Watson D.J.T.C.:
1 This appeal was heard at Rimouski, Quebec on May 22, 1996.
2 In its income tax return for the taxation year ending December 31, 1993 the appellant requested the following deductions:small business deduction (subsection 125(1) of the Income Tax Act (the “Act”)), $16,494;
manufacturing and processing profits deduction (s. 125.1(1) of the Act), $495.
3 The appellant reported the following income for that taxation year:net income for income tax purposes (form T2S(1)), $16,494;
investment income in Canada (form T2S(7)), $28,324.
4 By notice of assessment dated November 7, 1994, the Minister of National Revenue (the “Minister”) disallowed the small business deduction and the manufacturing and processing profits deduction for the taxation year.
5 On November 8, 1995, the Minister sent the appellant a notice of confirmation. In making the assessment of November 7, 1994 the Minister assumed the following facts:
[TRANSLATION]a. when the appellant filed its tax return for its taxation year ending December 31, 1993, in calculating its tax payable, it claimed a small business deduction in the amount of $3,463 and a manufacturing and processing profits deduction in the amount of $495;
b. according to form T2S(1), the appellant's net income for income tax purposes for its taxation year ending December 31, 1993 was $16,494;
c. according to form T2S(7), the appellant's investment income for its taxation year ending December 31, 1993 was $28,324;
d. in its fiscal year ending December 31, 1993 the appellant had no income from an active business, since its income was as follows:
| Income according to T2S(1) | $16,494 | | | |
| Less: | | | | |
| Investment income acording to T2S(7) | | | |
| Taxable dividends | | $4,984 | |
| Income from property | 29,732 | | | |
| Taxable capital gain | 1,108 | | | |
| Deductible taxable dividends | (7,500) | | $28,324 |
| Income from active business | nil | | | |
6 At the hearing of the appeal the appellant's representative, Emmanuel Deschênes, admitted the facts alleged in subparagraphs (a) to (c) and denied those alleged in subparagraph (d). In his testimony on subparagraph (d), he denied that the income from an active business was “nil”.
7 The question is whether the appellant had income from an active business within the meaning of subsection 125(7) of the Act for the 1993 taxation year.
8 Subsection 125(1) of the Act provides that a Canadian-controlled private corporation may deduct an amount equal to 16% of its income from an active business carried on in Canada. This deduction is only allowed if the corporation earns income from an active business.
9 Subsection 125.1(1) of the Act provides that a corporation is entitled to a 6% tax deduction (in 1993) for manufacturing and processing profits. Since 1988 this deduction no longer applies to profits for which the small business deduction can be claimed. In this appeal, the Court must first determine whether the appellant is entitled to the small business deduction.
10 The sections of the Act that applied to the 1993 taxation year and are at issue here are, in part, as follows:
125(7)(a) “active business carried on by a corporation” meansany business carried onby the corporationother than a specified investment businessor a personal services business and includes an adventure or concern in the nature of trade; [My emphasis]
(c) “income of the corporation for the year from an active business” means the total of:(i) the income of the corporation for the year from an active business carried on by it including any income for the year pertaining to or incident to that business,other than income for the year from a source in Canada that is a property (within the meaning assigned by subsection 129(4.1)), ... [My emphasis]
(e) “specified investment business” carried on by a corporation in a taxation year means a business ...the principal purpose of which is to derive income from property(including interest, dividends, rents or royalties), unless(i) the corporation employs in the business throughout the year more than five full-time employees, or
(ii) in the course of carrying on an active business, any other corporation associated with it provides managerial, administrative, financial, maintenance or other similar services to the corporation in the year and the corporation could reasonably be expected to require more than five full-time employees if those services had not been provided; [My emphasis]
129(4.1) For the purposes of paragraph (4)(a) and subsection (6), “income” or “loss” of a corporation for a year from a source in Canada that is a propertyincludesthe income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canadabut does not include income or loss(a) from any other business,
(b) fromany property that is incident to or pertains to an active business carried on by it, or
(c) from any property used or held principally for the purpose of gaining or producing income from an active business carried on by it. [My emphasis]
248(1) “property” means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes(a) a right of any kind whatever, a share or a chose in action,
(b) unless a contrary intention is evident, money,
11 The appellant's representative argued that it actively carries on a business within the meaning of section 125 of the Act and does not carry on a specified investment business as defined in paragraph 125(7)(e); he further submitted that this provision refers to the “principal purpose” of the business and does not mention the “result”, and that as the principal purpose of the appellant's business was not to derive income from property, it cannot be characterized as a specified investment business.
12 The definition of “income of the corporation for the year from an active business” in paragraph 125(7)(c) excludes income which the corporation derives from a source that is a property within the meaning assigned by subsection 129(4.1). The appellant's representative accordingly argued that, as it is not a specified investment business (it should be noted that the Minister did not argue that the appellant carried on a specified investment business), it does not have income from a property within the meaning of subsection 129(4.1). It would appear that the argument made by the appellant's representative does not take into account the word “includes” used in subsection 129(4.1). This word gives a completely different meaning to the provision, in that income “from a source in Canada that is a property” is not limited to income “from a specified investment business”, as the appellant's representative contended (at p. 45 of the transcript).
13 Under subsection 129(4.1), income “from a specified investment business” is deemed to be income derived from property. Accordingly, it does not exclude any other income which is considered to be derived from property within the meaning of the Act. In Sanilit Ltd. v. Minister of National Revenue (1987), 87 D.T.C. 442 (T.C.C.), Judge Rip of this Court said at 449:
The addition of subs. 129(4.1) limits the property used or held for the purpose of gaining or producing income from an active business by the corporation. Subsection 129(4.1) preserves the distinction between active business income and other sources of income.
