Charwood Investments LTD v. Minister of National Revenue, [1978] CTC 2545, [1978] DTC 1411

Delmer E Taylor:—These are appeals against income tax assessments by which the Minister of National Revenue disallowed the small business deduction from corporation taxes claimed for the’ taxation years 1973 and 1974 respectively. The appellant relied upon section 125 and the respondent relied, inter alia, upon sections 125 and 248 of the Income Tax Act, SC 1970-71-72, chapter 63.

Facts

Charwood Investments Limited (hereinafter called “Charwood” or “the Company”) was incorporated under the laws of the Province of Ontario in 1955—“To lend and invest money on mortgage of real estate or otherwise”. It has conducted operations continuously up to, including and after the years in question.

Contentions

The appellant asserted in the Notices of Appeal that it carried on an active financial business, and is entitled to the deduction provided under section 125 of the Act.

The respondent denied in the Reply to the respective Notices of Appeal that the appellant was engaged in an active business, or in any business at all; rather it was the respondent’s contention that the appellant’s income was income from property.

Evidence

In summary, the evidence of the appellant as provided by the current President and the office secretary, both shareholders, was that it received income from company shares, real estate, guaranteed investment certificates and mortgages. At December 31, 1973, Charwood had loans receivable from seven different companies and held eight separate mortgages, as well as holding shares in eight public and eighteen (18) private companies. Its real estate holdings mostly consisted of percentage holdings in large commercial developments, and the appellant was representéd on a “management committee” where, together with other percentage investors, the Company regularly reviewed the total investment.

A similar portfolio situation obtained at December 31, 1974, although there had been some changes due to purchases and sales. The Company does not have a public office address, telephone number or stationery, nor does it advertise for clients. It is located in the general office premises of Rosenberg, Smith, Paton, Hyman & Matlow, a Toronto law firm. Until his death in 1975, the senior Mr Rosenberg (father of the current President) was responsible for the investment decisions relating’ to the affairs of Charwood. Beryl L Roberts, office secretary to Mr Rosenberg Sr, effectively carried on the day-to-day requirements of the Company. It is a “family” corporation, one of several owned or controlled by the Rosenbergs. One of these other corporations engaging in generally the same kind of operation was Arthur Investments Ltd (hereinafter referred to as “Arthur”) and it was Arthur against which the total operating and overhead cost for all the “Rosenberg” companies was charged. This accounted for the fact that there were only minimal expenses shown on any financial statements for Charwood. Submitted as part of the evidence were the following:

Exhibit A-1—Letters Patent;

Exhibit A-2—Financial Statements—December 31, 1973;

Exhibit A-3—Financial Statements—December 31, 1974;

Exhibit A-4—List of Properties and Mortgages purchased 1971-1975;

Exhibit A-5—Financial Statements—December 31, 1975;

Exhibit A-6—Financial Statements—December 31, 1976;

Exhibit R-1—Financial Statements—December 31, 1972:

Exhibit R-2—Financial Statements—Arthur Investments Limited—July 31, 1974.

Argument

Counsel for the appellant relied primarily on the decisions in Her Majesty The Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156; Her Majesty The Queen v Cadboro Bay Holdings Ltd, [1977] CTC 186; 77 DTC 5115; Lazare Investments Corp v MNR, [1975] CTC 2036; 75 DTC 26; and Parico Limitée v MNR, [1975] CTC 2234; 75 DTC 173. Further, the Board was informed that the company Arthur recently had been the appellant in a similar appeal and, in an unreported judgment ‘delivered orally, the Assistant Chairman of the Tax Review Board had allowed that appeal. In substance the position of counsel for the appellant was that it was irrelevant whether the intention of section 125 of the Act had been to allow the deduction to investment businesses conducted by corporations, or even whether Revenue Canada interpreted the section in such a way as to deny the deduction in cases such as the instant appeal. The important fact was that Rockmore (supra) had established the principle that the kind of operation conducted by the appellant could be viewed as a “business” and that Cadboro Bay (supra) had determined that the “quantum” of such business was not itself relevant in deciding whether the business was or was not “active”.

Counsel for the respondent listed as support for the Minister’s disallowance the following:

Lois Hollinger v MNR, [1972] CTC 592; 73 DTC 5003; [1974] CTC 693; 74 DTC 6604:

Joseph M Weintraub v The Queen, [1975] CTC 112; 75 DTC 5050;

Henry Wertman v MNR, [1964] CTC 252: 64 DTC 5158:

Harry Walsh and Archie Robert Micay v MNR, [1965] CTC 478; 65 DTC 5293;

Her Majesty The Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156;

MRT Investments Ltd, E S G Holdings Ltd and Rockmore Investments Ltd v Her Majesty The Queen, [1975] CTC 354; 75 DTC 5224; [1976] CTC 294: 76 DTC 6158;

Clevite Development Ltd v MNR, [1961] CTC 147; 61 DTC 1093;

Tootal Broadhurst Lee Co, Ltd v Inland Revenue Commissioners, [1949] All ER 261;

Spence Building Limited v MNR, [1977] CTC 2104; 77 DTC 71;

Baramy Investments Ltd v MNR, [1977] CTC 2558; 77 DTC 400.

