Newton Ready-Mix Ltd. v. MNR, 89 DTC 595, [1989] 2 CTC 2369 (TCC)

Sarchuk, T.C.J.:— The appeals of Newton Ready-Mix Ltd. are from reassessments of income tax for its 1984 and 1985 taxation years. In filing its returns for those years the appellant included interest income in the amounts of $39,108 and $41,156, which amounts it reported as income from an active business carried on in Canada, and claimed the small business deduction pursuant to the provisions of subsection 125(1) of the Income Tax Act (the Act).

In reassessing, the respondent reduced the appellant's active business income available for the small business deduction by removing interest income earned in the amounts of $27,846.75 and $36,911.16 respectively from its other active business income and treating it as Canadian investment income for the purposes of paragraph 129(4)(a). In so doing the respondent assumed that the interest income had its source in surplus funds invested in term deposits, which funds were generated by the appellant's business activities in the manufacturing of concrete. These, according to the respond ent, were funds in excess of the appellant's day-to-day financial requirements and accordingly the interest income on the term deposits was income from a property as it was not incident to or pertaining to the active business carried on by the appellant.

The appellant was incorporated in or about 1969. Its shares were held by Delehay Holdings Ltd. (Holdings). Until his death in August 1985 Mr. Bruce Delehay was the sole shareholder of Holdings, following which his widow Joan Delehay became the sole shareholder. At all times the appellant has been in the business of manufacturing or processing concrete in a batch plant and delivering it to its customers. During the years in issue its concrete product was supplied almost exclusively to the residential market in the Surrey, Langley and Whiterock areas. This market included new home construction as well as renovations, the construction of driveways, patios and basement floors.

Holdings was also the controlling shareholder in Choiceland Developments Ltd. (Choiceland), a concrete pumping company. If the appellant's trucks could not get into a job site or could not reach the form or slab to be poured Choiceland would supply a concrete pumper to pump from the truck to the job site.

Evidence was adduced from Mrs. Joan Delehay and from her son, Mr. Joseph Bruce Delehay (Joseph). According to both, the operations of the appellant and of Choiceland had been for the most part managed and controlled by the late Mr. Bruce Delehay. Mrs. Joan Delehay testified that in later years she became more involved, coming into the office, helping her husband by making bank deposits, attending to the investment of the surplus funds and in her words being available to "go for this” and "go for that". For his part, Joseph began working weekends while still at school. In 1978 he was running the ready-mix plant and by 1982 he was dispatching the trucks and attending to some of the day-to-day operations of the appellant and of Choiceland.

From 1982 to 1987 the appellant owned seven ready-mix trucks, various pick-up trucks, two front-end loaders and a batch plant. The batch plant was described as a steel structure that holds sand and gravel, being basically the raw materials needed to produce ready-mix concrete. The appellant's plant was a 1956 model which by 1979 required a great deal of ongoing maintenance. Joseph recalled that in this period of time he had a number of conversations with his father with regard to updating the plant. They considered whether it warranted rebuilding or whether the appellant would be better served by acquiring a new plant. In 1981 or 1982 after looking at various options they decided to continue with their maintenance program. Joseph also referred to a company policy pertaining to the acquisition and disposition of moving equipment. It was his recollection that as a general rule the appellant purchased two trucks a year and disposed of the two oldest ones, at all times maintaining a seven truck fleet. In 1981 the appellant purchased two new mixers and disposed of two and also purchased a semitrailer mixer. In 1982 the same pattern was carried out. According to Joseph in 1983 and 1984 the appellant suspended this practice because of the recession in British Columbia which saw the volume of concrete sold by the appellant declining significantly.

By late 1985 and 1986 the market began to pick up as a result of which the appellant considered recommencing its acquisition policy. Joseph produced a schedule of items which he described as "sort of a forecast of money to be spent". While he did not recall the specific date when he drafted it, other than it was in 1986, he stated that it constituted the appellant's plans with respect to the acquisition of capital assets in the reasonably foreseeable future amounting to some $580,000. Joseph testified that all items listed on that document were in fact acquired with the exception of a new weigh batcher and loader and a new office. Furthermore, the appellant again considered the replacement of its batch plant in order that it could be computer controlled. Some oral estimates were obtained from which the appellant determined that the cost was excessive. This decision was followed by the expenditure of some funds in 1987 to expand and modify the existing plant.

