than undue reliance placed on the declared objects of incorporation and the powers granted to a company by its charter. Counsel for the appellant contends that, in this instance, the appellant's activities were well within the scope of its charter, and he referred the Board to paragraphs (a), (c) and (e) thereof (Exhibit A-1). Counsel then alleged that the loans made to Fanco were an integral part of the appellant's business operations and that the amounts of $315,000 in 1969 and $135,000 in 1970 were deductible either as expenses incurred to produce income under section 12(1)(a) of the old Income Tax Act, or as bad debts under section 11(1)(f).
15 Counsel for the respondent, on the other hand, contends that the appellant was a holding company, and described itself as such in the T2 income tax returns filed by it for the taxation years 1968 to 1971 inclusive. It was further submitted on behalf of the respondent that both its charter (Exhibit A-1) and its financial statements indicate that the appellant's business was that of investment. The fact that the loans, which were made exclusively to its subsidiaries with whom it was not dealing at arm's length, were made at the current bank rate and yielded a relatively small amount of revenue to the appellant, as well as the fact that no interest was charged on the later loans of $315,000 and $135,000 made to Fanco and the management fees earned through the efforts of Mr Godel were insignificant in comparison to the overall investment of the appellant, led counsel for the respondent to conclude that the advances made to Fanco in 1969 and 1970 were not made to produce income but were investments made by the appellant to keep Fanco, a wholly-owned subsidiary, alive and so that the consolidated financial picture of the public parent company might not be adversely affected by Fanco's serious financial difficulties becoming public knowledge.
16 Counsel for the respondent submits that the appellant's reason for existence was not to carry on the business of lending money but to carry on the business of investing it; that the advances made by it to Fanco—and which are the subject of dispute in this case—were interest-free; that Fanco was not charged any management fees; and that it cannot therefore be said that the advances were made for the purpose of earning income within the meaning of paragraph 12(1)(a) of the old Act. He therefore concludes that the advances made by the appellant to Fanco were capital in nature and non- deductible.
17 From the evidence, that is, the appellant company's charter, the financial statements of the appellant company, those of its wholly-owned subsidiaries, and the testimony of Mr Godel, it seems clear to me that the appellant company was a public holding company whose primary purpose was investment, and that its consolidated revenue and the value of its shares were directly related to the performances of its subsidiaries.
18 Although its charter did authorize the appellant company to make loans, and the company did in fact make loans in sizeable amounts to its own subsidiaries from funds largely derived from the sale to the public of its own stock and by the recirculation of moneys received in repayment of previous loans to its subsidiaries, such loans were strictly limited to the appellant's wholly-owned subsidiaries with which it was not dealing at arm's length. It was not in the business of lending money to the general public or to any disinterested third parties. In my view, such transactions are not those of what is usually accepted as a lending company but rather flow from an internal arrangement between the parent company and its subsidiaries whereby the financing of the subsidiaries can be met without borrowing moneys from outside sources.
19 From the facts of this appeal, it cannot be said that the appellant was in the business of lending money. What the appellant in fact did was invest in its subsidiaries in order to provide the necessary working capital or to meet overdue obligations of a subsidiary in order to prevent it from becoming insolvent. At no time was it established that the advances made to Fanco were for the purpose of earning income. In my view, the $565,000 advanced to Fanco by the appellant and the $75,000 advanced to it by Charter Credit Corporation in 1969 as well as the $135,000 and the $100,000 advanced to Fanco by the appellant and Charter Credit Corporation respectively in 1970 were capital investments made to avert the bankruptcy of Fanco.
20 Although Fanco's outstanding liability to the appellant as of December 31, 1969 was $315,000, the appellant proceeded to advance Fanco another $135,000 very early in 1970. However, on April 23, 1970, which was after the $135,000 advance had been made, the appellant, who was the owner of all the issued and outstanding shares of Fanco Products Inc, by an agreement of sale sold to one Sam Eidinger, the then president of Fanco and its original owner, all Charter Industries Limited's assets in Fanco as well as the loans made to Fanco by the appellant and by Charter Credit Corporation.
21 Article 1 of that agreement of sale of April 23, 1970 (Exhibit A-4) reads as follows:
NOW, THEREFORE, IT IS AGREED AS FOLLOWS:
1. The Vendor hereby sells free and clear, and the Purchaser hereby purchases, all the issued and outstanding shares of the Company and also the loans and the security attached thereto from the Vendor and Charter Credit Corporation to the Company for the price and sum of One Dollar ($1.00) and other considerations hereinafter referred to. Notwithstanding the foregoing, the loan from Charter Credit Corporation will remain its property and will be held in trust by Mtre T Polisuk, to be transferred to Purchaser on January first 1971, provided that prior to said date the Company has not been declared bankrupt or the Company has not made a proposal or voluntarily exercised any rights in virtue of bankruptcy, insolvency, liquidation or winding-up. If any of the foregoing events occur before January 1st, 1971, the said loan shall be returned by Mtre T Polisuk, to Charter Credit Corporation forthwith. Without limitation of the foregoing, it is understood and agreed that the Company may dispose of that equipment which is pledged in favour of Charter Credit Corporation at the best price that the purchaser is able to obtain.