The basic argument of counsel was that the appellant had not demonstrated a degree of activity in the financial operation of the corporation to characterize it as an "active business”. Counsel did not view the judgment in Cadboro Bay (supra) as definitive in recognizing only two types of income—from “business” or “property”, but asserted that, considered in conjunction with the Rockmore decision (supra), income such as that demonstrated in this case should be more appropriately classified as from a "passive business” operation, and therefore not qualified for the deduction sought. Alternatively, it was still open to the Board to find that only a portion of the appellant’s income arose from active business, while the other portion was from passive business (ie investment income earned with little or no commercial or industrial supervision or management).

Findings

In writing this decision I have provided little in the way of financial or statistical detail since in my view it would be of only limited use in reviewing the question at hand. To me, that question is—was there any degree of the appellant’s operation conducted in a manner consistent with earning income from a business as contrasted with earning income from a property? A review of the case history supplied by both counsel for the appellant and counsel for the respondent does not lead me beyond the conclusion reached in Spence Building Limited (supra) at pages 76 and 2111 respectively:

According to the judgments in the cases I have cited in this decision, it is an examination of the “activity” or “activities” of the operation in question which forms the basis for determining whether the income of a corporation should be identified as from a “business” or a “property”. The review in this case of the various possible factors and characteristics in such “activity” or “activities” has provided little enlightenment on how any “corporate business income” (once having been identified as such) might be regarded as from other than an “active” business. The Chief Justice in the judgment in the Rockmore Investment Ltd case demurred from giving any general conclusion on how the concept of “active” business is to be applied. The Board’s determination that the income in question in this appeal is from “property” and not from “business” leaves it unnecessary to pursue the matter of the “active” identification any further.

In my view, the judgment of Gibson, J in Cadboro Bay (supra) confirms the above position and is binding on the Tax Review Board, to the extent indicated therein at pages 5123 and 199 respectively:

Accordingly, implementing this principle it must be assumed judicially in interpreting the meaning of section 125 and its relationship with section 129 and with the whole scheme of the Income Tax Act, that any quantum of business activity that gives rise to income in a taxation year for a private corporation in Canada is sufficient to make mandatory the characterization of such income as income from an “active business carried on in Canada’.

I am satisfied that at least some of the functions carried on by or on behalf of the appellant company demonstrate a measure of activity greater than that normally required of or intended by an investor (particularly one dealing in long-term securities) whose only involvement after acquisition of the properties would be to clip interest coupons, receive dividends or interest payments, and collect rentals. The Company engaged in reviewing alternate uses for its funds—loans, real estate, mortgages or company shares; reviewing applications for funds and inspecting properties involved where either mortgages or percentage purchases of rental commercial real estate was involved; liquidating certain types of investments from time to time and reinvesting in other forms of security; dealing with, consulting and being consulted by brokers seeking to find investment capital; and held a seat with other percentage investors on a “management committee’’ which, however distant from the day-to-day operations of the rental properties, nevertheless took a continuing interest in the security and good administration of the total investment.

Counsel for the respondent expressed the view that to follow the proposal of the appellant eventually would lead to all corporate income qualifying as from “business’’ and none from “property”. I do not read that in the decisions rendered to this point in time. There is nothing to date which I would interpret to mean that the activity of simply acquiring a property (whether security, real estate or other) and subsequently servicing it to ensure protection, stability and continuation of return on the investment, should endow the income with characteristics as those of business rather than property. When the activity extends beyond such servicing (primarily the receipt of dividends, interest or rentals, and the operation and administration directly connected with such receipt of income) a case may be made as in Rockmore Investments (supra), that there are commercial as well as investment aspects to be considered. While recognizing the lack of specific criteria, in my view the evidence in the present case shows substantial and sustained commercial effect directed toward the enhancement of the Company’s investment income and its income base, beyond any minimum requirements associated with earning income from property.

Turning now to the alternative proposal of counsel for the respondent, the Board recognizes that indeed there might be varying degrees to which the several functions of the appellant in this decision indicate “business” rather than “property” income. The apportionment of the diversified interests of the appellant—real estate, mortgages, company shares, investment certificates, etc—between these two (business or property) does not appear to me to be a responsibility within the functions assigned to this Board. In my view, to whatever degree it may be a valid approach, that is a matter for reassessment rather than appeal review. The appellant has met the onus of discounting the respondent’s claim “that the appellant’s income was income derived from property; in the alternative, if it was income from business, it was not income from an active business”. The appellant’s income under review is not from property, it is from a business, using property as the business assets—both for operating and inventory purposes. To whatever degree significant, it is also an active business.

Decision

The appeals are allowed and the matter referred back to the respondent for reassessment accordingly.

Appeal allowed.