Joseph had not been involved in the accounting or banking aspects of the business to any extent. Accordingly, the evidence with respect to the term deposits came principally from Mrs. Joan Delehay. In 1978 her husband bought out his partners and at some point of time thereafter Mrs. Delehay began to assist her husband in the management of the cash and term deposits. On occasion they would discuss the affairs of the appellant in general terms. Following her husband's death her role appears to have been unchanged although she now was both a director and shareholder of the appellant. She said:

I let Joe (her son) handle all the business and management affairs of the company. I just was there. I decided to help him if he needed advice, which I gave him advice, and at the time that's what I was there for, just for, to be there.

It was her recollection that from 1978 the appellant never kept more in its current account than it required to cover expenses. She described her practice as:

Well, the profits, any extra money in our current account from our receivables, of course, would be bumped up into term deposits. Never kept too much money in our current account, just to cover our expenses, being the monthly expenses of running the business, paying our suppliers, payables and wages.

Although she professed to be actively involved in this aspect of the appellant's business, other than for the taxation years in question, she was not able to tell the Court what the status of the term deposits was at any particular time. More specifically she was not able to advise the Court on the status of the term deposits held by the corporation at the time of the purchase of the items listed on Exhibit A-5 in 1987 or immediately thereafter.

The evidence of both witnesses was that at all times the surplus funds were deposited in term deposits for the express purpose of acquiring capital assets for the appellant, and that it was required for that purpose.

An analysis of the term deposits for the taxation years in issue prepared by officers of Revenue Canada and filed as part of Exhibit A-11 discloses that the deposit stood at $250,000 as at July 1983. In December 1983 there were two term deposits, in the amounts of $257,543, and $50,000. In August 1984 the deposits amounted to $400,000 and in February 1985 to $409,516. In March 1985 it was substantially lower, having been reduced to $222,782. Finally the appellant's balance sheet as at June 30, 1985 shows cash and term deposits as of that date totalling $285,493.

With respect to the decrease in the amount held in term deposit in 1985, Mrs. Joan Delehay testified that she and her husband had, since 1962, lived on a farm where her husband raised registered Hereford cattle. In February 1985, they purchased a farm and "we needed funds so we used Newton Ready-Mix funds for the purchase. . .". Subsequently, after her husband's death, and acting on the advice of her accountants, the farm was sold by the appellant to Mrs. Joan Delehay. The nature of the transaction is somewhat unclear, however it is fair to say that the repayment of the moneys advanced by the appellant did not long remain in the appellant's hands, nor was it reinvested in term deposits. According to Mrs. Joan Delehay:

It was done on paper through my accountant. . .I'm trying to recall, but my accountant and my banker, all of us together went down to the bank and did the procedure of writing the cheques from my personal into Newton Ready-Mix, and then I believe it went from Newton up to Delehay Holdings. I'm not sure about that. l’d have to ask my accountant that.

The sole issue for determination in this appeal is whether interest income of $27,846.75 and $39,911.16 in the 1984 and 1985 taxation years, respectively, was earned on property which was incident or pertained to an active business carried on by the appellant within the meaning of paragraph 129(4.1)(b) of the Act so as to constitute active business earned by the appellant in those years. As counsel for the appellant noted the question is not whether the income was incident to or pertained to the active business but rather whether the property from which the income was earned was incident to or pertained to the active business carried on by the appellant. Subsection 129(4.1) of the Act provides:

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 property includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada but does not include income or loss

(a) from any other business,

(b) from any property that is incident to or pertains to an active business or a non-qualifying 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 or a non-qualifying business carried on by it.

Counsel for the appellant submitted that property pertains to or is incident to an active business when it has relation to the conduct of an active business. In other words if the property is of a kind such that it would not, on a reasonable view of the matter, be retained by the company but for the ongoing conduct of the active business, it is property which has relation to and is therefore incident to or pertains to an active business. Counsel succinctly notes that the question of whether the necessary relationship or nexus exists is one of fact, and that the Court's task is to identify the point at which the relationship is so removed as to be non-existent. Phrased in another way, is the property to be regarded as committed to the conduct of the business (The Queen v. Brown Boveri Howden, Inc., [1983] C.T.C. 301, 303; 83 D.T.C. 5319, cited in Atlas Industries Ltd. v. M.N.R., [1986] 2 C.T.C. 2392, 2401; 86 D.T.C. 1756)?