22 On September 13, 1971, an “Agreement of Transaction” was executed between Sam Eidinger as Party of the First Part, the appellant as Party of the Second Part, and Fanco Products Inc as Party of the Third Part (Exhibit A-5), Article 1 of which reads as follows:
NOW, THEREFORE, THIS AGREEMENT WITNESSETH:
1. Eidinger and Fanco on the one hand and Charter on the other hand each hereby give and grant to the other a full and final release and discharge of all obligations of the one towards the other arising in virtue of the Purchase Agreement, the Loan Agreement, Transfer and the Sale Agreement and the business transactions contemplated thereby and any other contracts or agreements heretofore made between them.
23 From a reading of these two agreements, I arrive at three conclusions:1. In my opinion, the appellant was aware of the pending bankruptcy of Fanco long before April 23, 1970, and therefore the moneys advanced to Fanco were not made to earn income but to keep Fanco financially alive until its shares and assets could be sold.
2. Regardless of whether the appellant considered the advances made by it to Fanco as loans, the nature and the purpose of the advances was in fact capital investment made to preserve the appellant's consolidated image. The appellant, moreover, has treated the advances made by it to Fanco quite differently from those made to Fanco by Charter Credit Corporation. (See Article 1 of Exhibits A-4 and A-5.)
3. It appears to me that the appellant, having sold to Sam Eidinger, on April 23, 1970 all the issued and outstanding shares of Fanco as well as the loans and the security attached thereto, as stated in Article 1 of Exhibit A- 4, and having thus assigned the loans and the security to Mr Eidinger by the deed of sale, cannot now claim these same amounts as bad debts in 1969 and 1970.
24 Notwithstanding the above, the main issue in this appeal, in my opinion, has been determined by applying the basic principle enunciated by the learned Mr Justice Kerr in the case of MNR v. Stewart & Morrison Limited, a decision of the then Exchequer Court of Canada ([1970] C.T.C. 431, 70 D.T.C. 6295) upheld by the Supreme Court of Canada ([1972] C.T.C. 73, 72 D.T.C. 6049), as reported at page 438 [6299]:
The question for determination is what was the true nature of the advances that made up the amount claimed as a deduction by the respondent.
The evidence adds up to this, as I appreciate it. The respondent decided that an American subsidiary, to be wholly owned by the respondent, would be incorporated and would carry on business in the United States and be a source of income and profit for the respondent. The subsidiary would carry on business as a separate American company in its own name and right, but it would, to use Stewart's words, be ‘master-minded’ by its parent company and their affairs would be closely related and managed. The subsidiary needed capital, but had none. The respondent would supply, or arrange to supply, the needed capital. It arranged and guaranteed a bank loan direct to the subsidiary and also made direct advances of money to enable it to get started and continue to operate. The advances were treated by both companies and by their auditors, and in the respective books and accounts, as loans from the respondent. Book entries do not necessarily denote the true nature of transactions, but I think that the advances in question were correctly treated as loans. The fact that the money so provided was used by the subsidiary to pay its operating expenses, and was lost in a losing cause, does not determine or change its nature of money lent by the respondent to the subsidiary.
In my opinion, the advances were outlays by the respondent of a capital nature, so far as it is concerned, the deduction of which is prohibited by Section 12(1)(b) of the Act and the appeal may be disposed of on that finding alone.
25 In my opinion, the legal issue and the facts in this appeal are on all fours with those of the Stewart & Morrison Limited case, and the Board can only conclude that the decision of Mr Justice Kerr in that case is applicable a fortiori to the facts of this appeal.
26 I hold, therefore, that the amounts of $315,000 and $135,000 advanced by the appellant in 1969 and 1970, respectively, to Fanco Products Inc and claimed as deductions and as losses to be carried forward to 1970 and 1971 were properly disallowed by the Minister because they are non-deductible capital expenditures within the meaning of paragraph 12(1)(b) of the old Income Tax Act rather than expenses laid out to earn income under paragraph 12(1)(a) or bad debts within the meaning of paragraph 11(1)(f).
27 The appeal is therefore dismissed.
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