14 It appears to the Court that the effect of subsection 129(4.1) is not to set aside the general definition of “property” contained in subsection 248(1). In fact, subsection 129(4.1) only expands the general definition by providing for specific situations in which income is or is not deemed to be property.
15 The appellant's representative referred to the exceptions provided in subsection 129(4.1), and in particular the exception providing that income “from a source in Canada that is a property” includes income from a specified investment business, but does not include income “from any other business”. He argued that, since the appellant's income is not from a specified investment business, it is from “any other business”; consequently, the appellant cannot have income from a property. He maintained that all the appellant's income, including interest income, is income from an active business.
16 The Act contains several separate sources of income: office or employment, business and property. All income must be classified according to source. The appellant's representative argued that, as the appellant is not a specified investment business, it is “any other business”, and none of its income may be classified as income from property. This argument does not appear to take account of the possibility that the appellant receives both income from a business and income from another source. Not all the income received by the appellant is necessarily from the business which it carries on. In Canadian Marconi Co. v. R., [1986] 2 S.C.R. 522 (S.C.C.), Wilson J. said at 531: “The question whether particular income is income from business or property remains a question of fact in every case”. The fact that a taxpayer carries on a business does not mean it cannot receive income from a property; the nature of the income must be determined by examining its source and assessing all the facts of the case.
17 The appellant's representative admitted that it received interest income; this is clearly income from a property as defined by the Act, because of the source from which it is derived. The Court therefore cannot accept the position of the appellant's representative that it should conclude that the income is from an active business because it is not from a specified investment business.
18 Paragraphs 129(4.1)(b) and (c) provide that income “from any property that is incident to or pertains to an active business carried on by it” or “from any property used or held principally for the purpose of gaining or producing income from an active business carried on by it” is presumed not to be income from a property. Under these exceptions, therefore, it must be income from an active business.
19 In R. v. Marsh & McLennan Ltd. (1983), [1984] 1 F.C. 609 (Fed. C.A.), Le Dain J.A. of the Federal Court of Appeal had to determine whether money invested by a taxpayer was “property used or held in the course of carrying on the business on the respondent” within the meaning of the exclusion in subparagraph 129(4)(a)(ii). At 621, he proposed the following test:
...Was the fund employed and risked in the business? In my opinion it was, because an amount equivalent to this notional fund was committed to the carrying on of the business in order to meet the company's obligations to the insurers.
Considering Le Dain J.A.'s statement, Wilson J. made the following comments in R. v. Ensite Ltd., [1986] 2 S.C.R. 509 (S.C.C.), at 520:...“risked” means more than a remote risk. A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would “have a decidedly destabilizing effect on the corporate operations themselves”: March Shipping Ltd. v. Minister of National Revenue, supra, at p. 374. This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset in the long term (see, for example, Bank Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307 (Scot. Ct. of Session)) from an investment made in order to fulfil a mandatory condition precedent to trade (see, for example, Liverpool and London and Globe Insurance Co. v. Bennett, [1913] A.C. 610 (H.L.), and Owen v. Sassoon (1951), 32 T.C. 101 (Eng. H.C.J.)Only in the latter case would the withdrawal of the property from that use significantly affect the operation of the business. The same can be said for a condition that is not mandatory but is nevertheless vitally associated with that trade such as the need to meet certain recurring claims from that trade: see, for example, The Queen v. Marsh & McLennan, Ltd., supra, and The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319 (F.C.A.).
Associate Chief Judge Christie commented as follows on the phrase “incident to or pertains to an active business” in Atlas Industries Ltd. v. Minister of National Revenue (1986), 86 D.T.C. 1756 (T.C.C.), at 1764 and 1765:Giving the words “incident to or pertains to an active business” their grammatical and ordinary sense, and bearing in mind their context, there must I think be a financial relationship of dependence of some substance between the property and the active business before the exclusion in paragraph 129(4.1)(b) comes into play. The operations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This I regard to be the basic approach to paragraph 129(4.1)(b).
20 Based on the foregoing passages, Judge Rip concluded in Sanilit, supra, that the term deposits in which the taxpayer had invested in that case were not incident to and did not pertain to the business carried on by it. Judge Rip drew the following conclusions, at 450;
The relationship between the term deposits and the business is weak. There is no evidence the appellant used the term deposits for his business.... I am not convinced that the whole amount of the term deposits was necessary for operating the business....
The capital in the term deposits came from business activities carried on for some collateral purpose such as expansion. The term deposits were not intimately related to the activities of the business....
It can thus be seen that the critical test to be used is interdependence between the income from property and the activities of the active business.21 The Court is persuaded that the appellant did not succeed in showing that the interest income was incident to or pertained to the business actively carried on by it. At page 31 of the transcript the appellant's representative stated:
[TRANSLATION]
Of course there was interest income. What must be understood from this is that the company was quite heavily capitalized; I formed this company with the sale of two other companies. Then, it had to develop and do a lot of research and development to develop its products. So it used the funds generated by the capital to make this possible, that is, it pre-used it in subsequent years to the point where it almost made losses....
22 In the Court's opinion the relationship between this income from property and the activities of the business actively carried on by the appellant is not close enough for it to conclude that this was income from an active business as authorized by subsection 129(4.1).
23 Subsection 129(4) defines what is meant by “Canadian investment income”. The interest received by the appellant is thus income from a property and “Canadian investment income” within the meaning of subsection 129(4). As the appellant's investment income was greater than its business income, there is therefore no remaining income from an active business which is eligible for the small business deduction.
24 For these reasons, the appeal is dismissed.
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