Mr. Pitfield contends that the evidence supports a finding that the property, being a portion of all term deposits, was required in connection with the conduct of an active business and was related to sustaining the business. There was a real expectation that the funds would be required and indeed they were so required and committed to use in the acquisition of capital for the business on a timely basis, having regard for commercial and economic conditions. He referred to the testimony of Joseph and Mrs. Joan Delahay which he said established that:

— the appellant had a history of replacing capital equipment at significant cost annually prior to 1983;

— the appellant suspended the replacement practice because of the recession in British Columbia which saw the volumes of concrete sold decline significantly from 1982 to 1985;

— the appellant spared expense and capital cost in respect of both vehicles and the batch plant during the recession knowing that when the cycle improved costs would have to be incurred in respect of each as additions or replacements;

— in 1987 when the business cycle was improving the appellant committed ap- proximatedly $500,000.00 to the acquisition of equipment which, but for the recession, would have been acquired at an earlier date;

— at the time when the commitments to the expenditures had been made, the assets of the appellant were sold and any unpaid purchase obligations were assumed by the purchaser;

Counsel for the appellant also submitted that the cases of The Queen v. Marsh & McLennan, Ltd., [1983] C.T.C. 231; 83 D.T.C. 5180; [1984] 1 F.C. 609, The Queen v. Ensite Ltd., [1983] C.T.C. 296; 83 D.T.C. 5315; [1986] 2 S.C.R. 509; [1986] 2 C.T.C. 459; 86 D.T.C. 6521; Supreme Theatres Ltd. v. The Queen, [1981] C.T.C. 190; 81 D.T.C. 5136, and The Queen v. Brown Boveri Howden, Inc., supra, are of little or no assistance in the determination of the question in issue. Each of the cases cited involved taxation years to which paragraph 129(4.1)(b) had no application as it had not been enacted.

He further argued and I quote directly:

The principles of statutory interpretation require that legislative enactments be read in such a manner that the full provisions thereof be given force and effect. There is a distinct parallel and no substantive difference between the words:

. . . property used or held by the corporation in the year in the course of carrying on a business . . .

as they appeared in subparagraph 129(4)(a)(ii) of the Act applicable before 1979, and the words:

. . .property used or held principally for the purpose of gaining or producing income from an active business carried on by it . . .

as they appeared in paragraph 129(4.1 )(c) enacted in 1979 at which time former paragraph 129(4)(a)(ii) was amended.

It is reasonable to conclude therefore that the words:

. . . property that is incident to or pertained to an active business carried on by it. . .

as enacted by paragraph 129(4.1)(b) in 1979 are broader in their scope and extent than those in paragraph (c) and encompass more kinds of property than might be contemplated by paragraph 129(4.1)(c). It follows that the kinds of property which may yield active business income after 1979 are more extensive than was the case in the years prior to 1979 as a result of which the cases cited in paragraph 3 hereof are of little assistance.

In this context, counsel for the respondent submitted that:

It does not necessarily follow from the amendments made, as suggested by counsel for the appellant, that more types of income are encompassed in the postamendment section 129(4.1) than were contemplated prior to 1979. Parliament redefined its terms, but what is abundantly clear is that Parliament intended to preserve a distinction between active business income and other sources of income.

I agree. In McCutcheon Farms Ltd. v. M.N.R., [1988] 1 C.T.C. 2349; 88 D.T.C. 1208 this Court held that sections 125 and 129 of the Income Tax Act as amended do not derogate from or alter the basic intention of Parliament to distinguish between active business income and income from property. Thus the test employed in Ensite Limited v. The Queen, [1986] 2 S.C.R. 509; [1986] 2 C.T.C. 459; 86 D.T.C. 6521 at 6524 et seq. is applicable. In McCutcheon Farms Ltd., supra, the appellant company carried on a business of farming and of processing and selling seed and chemicals. The company invested surplus earnings in term deposits. The principal was never withdrawn or encroached upon. The interest earned was automatically credited to the company’s current account as it became due. In McCutcheon supra the appeal failed because the term deposits were not "employed or risked" in the farm business. The term deposits were "surplus and collateral" to the active business, even though some of the interest was credited to the company's current account.

The respondent's submission is that the business operations of the appellant did not rely on the term deposits. Further, the evidence does not indicate that they existed as a back-up asset to be called upon in support of the appellant's business operations. In fact, during the taxation years in issue, the only recourse had to the term deposits was when Mr. and Mrs. Delehay used them to purchase a farm property for their own use.

I am satisfied that the respondent's assessment is correct. Section 125 of the Income Tax Act allows a Canadian controlled private corporation with income from an active business to obtain a deduction from the tax otherwise payable under Part I of the Act. The effect is to tax the active business income of small businesses at a rate lower than the normal corporate rate. The amount of the deduction depends upon the corporation's active business income. In calculating this deduction, Canadian investment income is excluded. By definition “income from any property that is incident to or pertains to an active business” is not Canadian investment income. On the evidence before me it is clear that the active business of the appellant was concrete production. Funds that were surplus to the day-to-day requirement of its concrete business were invested by the appellant in interest bearing term deposits. In essence the appellant's position was that these surplus funds, deposited into term deposits, were being maintained for capital expenditures.

Useful reference can be made to the decision in Atlas Industries Ltd. v. M.N.R., supra. In that case the appellant company was engaged in custom fabrication of sheet metal, production of ventilating equipment and roofing. The company invested its surplus funds in term deposits which generated interest income. Notwithstanding that the facts in Atlas Industries Ltd., supra are somewhat distinguishable the comments of the Court in finding that the interest income was Canadian investment income are both relevant and useful. His Honour Associate Chief Judge Christie said at page 2404:

The starting point I think must be that where a corporation is carrying on an active business and it has income from a source in Canada that is a property, that property is not necessarily to be regarded as being incident to or pertaining to the business. If that was intended, presumably Parliament would have said so.

His Honour continued:

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).

I am not satisfied that the evidence adduced establishes a financial relationship of dependence of some substance between the term deposits and the active business carried on by the appellant or that the appellant relied on the term deposits as an integral aspect of its business operations. Their testimony as to when the capital acquisition policy, of which they spoke in general terms, actually commenced was quite imprecise. There is no cogent evidence as to the amount of cash reserves required on an ongoing basis, e.g. for truck replacement. Joseph could not describe the capital replacement policy which is alleged to have been in place between 1975 and 1981, if indeed one existed. Furthermore, other than replacement of trucks, no other capital items appear to have been purchased prior to 1987.

Both witnesses referred to the 1987 acquisitions and emphasized that they were a continuation of the policy implemented many years before and flowed directly from a conscious decision made in 1986 at which time these acquisitions were discussed, considered and itemized. With respect I do not believe that the document relied upon was prepared in 1986 nor that it was prepared at any point of time prior to the known dates of acquisition in 1987 of the trucks, the mixers and the pump truck, being the first three items, listed therein. This is an after-the-fact document. It bears the notation “Invoices for items A to H are available" and it reflects in a number of instances the exact cost of the equipment. Neither the invoices nor the precise cost could have been available to the appellant in 1986.

Several other facts should be noted with respect to the appellant's contention that these funds were required for its future business needs. The pump truck, acquired at a cost of $60,757, although ostensibly purchased for the appellant, was found on cross-examination, to have been transferred to and used exclusively by Choiceland Developments Ltd. There is also some question whether the expenditures incurred in 1987 were paid for in full as is suggested by some of the evidence, or whether certain unpaid purchase obligations remained, which were assumed by the purchaser of the appellant's assets in 1988. It is also fair to conclude that an argument of a dependent financial relationship of some substance between the property and the active business was seriously jeopardized by the use of some $230,000 of the term deposits for the purpose of purchasing the farm property.

I am satisfied that the respondent's assessment in this instance was correct and accordingly the appeals are dismissed.

Appeals dismissed.